It never does any harm to emphasise the point that so-called QE is absolutely no different from running a physical printing press, even though there are occasional commentators who try to suggest it is different. Creating money by electronically crediting a bank with previously non-existent money is no different from running a printing press and shipping the newly printed money into the bank's vault. In both cases, money is created and an asset is purchased. It is just that the former does so without the bothersome necessity of running a physical printing press. I suspect that, if the central banks were to be undertaking the old-fashioned printing press method, there would be greater outcry against the policy of QE. Trucks filled with newly printed money arriving at banks would focus minds and attention on what is taking place. As it is, the modern method of money printing is just abstract enough to obscure the reality of what is taking place.
However, it seems that commentators are now starting to see that there is something wrong with the new policy of printing our way out of troubles, and the gold standard is moving up the agenda. This from Forbes:
There is nowhere left to hide. America’s governing elites begin to internalize the magnitude of their failure to generate jobs. CBO now predicts worse than 8% unemployment until 2014. America begins to engage, seriously, with the implications of the faltering dollar and reconsider the appeal of the gold standard. From The New Yorker to The National Interest to The Washington Monthly to The Nixon Foundation, thoughts turn to gold.The linkage between returning to a gold standard and the urge to print money is obviously related. Once again, there is talk of printing money in the US, or QE3:
As Wall Street parses the message the Federal Reserve chairman sent in his speech Friday from Jackson Hole, the narrative that has taken hold includes, on one level or another, more action to help boost the markets and the economy.The UK is also flirting with another round of money printing, with this from the Guardian:
That was supported Monday with key endorsements from Fed presidents Charles Evans and Narayana Kocherlokota, who both said they either would support further monetary measures or a continuation of the ones already in place.
Whether future moves come in the form of traditional quantitative easing or something else is what Bernanke and other Fed officials must decide between now and the next Open Markets Committee meeting on Sept. 20. The expectation for easing was heightened when Bernanke said the meeting would be extended from one to two days, indicating that serious consideration would be given to additional monetary measures.
The European Central Bank (ECB) is more constrained, with an inbuilt philosophical opposition to printing money:
Hopes of a fresh round of quantitative easing in the UK increased on Thursday after Martin Weale, of the Bank of England's monetary policy committee (MPC), used a speech in Doncaster to say there is "undoubtedly scope" for the radical recession-busting policy to be extended.
Weale, who was one of two hawks advocating an increase in interest rates until he changed his vote at this month's meeting, said the Bank could restart quantitative easing if oil prices continue to fall and the sovereign debt crisis in the eurozone worsens.
Warning that events on the continent are a greater threat to the UK economy than the slowdown in America, Weale said: "There is undoubtedly scope for further asset purchases to trigger further reductions in yields on government debt should the need arise."
Notwithstanding the growing discussion of a gold standard, one of the great curiosities about QE is how it has now entered into mainstream commentary as if it were a perfectly reasonable thing to do. There are all sorts of justifications given for the policy, but the lack of any remit for central banks to undertake the policy is quietly ignored or forgotten. The most obvious case of this is the Bank of England, which is supposed to use monetary policy to target inflation. Despite several years of overshooting the inflation target, as can be seen from the earlier quote, QE is back on the agenda in the UK. How is it that the Bank of England's remit is forgotten by so many commentators?
New York professor Nouriel Roubini called on the ECB to reverse monetary tightening immediately given the darkening global picture. "It should reduce rates to zero, and make big purchases of government bonds," he said.
Frankfurt is unlikely to heed the advice. The bank's president Jean-Claude Trichet, last week stuck to his anti-inflation script and said "we do not do QE".
The ECB began buying Spanish and Italian bonds for the first time yesterday, causing 10-year yields to plunge by 90 basis points. However, an ECB statement over the weekend came with too many strings to satisfy investors. The bank is likely to be tested over coming weeks.
David Marsh, co-chairman of OMFIF, said the statement was "half-hearted" and suggested that dissenting German hawks were imposing limits. "The ECB is clearly not going in with all guns blazing," he said.
It seems that there is a growing divide in mainstream commentary on the policy of printing money, with some expressing fear about the consequence of the policy and moving back to the idea of a gold standard, and others supporting the policy as a magic bullet for the economic woes that are assailing so many economies. At the heart of the debate is the question of inflation, with those who are anti-QE arguing that it is inflationary, and those in favour suggesting that the lack of massive inflation following early QE demonstrates that the fears of inflation are exaggerated. A good explanation comes from Liam Halligan:
Liam Halligan has captured one element of the reason for the lack of inflation, and another is the exporting of inflation through the 'carry trade', as the Wall Street Journal reports:
The reality is QE has already done an awful lot of damage. America has expanded its base money supply three-fold in two and a half years – from 6pc to 18pc of national income. But even this jaw-dropping measure hasn't led to much of an expansion in monetary measures, such as M2 that include bank lending, precisely because the banks, for all the propaganda to the contrary, are still determined not to lend. They can make more money simply channelling QE money into stocks and other investments.
Crucially, the banks also remain petrified of counter-party risk in the inter-bank market. Many of them, disgracefully, are still concealing vast sub-prime losses in off-balance-sheet vehicles. So they assume other banks are doing the same. Such mistrust between the banks – "we're lying, so they must be lying" – gums up the wheels of finance and starves even creditworthy firms of the funds needed to invest and create jobs.
That's why M2 has remained flat, despite a massive expansion of base money. The way to break the deadlock, though, isn't to do more QE, but to end inter-bank torpor by forcing "full disclosure" of bank losses. Such disclosure is barely happening, on either side of the Atlantic. The UK's monetary base has also tripled, while producing – for the same non-disclosure reasons as in the US – only minimal growth in M2.
For much of the past two years global investors borrowed dollars and Japanese yen at the rock-bottom interest rates set by the U.S. Federal Reserve and the Bank of Japan and then poured that cheap money into currencies like the Australian dollar and Mexican peso to earn much higher interest rates.The problems of the carry trade for the recipients has led to reactions to try to prevent the inflows of 'cheap' money, such as Brazil establishing capital controls:
Now, those popular "carry trades," which profited from a difference in interest rates as high as 12 percentage points in Brazil's case, are starting to unwind as investors lose faith in the outlook for global growth and fret over financial turmoil. If it continues, it will bring an end to a rally in emerging market and commodity-based currencies that began shortly after the Fed slashed rates to near zero at the end of 2008 and it could drive up borrowing costs for banks, companies and even households in those countries.
That unwinding could be cut short if the Fed's announcement Tuesday that it would keep its target interest rates at "exceptionally low" levels "at least through mid-2013" makes carry trades attractive again. But the problem with the strategy is that it is only profitable if currencies are either stable or if the funding currency is falling against the investing currency. And if the past week's bout of global financial turmoil persists and puts emerging market and commodity currencies under more pressure, many investors will be forced to throw in the towel and buy back dollars.
Brazil has been vocal on one of the themes put on the table by France as G-20 chair: how to better police capital flows globally. Several emerging countries, including Brazil, have been faced with buoyant capital flows in search of higher yields, which have put upward pressure on their currencies and hurt their exports.This is what I had to say in TFR magazine in December 2009:
Countries have reacted by imposing capital controls or intervening on their currency in a unilateral way. This has prompted the G-20 to try and coordinate capital controls better, so as to avoid adverse impact on growth from disorderly moves.
What we can see in Liam Halligan's analysis and my own explanation is the reason why it is that we do not currently see massive (or hyper) inflation in the money printing economies. However, what we can also see is the potential for inflation to start a rapid upwards climb in the QE economies. The only way that the money supply might be reduced is to reverse the QE, which would mean selling the government bonds that have already been purchased and destroying the proceeds of the sale. Could markets absorb such a sale when government debt is already flooding the markets? It seems improbable.
But there is also another factor, there is increasing talk of a US dollar ‘carry trade’, as a result of dramatically increased liquidity combined with near zero interest rates.
The idea is simply that a good return on investment can be made by borrowing at a low interest rate in one country, and investing in another that has a higher interest rate. In doing so, the inflationary effects of printing money are exported to the country that is the destination for the carry trade.
This was what happened when Japan resorted to quantitative easing, with the printed money going west in the yen carry trade, acting as one of the sources of excess liquidity for the credit bubbles that burst in 2007 and 2008. There is less talk of a sterling carry trade, but it’s fair to assume that, with monetary circumstances similar to the US, something similar may be taking place there (albeit on a much smaller scale).
The interesting point here is that, as a result of the carry trade, Japan itself did not experience the inflationary effects of printing money. The case of Japan is cited as the reason why inflation will not take place in the UK and US. However, there is a fundamental difference between the UK, the US and Japan.
During the period of the carry trade, Japan was generating a large current account surplus, so the flood of yen onto the market did not result in significant currency weakness. By contrast, both the UK and US have been (and continue) to run large current account deficits. In both cases the currency is already sitting on weak foundations and, therefore, export of the dollar and sterling into the carry trade will simply put more pressure on the value of those currencies. They are flooding the market with currencies for which there is already a potential over-supply.
What we can see is a problem looming on the horizon. Output in both the UK and US has fallen (and is still falling in the UK), which means that some of the effects of the reduction in credit are already ‘eaten up’.
Furthermore, the governments of both countries are stepping in to fill the void of private credit contraction with government borrowing. If the money sitting in central banks were to enter into the economy, there would be a real increase in the money supply and this would cause rapid inflation. On the other hand, if the money exits the economy via the carry trade, it will severely weaken both nations’ currencies and re-enter the economy through the back door of import-price inflation.
At the moment, the increase in money has not entered into the real economy, but it will do at some point. I suspect that it will be through the back door of the carry trade.
For the proponents of QE, the lack of massive inflation is used as a justification for continuation of the policy. For those who are arguing for a return to gold, they can see that somehow, at some point in time, the massive expansion of the monetary base in QE countries must eventually see a rise in inflation. For the latter, they are not always clear in their understanding/explanation of why massive inflation has not taken place. However, their instinct that QE must eventually have a price is correct. Furthermore, the price is already being paid around the world as easy money has flooded into other economies. That in turn is creating distortions in markets, and those distortions will ripple back towards the countries that caused the problem in the first place. Again in TFR, this is what I had to say about 'extreme policy' in the context of the 'carry trade':
We can see this instability taking place. We see, for example, the Swiss taking ever more radical measures to try to lower the value of their currency in the face of the 'safe haven' purchases of their currency. We can see the instability in the surge in the gold price. We can see the instability in the on-off panics in markets. Every day we see more examples of the instability.
From enactment to (unpredictable) result, there is a period during which the effects of the policy build and interact with the results of other policies and the markets, both domestic and international.
It can therefore often take a long time before the full effects become apparent. As they do become apparent, the other actors respond with their own policy provision, and the effects of that policy will again take time to impact.
Among all of the major economies, the responses to the economic crisis have been extreme policy making. We are only now seeing the full impacts of those policies, and the reactions to those policies are building. The underlying problem is that, the more extreme the policy of one actor, the more likely that the response of another actor will be extreme. The world economy is a dynamic system, and the actions of each policy will, in the end, lead to a response from other actors in the world economy.
As such, when actor ‘A’ pulls on policy lever ‘X’, they really cannot see the outcome of their own actions. The larger the actor, and the more extreme the policy, the greater the chance that the reaction of other actors will also be extreme. The greater the reaction of these actors, the greater the reaction that will be forthcoming in response.
And so it continues, creating an ever more unstable system; the more the levers are pulled, and the harder that they pull on them, the greater the potential for the policy intentions to be confounded, and the greater the general instability.
One way or another, the effects of extreme policies such as QE ripple out into the global economy, only to eventually wash back in unpredictable forms. The great conceit of the policymakers is that they think that they know what they are doing. In the end, the call for a return to a gold standard is really a call for the policymakers to take their hands off the levers of monetary policy, as they do not really understand what happens when they pull on the levers.