Investors have long taken comfort from the hope that, should economic conditions deteriorate, central banks will ride the rescue with more bond-buying. It might ultimately prove better, however, if policymakers in my opinion did not.
With the outlook for economic growth fluctuating over the past year, the so called “central bank put”, whereby quantitative easing could be renewed or its unwinding slowed, has at times become more important to investors than fundamentals. Holders of for example Italy’s 2.2 trillion of debt have taken comfort from the possibility that the European Central Bank could step in, again, if yields blow out too far. Only recently, Mavic Draghi, ECB president, said the bank could restart QE if necessary.
US stocks and bonds, meanwhile, jumped after Jay Powell, the Federal Reserve chairman, pointed to rising risks to global growth as he put interest rate rises on hold and mentioned the bank would change its balance sheet policy if necessary. For the market, that was a welcome change to an autopilot shrinking of the balance sheet – to me it adds additional concern.
After a decade of QE and largely buoyant markets, it seems unlikely that central bankers would want to go down in history as having ended the party. Scepticism has tended to focus on whether or not central banks have enough ammunition, or whether the political will exists, for further QE.
But, longer term, all of as including investors and policymakers should be more concerned by the damaging side-effects of QE.
For starters, it can act as a distortion to the business cycle. While capitalism relies on investors differentiating between good and bad companies, QE makes no such distinction. So-called zombie companies that might otherwise have died off can continue to function thanks to low borrowing costs. Instead, it is efficient allocation that dies. Capitalism in my opinion is fast disappearing.
While QE might have averted a depression after the financial crisis, it may now be weighing on growth. In pushing up the price of assets, QE exacerbates social divides. The wealthy become even wealthier as the value of their assets increase, but those with few or no assets are robbed the chance to earn higher returns on money they save, which is the majority of our population. It is quite simple to express the cycle, “The roots of populism lie in part in QE, driving asset prices up”. And, as central bankers are finding, the longer it goes on, the harder it becomes to exit – so the question remains when to stop. “Perma-stimulus”, as shown by Japan, is a policy that in my opinion should not be undertaken.
Economic historians writing about the decade following the credit crisis might reflect not that central banks failed to act but that, in the form of QE, they did far too much.