18 July 2014

There will be a price to pay for QE


The explosion of “money-printing” since the financial crisis is a dangerous delusion which has stored up trouble for the future, says Liam Halligan, writing for CapX. 

A Western central banker is ordering a pizza over the telephone. “Should I cut your pizza cut into six slices or eight slices, sir?” asks the youthful restaurant staffer. The central banker pauses and scratches his chin. “Hmmm, now let me see,” he says slowly, weighing every word. “I’m feeling hungry tonight … so cut my pizza into eight slices, please”. The central banker then pauses again, asks for a moment and gives his final instruction. “Actually, I really am quite famished. Could you slice it into ten?”


Economics rarely translates into side-splitting comedy. But the little turn above, an attempt to capture the nonsensical essence of quantitative easing, may provoke a wry smile.

There is no “free lunch”. To eat more, you must commit more resources – in this case flour, cheese, tomato paste and all the rest of it – and actually make a bigger pizza. Economists used to understand this, but apparently no longer. John Maynard Keynes certainly understood. “To think output and income can be raised by increasing the quantity of money,” he wrote in an open letter to Franklin Delaney Roosevelt in 1933, “is like trying to get fat by buying a larger belt”.

The notion you can create sustainable wealth by printing money – or, in its modern guise, by creating virtual financial balances ex nihilo – is deluded and dangerous. From Revolutionary France to Weimar Germany, from 1970s Latin America to Mugabe’s Zimbabwe, large-scale money printing has always ended in tears. Even back in the Third Century AD, a succession of hapless Roman Emperors sparked riots, and their own undoing, after using less gold and silver in their coinage.

QE on the scale we’ve seen since the Lehman collapse of 2008 would have been anathema to Keynes. “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency,” he wrote in Economic Consequences of the Peace, his 1919 masterpiece. “The process engages all the hidden forces of economic law on the side of destruction, in a manner which not one man in a million is able to diagnose”.

Five years ago, during the financial crisis, few mainstream economists dared publicly to question QE. No matter that unashamed base money creation crossed a line in the sand. And so what if central banks then used conjured-up funds to buy billions of dollars of toxic bank assets and swathes of government debt, denying the line in the sand ever existed.

More than “one man in a million” understood what was happening and yet almost all dismal scientists stayed silent. Lehman Brothers had collapsed. Financial markets were tanking. Politicians (and police chiefs) were scared. As such, it didn’t take much for the too-big-to-fail banks to win the debate that “extraordinary measures” were needed – and fast. Not least, as no debate ever happened.

When British QE began in March 2009, it was billed as a £50bn exercise. Its American equivalent, which had started five months earlier, was supposed to amount to $600bn. Eurozone policy bosses, then dismissing sub-prime as “an Anglo-Saxon problem”, declared the European Central Bank didn’t need to use expansionary monetary policy in response to “America’s credit crunch”.

Since then, of course, the Western world’s virtual printing presses have been running like billy-o. The US has conducted $3,500bn of QE over the last half decade, some 6-times more than advertised, as the Federal Reserve has more than quadrupled its balance sheet. The Bank of England has similarly increased base money four-fold and, with UK money-printing focused on gilt purchases, now holds over a third of all outstanding government bonds.

The ECB, while hiding its money-printing antics behind a myriad of technicalities to placate German voters, has more than doubled the eurozone’s base money supply since 2010. Bond yields have fallen on the Eurozone periphery not because of genuine fiscal consolidation, or because the single currency has suddenly become a coherent construct, but because ECB supremo Mario Draghi keeps dropping hints of more state-sponsored circular bond-buying to come.

This massive monetary expansion and unprecedented self-financing of government debt has happened without a single law being passed, barely any Parliamentary or Congressional debate and precious little mainstream media scrutiny. This, despite QE’s visible and rather nasty side effects.

QE hasn’t unlocked frozen inter-bank markets, as governments intended, or stimulated lending to creditworthy firms and households, as the bailed-out banks had promised. Instead, while some of the QE money has sat on the balance sheets of busted financial institutions pretending to be solvent, much of the rest has found its way into asset markets.

From early 2010, as oil prices closed back in on $100 a barrel, it became obvious that sophisticated investors, alarmed at the scale of the West’s “extraordinary measures”, were using crude as an anti-debasement hedge. So QE became a self-defeating stimulus, with the big money-printers, oil importers all, suffering as a result of dearer crude.

The funny money pushed up soft commodities too, combining with poor harvests to create the mid-2010 food price spike that, in turn, sparked the Arab Spring. So Western central bank policies boosted both oil and food prices, with dearer food in turn unleashing social unrest across the Middle East, putting further upward price pressure on oil.

In late 2010, another QE side effect loomed into view as Brazilian Finance Minister Guido Mantega accused the West of “currency wars”. Mantega rightly insisted that QE was designed to drive down the dollar, pound and euro against the large emerging market currencies, “stealing competitive advantage” from the rest of the world, while lowering the value of “hard currency” debts owed by the West.

The emerging markets are now fighting back – in the form of tariffs, export subsidies and other trade barriers. And so, protectionism grows – a major reason global trade is now expanding by just 1.3pc year-on-year, with volumes weaker only during the fully-blown financial crises of 2000/1 and 2008/9.

The bad blood QE has created between opposing trade diplomats, and the governments behind them, has wrecked the Doha “round” of trade negotiations. We’re now witnessing the first outright failure of a multilateral trade negotiation since the 1930s. QE-hungry investment banks don’t care. Neither do government ministers determined to sell their central banks ever more debt so they can keep on spending. But be in no doubt – the West’s outrageous monetary policy is generating deep resentment among the ruling and commercial classes of populous and fast-growing nations whose markets the West will increasingly need to access to secure our future prosperity.

Since early 2009, US stock indices have gained upwards of 200%. Last year they rose by a third. Western share prices have ballooned against a background of a deeply unimpressive economic recovery and slow profit growth. Now we see an ominous combination of high valuations and low trading volumes – classic crash territory.

Stocks may remain resilient. The QE unwind may be smooth. But I doubt it. And once the Western banks start lending again, the velocity of circulation (currently at historic lows across the big Western economies) will rise. All that QE money, created from nothing, will eventually send broad monetary measures into orbit. Strong inflationary pressures are inevitable.

Years of QE, and related rock-bottom interest rates, have warped stock markets, generated geopolitical palpitations and hammered domestic savers. The flip side of savers’ low interest-rate pain is, of course, a massive wealth transfer to the bailed-out banks. The masses have had to watch the financiers, having trashed our economy, get rich at everyone else’s expense all over again. That tears at the social fabric.

Some QE was needed in the early days of this crisis – to prevent widespread bank failure and fend-off social unrest. But a necessary emergency measure, so convenient to bankers and myopic politicians, has become a debilitating lifestyle choice. No-one knows, meanwhile, how this unprecedented monetary experiment will end.


Two central bankers are climbing a mountain. Suddenly, the fog comes down and they lose their bearings. They keep climbing, moving further from safety. Eventually, after hours of panic and struggle, they climb above the fog-line.

Exhausted, our two central bankers survey the scene before them. The most senior studies the map.

He jumps up, and points to a peak, miles in the distance, upon which the sun is shining. Smiling at his desperate colleague, he says: “Don’t worry, it’s fine. We’re over there …”

Liam Halligan is a columnist for The Sunday Telegraph