Like the proverbial Pied Piper, the coronavirus pandemic has escorted all global economies into their most turbulent era of existence. The Pied Piper walked into the German village of Hamelin as a stranger and managed to amass a massive following, only for the followers to subsequently fall into a trap from which they never really recovered.
A similar stance can be taken for the Fed Chairman, Jerome Powell, and the central banks all around the world, as they continue to bolster investor confidence by printing out an excessive amount of the world’s “reserve currency”.
As governments have rolled out financial aid during the debilitating epidemic, perhaps a big question needs to be answered: “Is there a way to ensure that the benefits of all the government spending ultimately go to local economies rather than financial and corporate elites?”
Deflation and secular stagnation are the absolute risks of our debilitating times. Forceful quantitative easiness (QE) and forceful structural reforms, including currency adjustment, are what is needed, to keep economies afloat.
Every time the Fed in the United States implements “quantitative easing,” aka printing more money, in a modern and developed economy, two things go up: Taxes and inflation.
Obviously, when taxes and inflation go up, more jobs are lost.
I have reasons to suspect that a lot of people don’t realize that the money to finance the recovery is actually being created out of, say, thin air by the central banks in the US, Canada, and even the Bank of England in the UK. The same practice is adopted in Bangladesh, Pakistan, India, and every other country that has the liberty to “manufacture” their own currency.
This is because a government that issues its own currency will never have the need to borrow its own currency!
For example, India has its own sovereign currency. In order to enable major cities like Mumbai or Delhi to spend more, the Reserve Bank of India manipulates the numbers on its computer screen and increases the quantity of ‘Indian Rupees’ in its bank account, once Mumbai or Delhi asks for authorization of such payments.
Being an issuer of a sovereign currency goes hand in hand with slumberous nights as one never has to worry about how they are going to pay their bills.
Theoretically, the Indian government can afford everything being sold in its own currency. Although inflationary pressures are a concern, they will never need to borrow the Rupee. That’s QE again!
When nations are faced with currency wars, one of the easier ways to stimulate the economy is to weaken the national currency. And, there are established ways of achieving this.
Money from thin air?
The central banks use this ‘new money’ to stimulate the economy by purchasing government bonds, either directly from the government or from financial corporations that already own government bonds.
This is what we know as quantitative easing (QE), and it is something US, European, and Japanese central banks have been doing for more than a decade. But previously there had been a mandate on reserve requirements.
Similar to the gold standard, where each dollar had been backed by a certain ounce of gold, the numbers being entered on the FED’s computer screens also had a certain reserve requirement. But in March 2020, the Federal Reserve has scrapped this mandate, which implies that the ‘new money supply’ is backed by ‘nothing but faith’.
For those who protest that money can’t be created out of thin air, I’d like to ask: Why not? Because that is exactly what commercial banks do!
If you go into a bank in the US and ask for a $100,000 mortgage loan, the bank simply creates journal entries on its computers for the $100,000. This money didn’t exist until you were keen enough to apply for the loan. Or as Ray Dalio puts it, “ credit has been created out of thin air”.
They may say that an equivalent amount has been kept with the central bank as a reserve requirement, but is there a way to verify this especially if you are an average Joe?
Any two people can create credit, and credit is what keeps the economy afloat. Institutions have a way of bailing out but most borrowers do not.
Not surprisingly, the Bank of Canada also has a history of creating money out of thin air. After its establishment as a crown corporation in 1938, the Bank of Canada (BoC) used money creation to buy treasury bills.
In essence, the Canadian government, through the sale of these bills to the BoC, was borrowing money from itself. The borrowed money was used to fund public initiatives, like the Trans-Canada Highway, Universities like my alma mater The University of Toronto, the airports, etc. Not to mention other facilities like universal Medicare and Old Age Security.
Every single establishment post-confederation within each of Canada’s provinces is somehow or another a result of this procedure.
In the year 1974, Canada largely abandoned its successful experiment in self-funding and began borrowing from the private sector. Result: Over the next 40 years, Canada paid a cumulative amount of $1.17 trillion in interest to private-sector financial institutions.
The ongoing pandemic experiment with quantitative easing has the potential to lead us back to the original mandate of the Bank of Canada. However, everything depends on what the BoC does with the money it is now creating.
Quantitative easing can take two forms. The BoC can purchase newly issued government bonds directly from the government, as was done 50 years ago. The government then spends this money on the economy.
Alternatively, the BoC can plow money into the economy by buying the bonds from financial institutions that already own government bonds. In this case, the government will enjoy no control over how the money will be spent.
Theoretically, these institutions will use the money they receive from selling their bonds to provide needed loans to the business community.
There is substantial evidence, however, that the principal beneficiaries of this form of QE are large asset managers, hedge funds, wealthy property owners, and the banks themselves.
Local economies have not benefited. Today, the Bank of Canada currently seems to favor the latter approach.
The BoC’s weekly $5 billion bond purchases over the next 12 months will be from the private sector. When this is practiced, Big Finance is, no doubt, pleased.
What we really need to have is a quantitative easing strategy for the people — one where the Bank of Canada returns to its original mandate and finances the government through directly purchasing its bonds.
The next question remains: Where will all this lead us to?
Canada’s administrative provinces and municipalities could have regular access to low-interest loans from the federal government. The power of money creation could be mobilized for building needed infrastructure, addressing environmental challenges, strengthening local economies, and promoting full employment.
Are there any legislators in Canada pushing for this? At this time of crisis, the need to do so is certainly there.
Where does this lead us to?
Very simply put excessive QE will only lead to a loss in purchasing power. The idea is that one would have to pay a larger sum of money to acquire the same product in the future as opposed to now.
The phenomenon implies it as is a measurement of prices in different countries using the prices of specific goods in others to compare the absolute purchasing power of the countries’ currencies.
But even if a loss of purchasing power isn’t a primary concern central banks will keep on printing more and more paper currency, simply because it technically helps the IRS and the big banks to stay afloat.
The cost to print a “$10” bill is roughly “$0.03” or 3 cents. This leaves $9.97 on the table of central banks which is accounted for as profits within the Internal Revenue Service’s book of accounts. This profit is known as ‘seigniorage”.
The money is then supplied by the FED to major banks in exchange for government bonds or other collateral through QE, depending on whether the FED plans to expand the economy or contract it. This money is also used to boost liquidity in the stock market as we have seen recently in addition to supporting large corporations with regards to working capital.
Photo by CNN
Back to the basics
Quantitative easing is an unconventional monetary policy tool used after conventional tools have become ineffective. The unconventional tool had helped get the US out of the Great Recession, but 2019 is not 2008, and there are many who believe QE is no longer a magic elixir.
That didn’t include the now former President Donald J. Trump, who has repeatedly called on by the Fed to lower interest rates, including in the spring, when he also pushed for the Fed to employ quantitative easing in order to give the economy and stock market a boost.
In a tweet made on April 5th, he stated the following: “You would see a rocket ship.”
And that was after the first-quarter GDP growth of 3.1%. In comparison to a GDP parameter of 1.9% towards the second half as the economy plunged 32.9%, and more than 32 million Americans had filed for unemployment it compelled him to return to the topic of lower rates again, calling out Fed chief Jerome Powell for not keeping pace with other countries in lowering their key rates.
There was a time when quantitative easing by the Federal Reserve was like the cavalry riding in to save the day. Then-Fed chief Ben Bernanke, a student of the Great Depression, utilized the approach to add liquidity and reserves to the financial system when it looked like the banking industry was on the verge of collapse in 2008.
The Fed bought specified amounts of financial assets, which happened to be mortgage-backed securities back then, thus raising the prices of those financial assets and lowering their yields.
Specifically, the Fed bought mortgage-backed securities at a time when many institutions wouldn’t dare touch them, as well as treasury notes and bonds.
Collectively, these actions made sure that financial institutions wouldn’t be left with worthless debt instruments (like some of the MBSs).
It pushed down interest rates across the board with such large (quantitative) actions, making borrowing cheaper for consumers and businesses alike (that’s the “easing” part). The idea is that individuals and corporations could borrow money cheaply for a long time, stimulating the economy.
By 2014, following three rounds of QE, the Fed’s balance sheet was approaching $4.5 trillion, compared to a pre-financial crisis balance sheet in 2006 of less than $900 billion.
The approach had worked. But how do you undo quantitative easing? By shrinking the Fed’s balance sheet.
In 2017, under the guidance of Chair Janet Yellin, the US Fed had started to “normalize” its balance sheet by not reinvesting the proceeds (money) when the debt securities matured.
Without the Fed as a customer in the financial markets, issuers had to raise yields and lower prices to be competitive. Fortunately, the effects on interest rates have been modest because the normalization has occurred over a number of years (until a recent blip, which we’ll address in a moment).
The return to “normal” allows the Fed to use QE again in the future if conditions call for it. The debate continues over what those qualifying conditions are.
Another significant question arises: Will QE likely favor or stimulate growth?
Many on Wall Street don’t believe that another round of QE — or even continuing to lower the Fed Funds rate directly — will stimulate more growth.
Ryan Severino, the chief economist at JLL, puts it this way: “You can’t say we’re in the best economy we’ve ever seen but we need quantitative easing to improve our situation.” Severino believes that lower interest rates are not the issue with tepid economic growth.
“Investment by businesses fell in the second quarter. The things that are holding them back are policy uncertainties, including trade uncertainties, not interest rates.” And he worries that when the next recession comes, QE will be less effective. “We’d be using a lot of our monetary artillery where it won’t have a lot of impact.”
The QE argument also reared its head last month when the Fed had to infuse the financial system with cash when there was a shortage of liquidity for member banks in overnight transactions.
The momentary spike in rates, and the entry of the Fed to calm the markets down, led Chairman Powell to announce that the Fed will be buying $60 billion of short term debt each month. To a lot of people, that sounds like quantitative easing.
Nancy Davis says it’s not QE because the Fed will be buying short term, not long term, debt. “In reality, those purchases should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis.”
Another round of QE might not have much of an effect anyway. Business surveys show that CEOs are less interested in lower interest rates and more interested in a clear direction on trade policy because of how it affects the economy and business investment. “If companies become too pessimistic,” says one expert “it’ll eventually spill over into hiring and wage increases. That could affect the consumer.”
A history of failure
Quantitative easing is just the latest chapter in the Federal Reserve’s 100-year history of failure. The American people have suffered long enough under a monetary policy controlled by an unaccountable, secretive central bank. Is it the right time to finally audit — and then end — the Fed?
Several years of tepid GDP in the US growth has proved that the formula for growing the economy is not always as simple as lowering interest rates. “But if the only tool you have is a hammer,” says a CEO, wishing to remain anonymous, quoting his colleague, “then everything looks like a nail.”
QE may pass off as a monetary hammer, but today’s moderately growing economy is’nt necessarily a nail. It just appears as one to some people.
Fiscal policy is not a panacea; it must be used with monetary policy. Central banks, businesses, and politicians must rally cooperatively to create growth.
Long before citizens had fretted the demise of quantitative easing, it fretted its existence. It proved the reverse of its image, an anti-stimulus, and economies have done alright not because of it, but despite it.