A Quick Exit From QE

In my Money Week column, I've been arguing that central bankers need to figure out a way to stop printing money - and fast. Here's a taster.

A good rule in life is that whenever you start something, it is helpful to have a pretty firm idea of what your exit strategy is going to be. Neither Britain or the US had one in Iraq, and got bogged down in a difficult war for years longer than they planned. Now it looks as if the Federal Reserve and the Bank of England are intent upon making precisely the same mistake with their policy of quantitative easing, or what in plainer language used to be known as printing money.
They’ve started it, but there is no clear road map for getting out.
In truth QE should stand not for Quantitative Easing – but for Quick Exit.
As the policy unfolds, it is becoming increasingly clear that its main impact is going to be to stoke up another asset bubble. Central banks won’t be able to stop printing money without risking another collapse in asset prices. Even more seriously, all the asset markets now look to be largely controlled by the central banks, a dangerous situation that is hardly going to help restore healthy economic growth.
Britain, perhaps because of the scale of the problems within its banking industry, has been one of the most aggressive countries in the world when it comes to what is politely know as ‘unconventional’ monetary policy. The Bank of England has said it will pump £125 billion into the economy by printing more money. But other central banks have done the same, led by the Fed in the US. Even the conservative European Central Bank has joined the party.
It remains to be seen how effective that is at lessening the impact of what was always going to be a deep recession. There are signs it is stimulating growth, although whether it causes inflation as well we have yet to find out.
But you can’t keep printing money forever – at least not without turning into Zimbabwe. At some point, you’ll have to declare the job done, and call a halt. But when? And how?
In a speech last week Charles Bean, the Bank of England’s Deputy Governor, admitted the Bank faced a “tricky judgment” on when to exit its money-printing strategy. Perhaps most surprisingly, Bean suggested that the Bank might well start raising rates, while still printing money by buying up gilts and other assets. He also suggested the Bank might have to hold the assets it is buying until maturity, because of the risks associated with releasing them back onto the market. One thing was clear, however. The Bank doesn’t really know how to get out, or when. If it did, it wouldn’t have to discuss it.
This is more than an academic debate restricted to central bankers and economists. It matters to investors.
It is becoming increasingly clear that the rapid rise of the markets over the last two months owes a lot more to printing money than it does to any of the over-hyped ‘green shoots’ of economic recovery. The S&P is up by 35% since its February and March lows. Many of the Asian markets are up by more than 50%. As Morgan Stanley noted in an analysis last week, “as we see it, an important driver behind this rally has been the excess liquidity that central banks have pumped into the system through rate cuts and quantitative easing.”
Investors aren’t stupid. They can see that there isn’t much point in holding onto cash when central banks are printing more of the stuff by the billion. Its value is only going in one direction, and it isn’t upwards. They have been switching their cash into equities, property, gold or oil: anything that is likely to hold its value even as money becomes less and less attractive. QE was designed to push bond yields down to help stimulate the economy, but money is bit like an animal: once you release it into the wild, you have no way of knowing where it will go. In fact, much of the freshly minted cash looks to have been invested in other markets.
The trouble is, that means the prices of most assets are buoyed up artificially by the tricks the central banks are playing.
For much of the last decade, the bubble in equity markets was sustained by what was known on Wall Street as the ‘Greenspan put’. Put simply, the rule stated that it was perfectly safe to invest in equities, since if they fell the former Federal Reserve chairman Alan Greenspan would always wade into the markets with a series of interest rate cuts to bail them out.
Now we have something that looks like a ‘QE put’: when markets collapse, central bankers will keep printing more and more money until they get them moving again.
There are two problems with that, however.
First, as Bean puts it, central banks face a ‘tricky judgement’ on when to put the brakes on QE. But so do investors. At some point, the monetary authorities will have to stop printing money, and when it happens the results will be far from pretty. In effect, anyone trying to put together an investment strategy doesn’t really need to be looking at the future of company profits, trade flows, or new technologies. They mainly need to be worrying about when the central banks will pull the plug – and making sure they aren’t the suckers holding bonds or equities when it does.
Next, it causes massive distortion of capital markets. It is not just bond markets that will take a big hit when central banks stop printing money. So will equities, commodities and property. They are all being kept afloat in the same tide of new money. But in the end, the health of a capitalist economy depends on the markets allocating capital efficiently between different sectors of the economy – and yet right now, the prices of most assets are, in effect, being decided by the central banks.
In reality, that is the real reason why quantitative easing will turn out to be a mistake - because of the massive distortion of the capital markets it creates. It would be better for the central banks to get out now while they still can.