If quantitative easing — the bulk purchasing of bonds and other financial resources — is good for the market and for investors, if follows that the withdrawal of quantitative easing is bad for them.
QE, as it’s called, has become the signature coverage of the planet’s most powerful central banks — those in the USA, European Union, Britain and Japan — since the 2008 financial catastrophe. The idea was to publish tsunamis of cash to push down borrowing costs and push up asset prices, fostering the wealth effect and preventing markets from spiralling into outright deflation.
All good things must end, and so it’s with QE. Its withdrawal, particularly among the countries that share the euro, must be done with delicacy and surgical precision, for fear that a cold-turkey strategy will produce a new crisis. However, does the European Central Bank and its QE maestro-in-chief, Mario Draghi, have that choice? His problem, and it is a big one, is that the ECB is running from bonds to purchase. Time is up. With rights, QE should stop now, all the more so because euro-zone growth and core inflation are firming up. But it can not.
By now, we know that central banks are somewhat proficient in generating new messes by attempting to fix old ones. The 2008 crisis, the largest financial botch job since the Great Depression, was in great part the consequence of hands-off banking law — thank you Ronald Reagan, Maggie Thatcher, Bill Clinton and George Bush — and years of market-warping low rates of interest. In came QE, then more and more QE. It become a monster and no one knows how to stuff it back into its cage.
QE worked, to some point. It likely did prevent the huge economies from sinking into deeper recessions and probably did help reestablish growth; cheap money has its own advantages. But in inflating the value of monetary assets, from home to equities, it made the rich richer, because the wealthy own almost all of the assets worth possessing. Too bad for the rest of us.
It created bubbles which will inevitably pop sooner or later. The affordable money encouraged consumers and companies to take on lavish amounts of debt, making a possible leverage catastrophe if prices return to normal levels and debt obligations grow. Bear in mind, as soon as your mortgage proceeds from 2 per cent to 3 percent, your debt-servicing prices rise by 50 percent.
QE was a godsend to highly-indebted sovereign borrowers like Italy, overseer of the planet’s third-biggest debt market. In the peak of the European debt crisis, in 2011 and 2012, it seemed like Italy was going to be another bailout sufferer. However, Mr. Draghi’s promise to do “whatever it takes” to keep the euro zone intact, which would eventually include fire-fighting steps like QE, delivered Italian sovereign bond yields plummeting. Italy, a no-growth, reform-allergic miracle for nearly two decades, can currently borrow 10-year cash at 2 percent; that is cheaper money compared to U.S. Treasury can increase.
What happens when QE ends? The sluggish countries will need to offer much higher yields to attract investors. Hello Debt Crisis, Part Two? The Italians are worried since they understand that Italy is, in effect, an ECB protectorate, as is Portugal.
The ECB is in a pickle since its QE program, operating at $60-billion ($88.1-billion) per month, has already vacuumed up more than $2-trillion of bonds because it was launched in 2015 and is bumping up against its limitations. These limits are defined by the “capital key,” where the ECB buys bonds in proportion to the magnitude of each nation’s economy. Also, purchases can’t exceed 33 percent of the bonds’ issues. The ECB is close to hitting the bond purchase limits of Portugal, the Netherlands, Ireland, Finland and Spain, with Germany not far behind.
Running from bonds could deny Mr. Draghi the slow, dull, hardly perceptible QE wind-down he obviously cherishes (as do the other central bankers). A quick end to QE could be catastrophic. Notice the “taper tantrum” of 2013, when the U.S. Federal Reserve roiled the markets by only mentioning asset purchases would need to end one day. Most importantly, Mr. Draghi must make sure that pulling the plug on QE does not send the euro on a roller-coaster ride which would deliver low-grade nervous breakdowns to corporate finance chiefs and investment managers.
Donald Trump will make his end-QE assignment even more complex. If the U.S. President’s tax reform package functions, the dollar would likely soar and the ECB could end down QE under the cover of this more powerful buck. If the tax reform flops — and it might, given that the President’s dismal legislative record — the dollar could enter the tank, sending violent spasms throughout the equity and debt markets. Under this scenario, a gentle wind-down of QE would not be possible.
There’s absolutely no easy way out for the QE program. But do not let this surprise you. It got too big too fast and went on too long, to the point where it became a crutch for sovereign issuers and a cocaine-style stimulant for large investors and corporations. QE solved one problem and caused another. There’ll be blood.