Time to ease up on quantitative easing
— Neil Collins is a Reuters columnist. The opinions expressed are his own —
Quantitative easing is like drinking. Nothing much seems to happen at first, so you take a little more. As the warm alcoholic glow spreads over you, it feels pretty good, and surely another glass will make you feel even better. Stop soon enough, before you start feeling woozy, and there are no ill effects. Go on until you can’t stand, and the effects can be disastrous.
The Bank of England’s QE programme has reached the danger point of impending wooziness. Just as a drink or two can stop you feeling depressed, so its operation to buy British government securities has been big and bold enough to prevent the money supply from shrinking.
If economists ever agree on anything, they agree that a shrinking supply of money in an economy is bad news. If credit is hard to find, then the natural instinct for both consumers and those running businesses is to stop buying anything they don’t desperately need, and start hoarding whatever cash they can.
Overall demand falls, companies find their decision to cut back vindicated, so they cut back again, firing workers. Unemployment, and the fear that they may be next, reinforce customers’ caution. A downward spiral is created, turning a recession into a slump.
This was the background to QE, and on this important but narrow measure, it’s been a success both in the U.S. and the UK (the European Central Bank has resisted the demands for it so far). The money supply, which was falling rapidly last winter, has rebounded.
NO CELEBRATORY TOAST FOR QE
So doubles all round, then? Well, not quite. The other reason for QE was to push up the prices of government debt in the belief that this would in turn raise the prices (and thus reduce the cost to borrowers) on all other debt, as lenders extended their lending to the private sector to maintain their income.
This has been an abject failure. On Tuesday the Bank, buying stock in its QE programme, was offered 22.75 percent of the entire outstanding issue of the benchmark Treasury 8 percent 2021 stock, actually spending 2.787 billion pounds. The holders saw the Bank as a forced buyer, and took advantage. As Marc Ostwald, a strategist at Monument Securities, commented: “This is what might be termed ‘fun and games’. But the key point is that selling this stock back to the market, as and when the time comes, will not be easy, to say the very least.”
The QE programme was supposed to include the purchase of investment grade corporate debt, but the Bank has been unable to find more than a few scraps and prices have barely budged. Meanwhile, the cost of money for any borrower where there is the slightest hint of distress remains ruinous.
On Wednesday, Rio Tinto <RIO.L>, the miner which has dug itself into a financial hole after overpaying for Alcan, raised $3.5 billion in five- and 10-year notes, but had to pay 8.95 and 9 percent respectively. The fund-raising was described as part of “the normal process of terming out existing debt facilities”. The damage done to the English language is matched only by the damage such expensive funds will do to Rio’s cash flow.
Rio’s experience, of lenders being able to demand a huge premium for even small risks, can be seen right through the market. QE, which was supposed to make non-government debt cheaper and more available, has had no impact where it was needed. It has merely raised the spread borrowers have to pay over the benchmark government stocks.
A NASTY HANGOVER ON THE WAY
A much worse hangover is coming. Quantitative Easing must be followed by Quantitative Tightening, and while the Bank can always find someone to sell it stock, at a price, the converse is not true. There are a few old Bank hands who can remember the desperate tactics dubbed the Grand Old Duke of York, where stock prices were driven down to a level where they were sure to rebound, allowing the Bank to sell stock as prices marched up the hill again. The culmination of this policy saw the issue of a 20-year Treasury stock on a yield of 15.5 percent. For the taxpayer, it proved the most expensive debt the UK government has ever issued.
At some stage, perhaps as soon as next year, both the British government’s Debt Management Office and the Bank will be trying to sell tens of billions of pounds of stock a month — the DMO to fill the hole in the government’s finances, and the Bank to prevent inflation taking off again. The cost of raising this money threatens to be terrifyingly high.
In June, the Bank will reveal whether it proposes to throw a further 25 billion pounds a month into its QE programme. Fortunately, it has a few weeks yet to see the dangers ahead. If it stops drinking now, it might just escape the financial equivalent of alcohol poisoning.