Comment: Have Central Banks unleashed a sledgehammer in QE?

The almost decade-long era of extraordinary monetary experiment, prompted by the global financial crisis, shows no sign of abating. Indeed, in the wake of the shock decision in the UK at the end of June, the reverse is now generally the case.

For the simple procedure at the heart the experiment, the term quantitative easing is unfortunately opaque.

Quantitative easing by the Bank of England, for example, has simply seen it create an irredeemable, zero interest rate obligation on itself in the form of many billions of pounds sterling, and use this extraordinary promise to purchase many billions of pounds of interest bearing UK government debt. The same procedure has been followed in Washington, Frankfurt and elsewhere. As the management guru Jo Owen put it in the Financial Times:

‘As a result of QE the public sector (the Treasury) is paying interest to itself (the BOE) on debt that it owes to itself...’

The BOE is now the proud owner of over 25 per cent of the outstanding debt of Her Majesty’s government. The recent announcement by Governor Mark Carney of a fresh round of aggressive stimuli colloquially termed ‘the sledgehammer’ will see this process accelerate, with the proportion of UK government debt owned by the BOE rising even further.

While extraordinary, the quantitative easing and consequent bond buying by London, Washington and Frankfurt pales by comparison to that underway in Tokyo.

On current projections, the Bank of Japan is set to own almost 60 per cent of the outstanding debt of the Japanese government by the end of 2018.

To maintain that such a procedure is not breaking the taboo of monetary financing of the fiscal deficit i.e. of central banks funding governments by effectively printing money, it must continue to be portrayed as temporary. The commitment that the bonds will ultimately be sold or redeemed, and that the money created will ultimately be destroyed, must remain unquestioned.

With the passage of time the credibility of this is looking increasingly threadbare. Whether a policy of ‘helicopter money’ is ever explicitly announced or not, the strong likelihood is that the taboo is broken, and that an era of widespread monetary financing is effectively underway.

The fundamental enabler of this extraordinary monetary experiment is the collapse of Bretton Woods in August 1971. After almost a quarter of a millennium broadly tied to gold, the money of the world was cut free. The collapse of Lehman Brothers in September 2008 has forced the major Central Banks to deploy with growing gusto the unanchored freedom created by the historic decision of pressured US President Richard Nixon.

This may end well. Patient voters and wise politicians may successfully deploy the freedom for government to spend without taxing or borrowing for the greater good. Unfortunately, the historic experience is not encouraging.

The fall of the Roman Empire in 476AD is one of the most widely debated events in history. Among a myriad of contributing causes, the progressive debasement of the coinage and the eventual collapse of the money economy arguably played a central role in plunging much of Europe into the Dark Ages.

The purity and weight – i.e., the intrinsic value of the silver denarius – had been sacrosanct to Romans for centuries. As a unit of account, a means of exchange and a store of value, it is credited by many with playing a key role in the monetary stability and economic success of the greatest Empire the world had ever known.

This began to change in 64AD following the great fire which destroyed much of the eternal city.

Rather than raise taxes or borrow to fund the massive re-building work, the Emperor Nero chose to scale back the purity and weight of the silver denarius. The long journey of progressive debasement had begun.

By the end of the third century, confidence in the denarius had all but evaporated. The destruction of the middle-class and their savings had brought the Empire to the brink of civil breakdown. The attempt by the emperor Diocletian to stabilise the economy by rebasing the denarius to close to its intrinsic value proved a jolting failure as the lack of silver caused trade and activity to contract sharply. The progressive collapse of the money economy intensified the fracturing of the weakening Empire before it ultimately succumbed to the Barbarian onslaught.

The current extraordinary monetary experiment is inevitably having many consequences. As property prices continue to recover sharply and stock-markets continue to scale new highs, it’s important to remember that the benign response of generally rising asset prices is unlikely to be the only one.

Indeed as Rome and the civilised world ultimately found to their great cost, the freedom to spend without anchor may not end well. The response of Nero to the great fire, and the decision of Nixon to cut money free, may yet be remembered as equivalent acts of historic folly.

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