A good rule in life is that when you start something, you should have at least some idea of what your exit strategy will be. Neither Britain nor the US had one in Iraq, and so have been bogged down in a difficult war for years longer than planned. Now it looks as though the Federal Reserve and the Bank of England are making the same mistake with their policy of quantitative easing (QE), or printing money as you or I would call it.
It’s becoming increasingly clear that QE’s main impact will 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, most asset markets now look to be largely controlled by the central banks, a situation that will hardly help restore healthy economic growth.
Britain has been among the most aggressive countries when it comes to ‘unconventional’ monetary policy. But other central banks have done the same, led by the Fed in America. Even the conservative European Central Bank has joined the party. And it remains to be seen how effective QE 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 too we have yet to find out. But one thing’s for sure. 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 judgement” on when to exit QE. Perhaps most surprisingly, Bean suggested that the Bank might well start raising interest rates while still printing money by buying 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 on to 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. But this is more than an academic debate restricted to central bankers and economists. It matters to investors.
The S&P is up by 35% since its February and March lows. Many Asian markets are up by more than 50%. But it is becoming clear that this rapid rise owes a lot more to printing money than to any genuine recovery. As Morgan Stanley noted last week, “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 on to 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’s 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 a bit like an animal: once you release it into the wild, you have no way of knowing where it’ll 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 being buoyed up artificially by central bank trickery.
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, former Fed 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 print 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 that 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 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 huge distortion of capital markets. It’s 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 markets allocating capital efficiently between different sectors of the economy. Yet right now, the prices of most assets are, in effect, being decided by the central banks.
That’s the real reason why QE will turn out to have been a mistake – because of the massive distortion of the capital markets it creates. It would be better for central banks to stop this disruption and get out now while they still can.