The end of Quantitative Easing

This article appeared originally in Gulf News: link to original article is not available.

We are approaching an era of less liquidity. When the financial crisis hit in 2007-2008 and its ramifications extending to almost a decade afterwards, central banks resorted to innovative schemes to stimulate their economies. Previously, one key resort would be to print money, which is directly correlated with a higher inflation rate. Other measures included increasing liquidity in economies through bank lending. This was done by either lowering interest rates or by reducing the reserve ratio – the percentage of cash that banks need to keep in relation to cash being lent out.


What the 2007-2008 crisis brought about is two alternative methods of increasing such liquidity. The first one was natural extension of lowering interest rates, except that those went into the negative with the sole purpose of discouraging deposits and encouraging spending in the economy. The second and more innovative approach came with a creative name to go with it: ‘Quantitative Easing’ (QE). The latter was a way to move debt from balance sheets of government and corporate entities to the central bank of the government adopting the measure, by buying bonds. The thought behind it was that a lower corporate debt burden will encourage them to raise minimum wage and spur their spending tendencies. Though debatable, the two measures worked somewhat well for a country like Japan, with a chronic deflation that was too stubborn to go away.


We are now approaching the end of the QE era. The US, through its Federal Reserve (Fed), is ‘tampering down’ its QE programme by buying less debt on a monthly basis. The Fed has also hiked its interest rates with more to come until the year 2020, with speculations putting the end figure at around 3%.  


The European Central Bank (ECB) and the Bank of Japan (BOJ) did not follow suit, which is unheard of for central banks that would usually do so. Not only that, but both central banks are continuing their QE programmess in the foreseen future, with their interest rates not nudging away from their zero to negative levels since the 2007-2008 crisis. 


Such unconformity in monetary views between the world’s largest economies is unorthodox, highlighting a generic trend of safeguarding one’s own interests. As a result, the divergence in monetary policies by the Fed, ECB, and BOJ over the past decade led other central banks to act in their own monetary interests.


The EU is a peculiar case because of its single currency. Trying to manage the second most aggressive QE programme, after the Japanese one, is not an easy feat with different member countries in need of different monetary policies. The European Central Bank was purchasing bonds from different EU governments to improve their finances, with Ireland and Greece exiting their debt programs partly attributed to that. Other countries that are not part of the euro bloc have resorted to other measures to ensure that they are not left disadvantaged by the euro’s devaluation. The Swiss National Bank, for instance,unpegged its franc from the euro, while Sweden’s Riksbankintroduced negative interest rates to disincentivize deposits.    


For the US, the main concern is to reduce debt levels by tampering down its QE, while simultaneously and gradually raising interest rates to bring its monetary policy back to normalcy. The story is slightly different for Japan.


Japan has been thus far the most aggressive of all central banks in its QE program. Not only that, but the Bank of Japan has even engaged in buying stocks to prop up Japanese stock markets. Though not necessarily directly related to QE, but the move is one that is conceived to being important for the economy. It also, just like QE, further encourages businesses to start spending their cash in the economy, through direct spending or by raising wages, instead of spending it on buybacks. 


Buybacks is when businesses buy their own stocks to inflate the price and make the businesses seem profitable even when they aren’t. In the US alone, buybacks were forecasted by Forbes to reach $100 billion in 2018. According to the Financial Times, the figure is at $754 billion in 2018, with Goldman Sachs predicting the figure to reach $1 trillion in the same year. South Korea is also in the process of supporting its stocks through buybacks.


As for countries pegged to the US dollar, the effect is that of liquidity tightness. That is, the increasing interest rates will find less and less borrowers in the region, with government spending stepped up to make for the shortfall. 


For countries like China, where the yuan is indirectly pegged to the US dollar through Chinese possession of treasuries, it has opted for a balanced approach towards managing its yuan’s value. Through allowing a more flexible band between which the yuan can fluctuate before an intervention is needed, and by reducing banks’ reserve ratio, the increase in liquidity has kept the Chinese economy going when higher interest rates in the US are attracting more investments.


The 2007-2008 financial crisis and its aftermath have shown, in light of all of the above various policies, that central banks are no longer in line with the monetary policies being taken by each. The European Central Bank and the Bank of Japan are taking the highway with regard to the US Federal reserve, while China and other countries are doing what is best for their own economies. As a result, different economies have lost their investment allure, with Argentina and Turkey being two cases in point.


The last thought that I want to leave you with: what will happen to emerging and frontier markets when the European Central Bank and the Bank of Japan reverse their QE programme, raising interest rates?