To Infinity! And Beyond! The story of the central banks expansion

by Shaun Richards

The story of the credit crunch can be looked at through the prism of the central banks. Their modus operandi is supposed to be action followed say two to three years later by a withdrawal of the action but the latter fizzled out at best. The ECB back in 2011 with its two interesr-rate increases and the US Federal Reserve with its interest-rate rises and promises of so called normalisation of a couple of years or so ago. That is before we get to the Riksbank of Sweden which has raised interest-rates into what already looks like a worse economic contraction than 2009. The exact details now are harsh on it as we were in a pre pandemic era but they were raising rates into the trade war slowdown. With its previous policy of running negative interest-rates in an expansion the Riksbank looks all at sea now.

In a broad sweep we got a wave of interest-rate cuts to what was then thought of as ZIRP or Zero Interest Rate Policy although most places actually stopped short of 0%. Remember when these were badged as emergency measures? Then the era of Quantitative Easing began as central banks bought sovereign bonds in ever larger quantities as it became apparent that the interest-rate cuts were not cutting the mustard. Later we got the era of credit easing as the central banks had yet another go at what the original interest-rate cuts were supposed to achieve.

The Pandemic Response

Even before the Corona Virus there were signs of the system creaking as we saw the ECB ease policy yet again last autumn. We got a sign the cupboard was getting a bit bare in the way it only cut interest-rates by 0.1% as who really believes that makes any real difference at all? Another way of looking at the conceptual problem is the way it found itself restarting QE less than a year after it had ended it. The proclamations of the “Euro Boom” had disappeared pretty much as quickly as the stimulus did as we saw that Germany was finding the trade war heavy going and economic growth had essentially gone.

The response of the ECB to the pandemic has been to expand its new QE programme from the original 20 billion Euros a month to an average of a bit over 5 billion Euros per day. There was no further interest-rate cut which suggests it thinks it is at the “lower bound” for interest-rates which in practical terms can be defined as the lowest interest-rate they think they can apply without causing a run on the banks. As so often policy is driven by “The Precious!  The Precious! “. Indeed one aspect of QE can be looked at like that as for example the large holdings that the Italian banks have in Italian Government Bonds are about the only profitable activity they seem to have. They are being rather spoon fed this  as we saw after the “bond spreads” comment by ECB President Christine Lagarde at least a hint of how much lower Italian bond prices would be without The Frankfurt Whale.

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There is a sub plot here however and as it does not happen often I thought I would point it out. By effectively blocking further interest-rate cuts the Euro area banks are doing the real economy a favour as in my opinion further cuts here are only likely to make things worse.

US Federal Reserve

In terms of interest-rates then the normalisation efforts ended up taking something of a U-Turn and then a full retreat as we find it back just above 0% ( strictly the range is 0% to 0.25 %). So back to where it started but the main change in the Pandemic era is this.

“(Reuters) – The Federal Reserve’s balance sheet increased to a record $5.86 trillion this week and the central bank reported greater use of some of its newly launched liquidity facilities, all part of its efforts to keep markets functioning smoothly amid heightened volatility related to the coronavirus pandemic.

In the three weeks since the Fed’s effort to limit the economic damage from the outbreak kicked into overdrive, the central bank’s balance sheet has mushroomed by roughly $1.5 trillion. It is now the equivalent of a quarter or more of the size of the U.S. economy before the crisis struck, and will certainly grow larger in the weeks ahead as the Fed keeps piling on assets and the economy likely shrinks.”

As you can see that is quite  a change as for example the previous peak was of the order of US $4.5 trillion and the normalisation efforts brought it back below US $4 trillion. But according to Reuters there is more.

“The central bank continued to snap up Treasury securities, mortgage bonds and other assets, according to data released on Thursday. The Fed’s holdings of mortgage-backed securities increased to $1.46 trillion from $1.38 trillion. Treasury holdings rose to $3.34 trillion from $2.98 trillion.Use of the Fed’s central bank liquidity swap lines, which allow foreign central banks to exchange their local currency for dollars, rose to $348.5 billion Wednesday from $206.1 billion the previous week.”

Thus the Federal Reserve is offering liquidity about as fast as it thinks it can and I am omitting some of the smaller programmes as on this scale even billions are relatively insignificant

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Bank of England

It too felt it had scope for interest-rate cuts and brought Bank Rate down to 0.1% which is its estimate of their lower band or as much as it feels the banks can take.You may note that either the UK banks are in worse shape than the Euro area ones or it feels the ECB has made a mistake.

Moving onto QE it has announced an extra £200 billion which will take the total to £645 billion. It is cracking on with this as it has bought some £4.5 billion on 3 days this week. Last night it announced it will increase its Corporate Bond holdings to £20 billion which will at least give us a laugh! Why? Well it really struggled to buy £10 billion last time although I am sure the Danes were grateful as it help prop up their shipping company Maersk, for example.

Comment

My To Infinity!  And Beyond!  theme has turned out to be rather prescient but let me now switch to the real winners here. The first is governments who via the impact of all the QE purchases  are able to borrow extraordinarily cheaply. For example my home country the UK has a ten-year yield of 0.32% in spite of fiscal promises such as the writing off of £13.4 billion of NHS trust debt yesterday. Germany has announced quite a fiscal expansion yet is being paid to borrow with a ten-year yield of -0.43%. So the winners of the era of central bank “independence ” have been those who made them independent.

Next on the list are the banks who continue to have liquidity dripped and poured into them as well as subsidies handed out. However if you look at their share prices you see that the real winners hear have been their management who have been able to profit in spite of the lack of a viable business model.

As for the rest of us, well if the tales I am receiving about small business borrowing are true we are somewhere between not so much and none at all.

 

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