As the EU plan to signal a cut in interest rates this month, one must investigate the impact and legacy of the phenomenon which is QE. After the phenomenon that was the global economic crisis, we saw the implementation of an unconventional policy rarely used and widely accepted of having uncertain outcomes. The idea of QE was to help deal with the liquidity trap which had crippled the economy. After the crisis, Central banks around the world heavily cut interest with interest rates in UK falling from 4.5% in October 2008 to 0.5% in March 2009. With the recession not faltering, normal open market operations such as cutting interest rates were no longer ineffective in stimulating growth and lending. Central banks thus resorted to this unconventional measure of quantitative easing in which they purchase government securities or other securities from the market in order to increase the money supply and encourage lending and investment. Since 2009, there has been £435 billion of QE in the UK, with the Fed’s programme reaching $4.5 trillion by 2015[i].
While the aim was to jump-start faltering economies plagued with low consumer confidence and little bank lending, the impact of QE has been counterproductive by creating a global economy built on unnatural, weak foundations. The crux of the negative impact has been the length of time these unconventional measures have been in place for. Ultra-low interest rates alongside Central bank injections were meant to be short term measures intended on having the impact of electric shock to the heart in order to kick start to the global economy. However, what we have seen is a continuation of this policy which has had the adverse effect of normalising conditions which were only meant to be implemented for a very short amount of the time. The impact of normalising conditions of ultra-low IR and significant QE was seen in 2 key issues – inflated asset bubble and debt-fuelled growth.
The critical function of QE was the targeted buying of assets by Central banks in order to inject liquidity into the economy. A side effect of this has been the artificial inflation of assets caused by the increased demand created by Central banks. As shown in the graph above, Stocks in the S&P 500 have increased more than proportionally with QE injections by the Fed. As this asset inflation was not caused by company growth or increased profitability, the gains were unsustainable and as seen last October and November with the stock market crash, will ultimately come to an end. The impact of a stock market crash can see billions of pounds of valuations wiped of companies leading to indirect impacts such as unemployment. It is key to acknowledge that the crash coincided with the fed’s normalisation policy, specifically with the expectation of a scheduled rate hike. Furthermore, the targeting of bank assets in order to stimulate spending failed to reach the desired outcome as Central banks cannot force banks to lend to customers and consumers. Coupled with low consumer confidence, the desired effect of kickstarting investment and economic growth could not be attained and stagnation followed.
“Long-term data suggests that higher debt levels are not correlated with higher GDP growth rates. Therefore, lowering rates to encourage more debt is useless at the second derivative level”. – Jeremy Grantham (chief investment strategist at GMO)
The other negative impact of financial repression (QE and low IR) was the debt-fuelled growth created. Ultra-low interest rates offered many firms the opportunity to fuel their growth via cheap borrowing in order to finance expansions or Acquisitions to name a few. According to UNCTAD’S 2018 report, Global debt had risen sharply to $250 trillion – 3 times the total world income[ii]. The issue with excessive reliance on debt-fuelled growth is that it is inorganic and conceals the financial instability in the global economy. It is an unsustainable form of growth which at one point will burst, potentially causing far greater consequences than the global financial crisis. While debt-fuelled growth has worked to an extent in America to kickstart economic growth, the desired effect was negligent in the eurozone with growth still stagnant. The BIS – which is known as the central bank of central banks – said a repeat of the 2008 financial crash was likely with the current policy of low productivity, high debt and lack of central bank firepower stalks the global economy.
“In almost every respect, adhering to a policy of low rates, employing quantitative easing, deliberately stimulating asset prices, ignoring the consequences of bubbles breaking, and displaying a complete refusal to learn from experience has left Fed policy as a large net negative to the production of a healthy, stable economy with strong employment.” – Jeremy Grantham (chief investment strategist at GMO)
The easiest way to see the failure of financial repression is with the recent news of the ECB planning to announce a schedule IR cut. Economists expect the ECB to cut IR to -0.5% in September[iii]. This is further damning as the ECB was planning to start their gradual normalisation policy next year. They are not alone as nations such as Australia, Russia, India and Chile have already started easing. The global shift back to cutting IR highlights the failure of QE in stimulating sustainable growth and exposes the weak fundamentals of the global economy which is saddled with debt and artificial asset inflation.