The West’s bean counters are guilty of a great white lie – The Telegraph – 07.11.22
By pushing the QE experiment too far, central banks have tainted the whole apparatus of emergency money - by Ambrose Evans-Pritchard.
Western central banks are guilty of an enormous white lie. They led the public and the political class to believe that quantitative easing (QE) was tantamount to printing money, and that it could be reversed painlessly once the deflation threat had passed.
They were throwing sand in our eyes. The process is not remotely equivalent to printing bank notes. The central banks have conducted QE in such a way that there is a liability owed to commercial banks on the other side of every bond purchase. That liability is contracted at floating rates.
The US Federal Reserve, the Bank of England, and the European Central Bank, among others, have borrowed short to buy long. This is a variant of the maturity mismatch that blew up Northern Rock and Lehman Brothers after the short-term funding markets froze during the global financial crisis.
The consequences are catching up with the central banks as inflation forces them to raise interest rates at a galloping pace. They risk rendering themselves technically insolvent.
“Federal Reserve interest rate hikes are painful for the economy. But they are also painful for the Federal Reserve itself. It is a self-harming process,” said Padhraic Garvey from ING.
ING says the Fed has incurred a paper loss of $1 trillion (£880bn) this year on its $8.7 trillion balance sheet of US Treasuries and mortgage debt. Its holdings are trading at an average 7pc discount to par value. This is going to be hard to explain to Congress.
The Fed has also racked up an annual interest bill of $170bn that must be paid to counterparties, either on the excess reserves of commercial banks or on its reverse-repo facility. The terminology is obscure.
The cost is real and will eclipse the interest income from the Fed’s bond portfolio by a wide margin as US interest rates near 5pc.
ING says the Fed will be “deep in the red” by next year. Ultimately, the US taxpayer will shore up the system but the political economy implications of what has happened are not trivial.
The Swiss National Bank has already skidded into trouble. Over the first nine months of this year, it lost $143bn on its asset holdings, equal to 20pc of Swiss GDP. This has wiped out three quarters of the SNB’s equity capital.
The Swiss QE portfolio includes global stocks such as Meta and Google, accumulated in a heroic effort to hold down the franc, otherwise known as currency manipulation. Another leg down on Wall Street could force the SNB to go cap in hand to the cantons for a humiliating recapitalisation.
The Dutch central bank (DNB) has had to write a letter to the Dutch finance minister warning that rising interest rate payments to counterparties are eroding its equity buffers.
“For the coming years we expect losses to be considerable, especially in 2023 and 2024. Should our buffers become too depleted... additional measures may be necessary to restore our balance sheet to solidity. In an extreme case, a capital contribution from the Dutch State may be necessary,” it said.
DNB is exploring a revaluation of its large gold reserves as a “solvency backstop”. If the Dutch are having to do this, we can be sure that weaker central banks in the ECB network are in worse shape. It is likely that gold reserves will have to be mobilised in several states to boost equity capital. The barbarous relic may get its revenge on fiat paper.
The great white lie dates back to a speech in 2002 by a young Fed governor called Ben Bernanke on the risks of deflation.
“The US government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at no cost,” he said.
The Bank of England picked up the metaphor in its early explanations of QE, insisting that buying bonds with electronic money was the same as buying them with printed banknotes, but simpler.
The Bank has since come clean. “QE doesn’t involve ‘printing money’. The policy is more accurately seen as a maturity swap,” it says. Chalk and cheese.
The Bank has to pay interest on commercial bank reserves (the flip-side of QE) at Bank Rate, already 3pc and rising. This is a fiscal cost indemnified by the Treasury.
Sir Paul Tucker, ex-deputy governor, says the Government could save £30bn to £45bn a year on its £840bn QE portfolio by limiting payments to the banks (“tiering” in jargon), but acknowledges that this is not the “easy-win” that some suppose. It would amount to a windfall tax on banks at a time of mounting financial stress. Critics say it would set off a credit crunch and backfire badly.
One can forgive the original white lie by central banks. They never imagined that QE would drag on for thirteen years, or reach such proportions. What was less forgivable was to keep buying bonds à outrance after the macroeconomic trade-offs had turned toxic and after the broad money supply (M3, M4x) had caught fire, guaranteeing inflation.
The Bank for International Settlements studied the latent risk in a joint report with officials from central banks in 2018. They concluded that a “snapback” in interest rates was potentially dangerous. The global financial system, especially the non-bank shadow sector, had been lured into positions that could not be unwound with the flick of the fingers, and could not withstand a rate shock. A liquidity crisis was likely.
The report was so sensitive that publication was delayed. It was then released quietly and buried. One paragraph catches the eye. It warned of a collateral crisis in the “marked-to-market value of derivative contracts” leading to distress fire sales. That is what happened to the UK pensions industry in September. Regulators ignored the warning.
Philip Turner, one of the authors of the BIS report, says a decade of financial alchemy has left the global system overleveraged, opaque, and an accident waiting to happen. “UK pension funds are just the first bodies to float to the surface,” he said.
Let us be clear, QE was necessary to avert an implosion of the money supply and a second great depression after the Lehman crisis.
The fundamental policy failure lies with governments. They imposed premature fiscal austerity in the US, UK, and Europe before economies had recovered, and at a time when banks were slashing credit to repair their balance sheets – made worse by ill-timed regulations forcing lenders to raise capital buffers too fast during the slump. Zero rates and QE were needed to offset the self-inflicted damage.
But by pushing the experiment too far, and by misrepresenting the trade-offs so dismissively, the central banks have tainted the whole apparatus of emergency money. The bar for a liquidity bail-out in the future is henceforth exorbitantly high, and we may well need one.
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The Swiss National bank has lost $143bn on its asset holdings this year, equal to 20pc of Swiss GDP Credit: Denis Balibouse/Reuters