The fat years: CentralBanks and The Politics of Quantitative Easing

The term “quantitative easing” (QE) describes measures taken by central banks, such as the permanent purchase of mostly long-term securities and government bonds, which are held by commercial banks, when interest rates are already at zero and an expansive monetary policy is to be continued. This will reduce the supply of government bonds on the financial markets themselves, thereby increasing their price, while profits and interest rates on them fall. QE is part of the open market policy of central banks, i.e. funds are made available for private institutions by the central banks through the purchase of securities (government bonds) and through repo transactions. At this point, the central bank engages in money creation. If the central bank buys government bonds of its own government from private investors, then on the right-hand side of its balance sheet are the government bonds, while on the left-hand side are liabilities to third parties. The sellers of the securities, so the idea goes, should now reinvest the money they’ve received, so that the real economy is stimulated; or they should grant more credit. But the sellers of long-dated government bonds used, in the last years, the cash much more to rebalance their portfolios. Because there was an increasing demand of central banks for government bonds, the yields on them fall. The rebalancing of the portfolios of private investors therefore included a higher demand on assets like equities, corporate bonds and real estate. In the U.S. after the financial crisis of 2008, cash was flooding into high yield corporate bonds especially, inflating corporate debt and leading to the existence of zombie corporations, which could only afford to service the interest payments on their outstanding debt. As such, it is realistic to assume new stimulations in financial market speculation with QE policies. Thus, QE policy does not automatically lead to higher real economic growth, but it does accelerate the rise of stocks and other asset prices and generally functions in times of recession as a monetary incentive system for speculative capital, which engages in increasingly risky business with the inflowing money flows. It also happens, however, that commercial banks do not want to sell any securities to the central bank because they currently have no money needs. In addition, central banks can hardly control the credit creation of commercial banks, the credit demand of the non-banks, the market interest rates and the money reserves of the commercial banks. Before the Covid-19 crisis, many central banks finished their QE programmes, but they were quickly reinstalled in 2020, selling safe government bonds, as the need for funds among private investors emerged because of the restrictions and lockdowns during the pandemic.

By keeping interest rates low as an (unsuccessful) attempt to generate economic growth, central banks have pushed companies and households to take on more debt. This creates a debt trap and rising instability. We can also now see a lot of zombie corporations due to favourable financing conditions, which produce overcapacities and therefore contribute to deflationary pressure. During the Covid-19 pandemic especially, there are thousands of smaller companies that are almost bankrupt and kept in business by cheap credits, but are unable to start large investments even if they can get loans at low interest rates. The number of these zombie companies is growing by the day. In 2020, more than 200 big U.S. corporations were identified as zombie corporations, with debts of $1.36 trillion. The granting of cheap loans is called “evergreening”, which supports those companies that have hardly any chance on the market. For example, analysts at Deutsche Bank complain that the monetary policy of the ECB “has brought disproportionate benefits to borrowers with the lowest credit ratings” [ER1] and prevented the process of creative destruction. In 2020 during the Covid-19 crisis, corporate profitability and profits fell sharply, with the exception of Big Tech, Big Finance and now Big Pharma. Wages also fell. These results were at first deflationary.[1] (Low central bank interest rates can in general reduce the state’s budgetary discipline, lead to asset inflation, the prolonged survival of unprofitable companies and the zombie banks, and finally to the dissatisfaction of savers.[2])

During the Covid-19 pandemic, the Bank of England has bought government bonds directly. In 2020, central banks were quick to issue emergency loans to provide short-term liquidity for private investors. The Fed launched the purchase of loans from companies with US $2.3 trillion. Central banks have pumped around $9 trillion worth of new money into the global financial system. The firepower of central banks regarding their financial means is today immense. It is important to note that even players from the shadow banking system, such as large investment funds, can now receive central bank money in exchange for securities. They can also use central banks to liquidate securities, a privilege previously reserved for commercial banks. Central banks can thus create enormous sums of money as long as there is confidence in a stable monetary standard. But this in turn depends on the strength of the national economy, generally of capital accumulation.

In 2020, the Fed sold government bonds to financial actors who held cash and provided cash to hedge funds and securities dealers. The Fed thus secures a minimum price for the securities held as collateral and guarantees a maximum price for the provision of liquidity. The Fed bought treasuries and all kinds of securities for about a $1 trillion and acted in repo transactions as a counterpart to creditors and borrowers on the money and capital markets. An expansion of open market operations occurred and a provision of liquidity. The Fed also reactivated the overnight repo facility for the shadow banking system (which was closed a few years after the crises of 2008). By hedging the repo market (government bonds are fundamental here), collateral should not lose excessive value and at the same time the circulation of money should be saved. Repo transactions grew immensely over the last years and gained new importance.

Repo means in this context that commercial banks sell securities to the central bank and buy them back after a certain period of time (mostly short-term), whereby the former now have additional cash for a certain period of time. The amount of interest on the repo is the difference between the sale and repurchase price of the security, both prices being set by the central bank. (cf. Binswanger 2015: Kindle Edition: 759f.) Repo are therefore contracts in which securities are sold at a certain price in order to sell them back again after a certain period of time. The borrower has to pay a risk premium on the security, which depends on its quality. Repos involve the promise of a trade at par. In times of crisis, the repo rate, the risk premiums and the margin calls increase and the repo transactions can become expensive.

In Europe, the repo market is intended to link the various securities markets in the currency area and facilitate the ECB’s monetary policy decisions. The amount of repos that the ECB settles each day has an impact on the amount of central bank money available. The establishment of a European domestic financial market, in which securities and foreign exchange are traded, is thus kept flexible. The repo market offers a wide range of investment and financial opportunities for private and governmental financial actors. The high demand for collateral for repo transactions enables governments to place their bonds on the financial markets. Central banks, in turn, use the repo market as an instrument for their monetary policy.

In their official policies before the crises 2008 and in 2020, the Fed assumed care for the liquidity risks in the short-term, but not necessarily for the insolvency risks of banks. The liquidity risk in the commercial banking sector is created by producing financial liquidity through payment promises. The central bank acts within this framework and provides liquidity if necessary (QE). To take care only of liquidity risk is not sufficient anymore for the shadow banking system to stabilise it during crises. In 2013, the Overnight-Reverse-Repo-Facility for government bonds was already transformed into a permanent facility for banks and shadow banks. Thus, the need for safe government bonds was met, while the need for central bank money was not yet satisfied with a permanent facility. When disagreements arise about the liquidity and solvency of financial institutions, the financial system becomes destabilised. If the price of the securities excessively falls in certain periods and has negative effects on the repo transactions (repo rate rises), the institutions in the shadow banking system do not have sufficient funds to meet their liabilities. Normally, these funds are then made available through the private banks, while the competition between banks keeps the repo rate low. It can even happen that there are enough securities held by the Fed, like in 2019, and enough reserves at the big banks, but the latter are not willing to lend their money, like such as at the end of 2019. The importance then of repo transactions is increasing. When the Fed sold a small portion of its securities (to reduce it balances) and did not renew repo transactions, the repo rate rose sharply in September 2019, reflecting a higher short-term demand for liquidity from private financial actors in the shadow banking system. This demonstrated that it was now necessary again to give the shadow banking system access not only to safe securities but also to money funds. A new crisis hit the repo market when the repo rate for overnight transactions rose sharply to such a high level, which it hadn’t reached even during the crisis of 2008, and so the market came close to collapse. When the repo rate reached 10 per cent, the Fed had to set a cap and was forced to reopen its repo facilities to commercial banks and shadow banks. These measures were also essential for stabilising the financial system during the Covid-19 crisis. To prevent a collapse of the repo market, the Fed pumped an additional $75 billion per day into the money market, calming the situation down after a while.

Central banks must now create market liquidity by issuing promises to buy (not promises to pay) and therefore take care on insolvency risks. Central banks are now themselves acting as dealers in the financial markets by buying and selling assets to stem the downward movements through their own money creation. Central banks offer financial actors in repo transactions a bid-ask spread, a buying and selling price for financial products to hedge a framework in which they can be traded. Uncertainties should be converted back into a calculable risk. The price of repo-funds is now increasingly determined by the market-based valuation of the collateral (not through interest policies), which fluctuates constantly. This takes place in the shadow banking system via repo transactions, which in turn is intended to stabilise the key interest rate policy for private banks. So with central banks and state policies, the logic of capital is still accepted; there is no hard regulation by laws, but in times of crisis this logic has to be adjusted by central banks. The circulation of money capital is now even increasingly secured by central banks. We can see here a new framing of the neoliberal laissez-faire.

QE policy was still oriented towards the provision of liquidity by exchanging government bonds, while central banks had to further intervene in the crises directly in the money and capital markets in the role of market makers, guaranteeing supply and demand for almost all securities. Bailouts, Emergency Liquidity Assistance and deposit insurance were previously used to protect the official banking sector. The shadow banking system, on the other hand, only had its own private security mechanisms, which were normally considered sufficient. But after the fall of Lehman Brothers, which was one of the most important broker dealers in the shadow banking system, and in the crisis 2008, the Fed created additional collateral structures, new facilities for the shadow banking system, so that it could obtain money and government bonds.

Central banks may have now strengthened their position as a central circulation point, while still guaranteeing at first the circulation flows of fictitious and speculative capital. Prices for derivatives, for example, are fluctuating on the markets and are not fixed, but an acceptable framework can only be set by central banks. It is about a policy that makes it possible to guarantee the logic of capital even during a crisis mode. The stabilisation of the financial system now also requires that securities in the whole banking system, and for this a liquid market for securities collateral is necessary, which in turn requires a functioning repo market. Shadow banks are becoming increasingly important in providing liquidity and central banks are increasingly fulfilling the function of securing this liquidity. Here, both private capital and central banks acquire stronger power relations.

Already in 2008, the Fed acted as a market maker and as a broker dealer to restore market liquidity. The Fed gave loans or exchanged Treasury Bills for all available securities, regardless of their credit quality. Today there is an implicit guarantee of central banks for hedging the trade with securities, which is equivalent to a put option, with which the prices of assets cannot fall below a certain level. The Fed acted as a counterpart via the establishment of new facilities for both lenders and borrowers on the money and capital markets. It bought large amounts of mortgage-backed securities, providing liquidity and collateral to the shadow banking system. This helped re-launch the securitisation market and to support money market funds. The Fed’s own repo transactions also revived this private sector. Parts of the money market were thus integrated into the balance sheets of the Fed. Already in 2009, commercial banks were so saturated with reserves that an active monetary policy of the central banks qua repo was more difficult and thus they have further lost their influence on the money creation of commercial banks. In addition, central banks continued to grant cheap loans to commercial banks, with which they in turn buy higher-interest securities or grant loans to the private sector at high interest rates, enabling them to recapitalise their companies and put their balance sheets in order. At the same time, the purchase of government bonds according to BaseI III does not have to be backed by equity capital. The situation changed again in 2020 because of the Covid-19 pandemic.

With the swap lines (currency swap agreements), already in 2008 the Fed offered other major central banks a temporary reciprocal currency arrangement to guarantee liquidity in U.S. dollars. The Fed agreed to keep a supply of dollars available for trading with another central bank at a specified exchange rate. In return, Fed received an interest rate premium, so that the swap lines were only used when there was no liquidity left in the markets. The dollar amounts that other central banks received from the Fed were passed on to domestic illiquid banks (which also had to bear the cost of the swap line). On 3 October 2008, the Fed granted the ECB, the Bank of England, the Bank of Japan and the Swiss National Bank access to unlimited dollar liquidity. Within three years, the amount of credit extended under swap facilities grew to a staggering $10 trillion. (cf. Tooze 2018: 252)  In 2020, as many companies struggled to meet their dollar obligations due to a lack of revenue, the Fed even extended its existing currency swap lines across the previous participating central banks to ensure dollar liquidity. The Fed opened a temporary window of opportunity for foreign central banks to use their U.S. Treasury Bonds to close repos with the Fed. The Fed became again the world’s central bank.

In the central banks, both the volumes of long-term refinancing transactions and the balance sheet totals have increased in recent years, and their purchases are partly covered by poor-quality collateral. Unsalable securities were stored in bad banks, which were founded by the state, and enormous bond-buying programmes were set in motion. As the balance sheets of private banks were cleared of bad assets and credit, these banks improved again. But not all banks made use of the Fed’s facilities, as their creditworthiness in the financial markets would be affected. In the course of the financial crisis of 2008, a large proportion of the rotten mortgage-backed securities (MSB) were thus deposited on the central banks. The inflation of central bank balance sheets has been driven by measures to rescue the existing financial system in particular, while the quality of central bank assets has deteriorated significantly.[3] While central bank assets are not at a historical record level compared to GDP, the criteria for covering the money created by central banks (cash and reserves) have never been so precarious. In the past, central bank money was backed by gold, then by secure debt (government bonds), but today it is not even backed by secure debt because the assets of central banks include risky stocks, mortgages and non-tradable credit claims of commercial banks.

Debt always becomes a problem if it exceeds the capacity of companies, states and households to repay it in the long run.[4] Therefore, if one wants to follow Keynes at this point, the real interest rates of commercial banks should be low enough to allow continuous repayments, no matter whether they result from income, profits or taxes, and there should also be political control of lending, because too high (real) interest rates lead to intensification and extension of working hours, pressure on profit rates and higher taxes. Despite the low interest rate policy of central banks and the oversupply of money and money capital, the real interest rates of private banks have not fallen in the last decades, as mainstream economics would like to think, but have risen. The interest rates of central banks and commercial banks do not have to be synchronised. Only a few institutions can borrow money from the ECB at zero per cent interest rates, while commercial banks set their own interest rates for lending, always assessing the risk of the debtors, calculating their returns and observing the policy of their competitors in lending. It is also important to note that debtors do have the power to influence the supply of money and monetary policy.

Let us summarise: in a monetary system, which has replaced gold, legal money is created in the credit relationship between commercial banks and the central bank. The latter obtain fictitious capital when they grant loans to commercial banks that represent payment claims. Since the financial crisis of 2008, this relationship has shifted. The stability-oriented monetary policy, according to which commercial banks can only lend central bank money against first-class collateral, has generally been abandoned: today, fictitious capital with a high probability of devaluation accumulates at the central banks instead of first-class monetary claims. In fact, it no longer matters what the central banks buy from commercial banks or even the shadow banks in order to provide them with additional reserves; it seems as though it is enough to hope for future economic growth, so that at some point the debts could perhaps be repaid.

With regard to the low interest rate policy of central banks, their supporters argue that it would encourage borrowing by companies and consumers. This has demonstrably failed to happen after the financial crisis of 2008. Instead, this policy is increasing the demand for derivatives, securities, shares, real estate, etc., and with it also the prices of assets. It is also known that the enormous credit money injections by the Fed and other central banks that we have seen since the global financial crash of 2008 have not led to consumer price inflation in any major economy, but instead have led to an increase in financial asset prices. Banks and financial institutions, awash in the largesse of the Fed and other central banks, did not excessively on-lend those funds (either because the large corporation did not need loans or the small ones were too risky to lend). Instead, companies and banks speculated more in the stock, derivative and bond markets, and in the face of low interest rates, borrowed even more, paid out increased shareholder dividends and bought back their own stock to boost prices.

Low interest rates generally reverse the relationship between savings and debt incentives: those who save money receive low amounts of money; those who take out loans, for example to speculate, receive “cheap money” and at least the option of high returns (Stelter 2013: Kindle-Edition: 834)[5] As we have already seen, interest rates and the prices of securities behave inversely to one another. The price increase of assets resulting from low interest rate policy makes those richer who already hold enough assets, such that they prefer all those who invest their assets in securities, shares, real estate and derivatives. This in turn benefits the financial industry, which not only collects fees, bonuses and commissions by trading the assets, but also creates credit and realises returns.[6]

Of course, the negative aspects of the zero interest rate policy for commercial banks must also be taken into account, as it reduces the spread between lending and deposit rates. Moreover, commercial banks today have to pay for parking money at the ECB. Due to the ECB’s purchases of government bonds that are considered stable, interest rates are also falling, especially on German government bonds. Thus with 80% of all German government bonds, no more interest payments flow from the state to commercial banks; they must rather pay in order to acquire government bonds.[7]

The industrial companies, in turn, have to struggle with low profit rates and a lack of effective demand due to the over-accumulation crisis. And when the profits of companies rise again, because, for example, interest rates are low, they often buy enough of their own shares to increase their share price. New investments in production only take place when the profit rate on future investments is expected to increase and demand is expected to simultaneously rise.

For a short period, the Fed started to raise key interest rates, probably with a view to lowering them again in the next crisis. The measures introduced relate to short-term interest rates, the change of the central bank balance sheet (sales of government bonds) and the dosage of the adjustments. If central banks raise the short-term interest rate, other interest rates charged for borrowing money to invest and speculate can rise too. This effort to regain some space for manoeuvre in monetary policy can be a factor in monetary policy, although this in turn has negative effects on the financial markets and the real economy. If central banks end the low-interest-rate policy, and as a result of which real interest rates would also further rise, many industrial companies, households and many countries, including some of the industrialised countries, could become insolvent. Also, the state cannot make debts arbitrarily, since it is constantly evaluated on the secondary markets. Even cancelling the debt does not fix the problem; for example, the ECB has increased the liquidity of private banks by buying up government and corporate bonds in order to drive their power to create credit, and thus to create bank deposits. This money circulates even if the bonds are written off. At the moment, central banks again stopped raising interest rates.

It also remains unclear what significance the shrinking of the Federal Reserve balance sheet will have with regard to tighter monetary policy. At the same time, debt continues to grow and with it the possibility of external shocks, especially due to the sharp rise in asset prices in parallel with the increase in debt. If these prices fall rapidly, there will probably be a financial collapse, or at least a collapse in the markets, for which even more money will have to be made in response. Higher interest rates can also lead to a stronger dollar and to capital inflows from the emerging markets to the U.S. financial markets, making them even more crisis-prone.

[1] The profound deflationary impulse of the past three decades was primarily due to a huge increase in global labour supply resulting from favourable demographic trends and the entry of China and Eastern Europe into the global economic system. The urbanisation of China, as well as other economies in Asia and Eastern Europe, and the incorporation of many millions of low-wage workers into the global economic system depressed global prices. Investment in fixed capital declined in the developed countries. Domestic demand also weakened in developed countries at the same time global supply increased. This combination exerted downward pressure on inflation and thus downward pressure on both nominal and real interest rates.

The question of inflation or deflation is today uncertain. If already increasing aging has an inflationary effect (retirees do not produce but consume), higher inflation may also be the result of high government deficits being increasingly financed by central banks. Former Treasury Secretary Larry Summers and former IMF Chief Economist Olivier Blanchard both warned that the proposed $1.9 billion spending package by the U.S. Congress, on top of last year’s $900 billion stimulus package, risks inflation. Monetary inflation is first seen in money and capital markets, for example as a stock market boom. Prices of industrial products still temporarily stagnate while stock prices rise and interest rates fall. A rise in capital prices that exceeds the growth of real capital prices, and is not accompanied by falling prices in industrial product, might be a sign of inflationary danger. Most mainstream economists instead say that it does not matter if debt levels rise because interest is now really low and as the economy recovers, government revenues will rise, emergency spending will cease and the cost of debt servicing will be manageable for all actors. But even modest changes in interest rates can produce stronger movements in net interest as a share of the economy in the future. Average repayment terms on government is now falling, so that government might soon enter the territory of expanding debt to pay the cost and repayment of existing debt.

The combination of loose monetary policy, accumulated consumer savings that have not been able to spend due to the Covid-19 pandemic and already falling unemployment may also contribute to rising inflationary pressures. The current inflationary pressures might also result from the short-term supply constraints that are inevitable when restarting a temporarily depressed economy. But there would be enough capacities to support supply again. At the moment, we see at least sharp rises in some commodity prices, which are the result of slow returns and partial breakdowns in the global supply chains of trade by lockdowns.

[2] Since 2015, the ECB has lowered the deposit rates for private banks to minus 0.4 and the key interest rates to zero, and has also launched an enormous bond purchase program of €80 billion per month, which was reduced to €60 billion. On the secondary markets, the ECB can buy the government bonds of EU countries, which are participating in the EMSF and ESM, without limit. So far, however, neither a strong increase in inflation nor higher corporate growth rates have been achieved. However, a further explosion of prices on the stock markets has been initiated, with very high price-earnings ratios (ratio of market capitalisation of companies to GDP) and further increases in Tobin Q (market asset value of the company). The real estate sector is now also clearly overheated due to the low interest rate policy of the central banks in Japan, China and parts of Asia and Europe. In addition, the negative consequences of the low interest rate policy for savers, pension schemes and life insurance companies must be taken into account.

[3] Between 2007 and 2012, the Fed increased its balance sheet total from $900 billion to $3.0 trillion. (Stelter 2013: Kindle Edition: 2465)

[4] Private banks create deposits when they make loans to borrowers, but they do not create the interest, so that there is always more outstanding debt in the system than there is potential to repay the debt. The only way to overcome this structural gap, at least temporarily, includes institutions taking out further loans with a later maturity date compared to the loans extended to earlier institutions. This structural feature of outstanding debt permanently fuels competition for larger yield differentials so that debt can be repaid in the first place.

Moreover, there can be a difference between the total price of commodities and services on the market and the available purchasing power, which in turn makes it necessary to expand lending if the economy is not to slide into recession. This in turn strengthens the power of commercial banks, since governments, most businesses and households can hardly survive without credit.

A third dimension concerns the growth rate of the world economy that would be necessary to repay the outstanding debt, or at least to sustain the debt-based money flows.

[5] The savings rate in the U.S. fell from 11% at the beginning of the 1980s to 1% in 2015. Borrowed money was used mainly for speculation or even for consumption.

[6] In 2015, the majority of long-term corporate loans issued in the Euro zone served to purchase existing real estate, securities and derivatives (€2.4 trillion). (Häring 2016: Kindle-Edition; 144) With mortgage loans amounting to €3.9 trillion and consumer loans amounting to €1.2 trillion, private households were in debt, with €1.2 trillion going to other financial institutions; €2 trillion of loans went to countries outside the Euro Zone, €1.1 trillion to other Euro foreigners. (Ibid.) With regard to mortgage loans, it can be said that as the price of real estate rises, the assets of homeowners also rise, which in turn serve as collateral for new loans, e.g. consumer loans. The low interest rate policy of central banks strengthens above all the raw material and capital markets, while the speed of money circulation decreases. These are deflationary processes.

[7] After the financial crisis of 2008, Germany in particular benefited from the generation of further fictitious capital, because countries such as China or Brazil made extensive investments with the help of the globally floating fictitious capital and a considerable proportion of their orders for the required capital goods went to German companies. Because the German capital market was not so badly affected by previous financial crises, financial capital seeking investment was also more strongly oriented towards Germany. In addition, German companies can obtain financial capital relatively easily and cheaply, while the German government can sell its government bonds at negative real interest rates, which, driven by both factors, means that the debt of the German national budget remains lower than in other countries and, in the course of this, government interest expenditure also falls.

 [ER1]Citation details for this quote?

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