Opinion
Over-printing of money to spur growth has upped risks
Summary
- The continuous money printing has led to tremendous misallocations of capital.
Before he became US treasury secretary in 2009, Timothy Geithner was president of the Federal Reserve Bank of New York. As part of this job, Geithner had to deal with the after-effects of investment bank Lehman Brothers going bust in mid-September 2008. There had to be some “foam on the runway", Geithner had said, to handle the crash-landing.
To stay in operation, many financial firms needed to borrow money on a daily basis. The market had totally dried up, with firms that had cash holding it close. The US Federal Reserve stepped in to provide some foam on the runway by printing money that it pumped into the financial system by buying bonds. This was expected to be a one-off . But soon, it became a regular thing and was termed quantitative easing (QE).
In the first round of QE in November 2008, the Fed planned to print money and buy bonds worth $600 billion. The second round of another $600 billion was announced in November 2010. In September 2012, a third round, in which the Fed planned to buy bonds worth $40 billion every month, was announced. This was a very unconventional way of carrying out monetary policy.
Fourteen years later, the Fed is finally getting around to withdrawing some of that money. Hence, it is worth looking at how monetary policy has changed.
Up until 2008, central bankers largely tried to influence short-term interest rates. But through QE, the Fed drove down long-term interest rates by printing money and flooding it into the financial system, hoping that at lower interest rates people would borrow and spend more, and companies would borrow and expand, reviving economic activity.
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Soon, other rich-world central banks followed the Fed’s QE; the Bank of England in March 2009, the Bank of Japan in August 2011 and the European Central Bank in January 2015.
This led to extremely low interest rates. When interest rates are low, people tend to borrow and bring their future consumption forward and this spending then essentially drives growth. The rich world ended up depending too much on this formula. So, low interest rates had to continue, requiring constant money printing, leading to the size of the Fed’s balance sheet burgeoning to $4.5 trillion in late 2014, from $905 billion in early September 2008. The Fed then took a breather from printing more money.
This is when other central banks took over. As Edward Chancellor writes in The Price of Time: “In the two and a half years after 2015… the European Central Bank and the Bank of Japan… acquired a further $5 trillion worth of securities." Further, after covid broke out in early 2020, central banks resorted to even more money printing.
The continuous money printing has led to tremendous misallocations of capital. When interest rates are very low, the present value of future cash flows tends to go up. Theoretically, this makes funding even businesses that are expected to generate a profit far into the future a possibility. This explains the huge rise of loss-making startups with valuations of a billion dollars or more.
It also explains the popularity of Special Purpose Acquisition Companies (SPACs), which are set up to raise money through an initial public offer (IPO) to buy another company. At the time of the IPO, a SPAC does not need to state which company it plans to acquire or have any other business operation for that matter.
As Chancellor writes: “SPACs… were used to purchase speculative ventures, in electric-vehicle technology, space travel, flying taxis, cannabis farming and a company to ‘augment humans to enhance productivity and safety’." This reminds one of the South Sea bubble in the early 18th century. Many companies came with an IPO and as Charles Mackay writes in Extraordinary Popular Delusions and the Madness of Crowds, this included “a company for carrying on an undertaking of great advantage, but nobody to know what it is."
Of course, low interest rates pushed investors to take on higher risk to generate returns. This led to bubbles “in cryptocurrencies and digital art, in luxury goods (supercars and Swiss watches) and household pets (Cockapoos selling for $5,000 a pup), and in collectibles (baseball and Pokémon trading cards)," along with bubbles in stocks, bonds and real estate. Given that the rich already owned many of these assets, they became richer and inequality in societies went up.
Further, low interest rates led to almost everyone borrowing more, including corporates, which borrowed to buy back shares, pushing up their earnings per share and stock prices. Governments borrowed to spend more. Data from the Institute of International Finance suggests that global debt as of March 2022 stood at $305 trillion, or 348% of the world’s gross domestic product (GDP), up from 286% in 2007.
Hence, central bankers of the rich world just concentrated on one point, which was to push growth by driving down long-term rates, totally ignoring the eventual negative effects.
Finally, the US Fed is now gradually withdrawing some of the money it printed. The size of its balance sheet has shrunk to $8.79 trillion from a peak of $8.96 trillion. But the money printed by other rich-world central banks, running into trillions of units of their respective currencies, is still floating around. Clearly, we haven’t seen the last of this.
Vivek Kaul is the author of ‘Bad Money’.
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