"There are three kinds of people: the haves, the have-nots, and the have-not-paid-for-what-they-haves.”
The impact of QE
When central banks buy Treasury debt, central bank reserves grow and, when that happens, base money supply increases. Money supply is an important driver of economic growth; hence, it is fair to say that economic activity not only benefits from the fall in interest rates that typically comes with QE; it also benefits from the increase in money supply.
Having said that, when money supply grows rapidly, inflation often follows. With the dramatic increase in QE since 2008, one could therefore fear the worst. Disinflationary factors such as demographics and globalisation have undoubtedly contributed to keeping inflation in check (see for example The Inflationary Impact of Ageing from April 2018), but it is still remarkable how little impact all the QE has had on inflation in recent years. There is a very good reason for that, which I will share with you below.
The Art of Defaulting
I have been thinking about QE vis-à-vis inflation for a long time, but two emails over the last few weeks forced me into action. Back in December, a British reader of the Absolute Return Letter wrote to me, asking me to address a number of questions in response to The Art of Defaulting, (the Absolute Return Letter of December 2018):
1. What will happen to all the UK Treasury debt currently held by the Bank of England when it matures?
2. If the Bank of England were allowed to monetise that debt, wouldn’t the debt problem go away?
3. What would the inflationary impact of such a process be?
4. Could debt monetization be used to solve the DB pension problem?
5. As lots of DB pension obligations are to low paid workers, a DB meltdown would probably raise inequality in society. Couldn’t monetization therefore reduce that inequality?
Lo and behold, only a couple of weeks later, another email showed up in my inbox, this time from a reader in British Columbia. He said:
“It is my belief that QE is not money printing – it is simply a swapping of non interest-bearing notes (cash) for interest-bearing ones (bonds). The cash is borrowed from the Treasury and is “tied” to the bonds it purchases. Therefore, this is not true money printing. It also explains why we never experienced the inflation people predicted from the money printing of QE. It wasn’t, so we didn’t get it.”
Well, that was a bit of a handful! Consequently, I decided to turn my response into an Absolute Return Letter, so let’s get started. One thing to point out before I start, though. In the following I talk mostly about the Bank of England (BoE) and Bank of Japan (BoJ); however, pretty much every conclusion I come to over the next few pages can be applied to central banks all over the World.