US Federal Reserve building

Money & Markets: Monetary policy turns the unorthodox into the ordinary

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Quantitative easing was billed as a temporary fix to stem the recession, but trying to reverse it has hit the global financial machine.

There isn’t much engineering and technology done these days without rivers of capital being diverted into the balance sheets of companies involved. US corporate bonds alone account for $8 trillion of debt.

If ‘neither a borrower nor a lender be’ was a thing, the huge companies we see today simply wouldn’t exist. Even tech giants with huge profits like Apple, which are awash with cash, still borrow huge sums by issuing their own bonds.

These oceans of debts meet continents of demand for interest on capital. Corporate bonds are warehoused by banks, using financial engineering to slice and dice them, packaging them up to suit the purposes of the capital in search of a return. Companies need to issue debt, capital needs to earn returns by taking on the risks of holding that debt, so that makes for a massive market. Central bankers, like the Bank of England, the US Federal Reserve and Europe’s ECB, try to balance the system with the right amount of liquidity (call that money and collateral) and the right level of interest rates to enable the whole inconceivably complex whirligig of the capitalism machine to churn away, smoothly matching the needs of borrowers and lenders.

When this byzantine world of debt froze in 2007/2008, the central banks of the world, and particularly the US Federal Reserve, back-stopped the system with massive injections of money available to be swapped with them by banks, institutions and companies for what had suddenly and systemically become unsalable and untradeable assets.

This action by the Federal Reserve, with the same from Japan, Europe and China, defibrillated the global economy, which was rapidly seizing up.

Years later it was decided that it was time to reverse the process and get back to ‘normal’.

As I have been writing in this column, the Federal Reserve has been reversing this process of providing liquidity for about a year. I have commented that this process would have bleak prospects. In a nutshell, Quantitative Tightening, or QT, is the opposite of Quantitative Easing. With QT, money becomes harder to come by and consequently interest rates go up and money floods out of assets like corporate bonds as a cascade of negative economic pressure hits.

Hit it did at Christmas, with what amounted to a market crash in Europe and the US. All the indicators say the global economy sits on the brink of recession. A year of US QT, a mere slice of its mountainous balance sheet levelled, and hard times are here.

Now for the good news. The Federal Reserve plans to end QT this year and perhaps as early as September. The ECB has decided to start up its only recently ended QE again. The markets have rallied like a cocaine-infused rock star.

What was once ‘unorthodox monetary policy’ is now just ‘monetary policy’ and all part of the neologism MMT, Modern Monetary Theory, which is currently pretty much what anyone wants to say it is, so long as they say it with enough volume and conviction.

For the global economy MMT is going to be the battle cry of those pressing the central bankers for more, more, more liquidity in a financial reality where everyone depends on either issuing debt or buying it.

Which is great news for the coming years if you are an engineering company wanting to roll your levered-up balance sheet, or you’re a tech zillionaire wanting some liquidity to go buy that island or fly to the planets.

However, QE, like all the CDO, CDI and cockeyed derivatives that nearly brought the roof down back in 2007-2008, is a new financial instrument and it is these methods that cause all financial catastrophes.

While the main consequences are understood and can be seen as beneficial, the full ramifications of the new dynamic are poorly understood and ultimately exploited, as they say in cryptocurrency land, ‘to the Moon’.

Be it trading tulip bulb options in Holland, producing paper money in France, letting leverage run wild on Wall Street in 1928 or firing up the property boom of 2006 with securitisation, ultimately the usefulness of the innovation is taken far beyond its safe utility. The boom created by the new financial system or gadget turns into a bubble and then a crash.

Meanwhile we can all make hay, as when QT is actually dead, off will go asset prices, companies will be begged to borrow money and as long as the wheels stay on the new MMT charabanc there will be more than enough money to go round. Which, however mad that might be, is far better than to be thrown into a valley of recession by ‘old monetary policy’, which believes in things like ‘moral hazard’ and ‘you can’t have your cake and eat it’.

Well, we will see, because if you like cake, it will soon be time to get in the queue for it. QT is dead and with it ‘old orthodox monetary policy’ is over, too.

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