Whose QE was it, any­way?

Financial Mirror (Cyprus) - - FRONT PAGE -

Be­tween 1913 (when the United States Fed­eral Re­serve was founded) and the lat­ter part of the 1980s, it would be fair to say that the Fed was the only game in town when it came to pur­chases of US Trea­sury se­cu­ri­ties by cen­tral banks. Dur­ing that era, the Fed owned any­where be­tween 12% and 30% of US mar­ketable Trea­sury se­cu­ri­ties out­stand­ing (

with the post-World War II peak com­ing as the Fed tried to prop up the sag­ging US econ­omy fol­low­ing the first spike in oil prices in 1973.

We no longer live in that US-cen­tric world, where the Fed was the only game in town and changes in its mon­e­tary pol­icy pow­er­fully in­flu­enced liq­uid­ity con­di­tions at home and to a large ex­tent glob­ally. Years be­fore the global fi­nan­cial cri­sis – and be­fore the term “QE” (quan­ti­ta­tive eas­ing) be­came an es­tab­lished fix­ture of the fi­nan­cial lex­i­con – for­eign cen­tral banks’ own­er­ship of US Trea­suries be­gan to catch up with, and then over­take, the Fed’s share.

The pur­chase of US Trea­suries by for­eign cen­tral banks re­ally took off in 2003, years be­fore the first round of quan­ti­ta­tive eas­ing, or “QE1,” was launched in late 2008. The charge of the for­eign cen­tral banks – let’s call it “QE0” – was led by the Peo­ple’s Bank of China. By 2006 (the peak of the US hous­ing bub­ble), for­eign of­fi­cial in­sti­tu­tions held about one-third of the stock of US Trea­suries out­stand­ing, ap­prox­i­mately twice the amount held by the Fed. On the eve of the Fed’s QE1, that share stood at around 40%.

Span­ning a decade (2003-2013), QE0 was the most sus­tained and un­in­ter­rupted surge in cen­tral banks’ pur­chases of Trea­suries on record. It is dif­fi­cult to de­ter­mine the ex­tent to which the Fed’s QE1 dur­ing the cri­sis owed its suc­cess in bring­ing in­ter­est rates down to the fact that it was be­ing re­in­forced by what for­eign cen­tral banks world­wide – no­tably in Asia – were do­ing si­mul­ta­ne­ously. It is in­struc­tive, how­ever, that the Fed’s next two pol­icy in­stall­ments, QE2 and QE3, were not matched by large for­eign pur­chases and ap­peared to have only mod­est ef­fects in fi­nan­cial mar­kets.

Af­ter the tur­moil of the 2008 cri­sis sub­sided, a va­ri­ety of indices of fi­nan­cial con­di­tions dis­played com­par­a­tively low lev­els of volatil­ity (by his­toric stan­dards) through the spring of 2013. But that spring bloom of sta­bil­ity soon faded. A com­bi­na­tion of fall­ing oil and pri­mary com­mod­ity prices, an over-ripe busi­ness cy­cle, and the Fed’s an­nounce­ment of its in­tent to start “ta­per­ing” its as­set pur­chases brought the decade-long boom in many emerg­ing mar­kets to an end. Since then, growth in th­ese economies has slowed markedly, their stock mar­kets have slumped, cap­i­tal out­flows have es­ca­lated, and many of their cur­ren­cies have crashed.

In tan­dem with this grim turn of events, nu­mer­ous emerg­ing-mar­ket cen­tral banks re­versed course and be­gan sell­ing US Trea­suries. We would not know about th­ese sales, how­ever, from the Fed’s quar­terly re­port of the Fi­nan­cial Ac­counts of the US: Around the time of­fi­cial sales com­menced, the Fed stopped re­port­ing US Trea­suries held by for­eign of­fi­cial in­sti­tu­tions (a se­ries of data that had been avail­able since 1945). The re­port now shows only the ag­gre­gate fig­ure, which com­bines cen­tral bank hold­ings with those of the pri­vate sec­tor.

For­tu­nately, the US Trea­sury still pub­lishes the in­for­ma­tion. As of the end of 2015, the share of Trea­suries held by for­eign cen­tral banks is more than 1.5 times what the Fed holds. But this fig­ure is sig­nif­i­cantly down from its peak and, with cap­i­tal out­flows from China and else­where show­ing lit­tle signs of abat­ing, is now trend­ing lower.

The fit­ful and dis­or­derly un­wind­ing of QE0 is most likely over­whelm­ing the ef­fects of re­as­sur­ances by Fed of­fi­cials that they will main­tain a large bal­ance sheet. In­deed, tighter liq­uid­ity con­di­tions and in­creased volatil­ity in fi­nan­cial mar­kets are the byprod­uct of the re­ver­sal in the long cy­cle of for­eign pur­chases.

The un­wind­ing of QE0 does not nec­es­sar­ily im­ply a de­cline in the rest of the world’s ap­petite for US Trea­suries. In times of fi­nan­cial tur­bu­lence, US Trea­suries have his­tor­i­cally been a safe haven for pri­vate flight cap­i­tal. But the change in own­er­ship tak­ing place now does carry im­pli­ca­tions for fi­nan­cial sta­bil­ity. The change from the steady (and of­ten pre­dictable) pur­chases of the for­eign cen­tral banks of the 2003-2013 era to the less pre­dictable hands of pri­vate in­vestors, who are more sen­si­tive to changes in rates of re­turn, is likely to be the sig­na­ture of this stage of the global cy­cle.

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