More pain in store as central banks turn the taps back on
Another $300bn (£247bn) from the Federal Reserve. Fifty billion francs from the Swiss National Bank. And, in case anyone forgot, it is only a few months since the Bank of England stepped into the market and started buying gilts again as sterling and bond prices tumbled during the liability-driven investments (LDIS) crisis.
After a tumultuous week on the financial markets, the system has been saved from collapse, and people can still get their money out from the bank if they want to. Yet we should be clear on one point. That has come at a cost. The monetary madness of the past decade is back with a bang.
That will have consequences. The money injected into the economy to prop up the banking system will inevitably come out somewhere. Banks have had their losses made good, and that is going to incentivise more risky lending. Meanwhile, the markets are already reducing their expectations for interest rate increases, which will ease credit even further. Add it all up, and there is only one outcome. The chaotic events of the last week mean that inflation will be higher for longer – and it is now certain that it will be just as hard to bring rising prices back under control as it was during the 1970s and 1980s.
After a decade and half of new regulations, lectures on how there could be no return to the bailouts, and tighter capital requirements, it turns out that no major economy is willing to allow a significant bank to go bust. With Silicon Valley Bank (SVB) in dire straits last week, and with all the regional lenders under pressure, the US Treasury Secretary, Janet Yellen, and the Federal Reserve chairman, Jerome Powell, stepped in with an emergency package to rescue the depositors. The bank itself might be wound up, but if you had money with SVB you will get it back in full.
When it updated the market at the end of the week, it turned out that the Fed’s balance sheet, a rough measure of the amount of money it has created, had expanded by a massive $297bn over the course of a few days, more than at the height of the 2008/2009 crash.
In Switzerland, the markets had run out of patience with Credit Suisse, and with no private investors willing to offer it so much as another centime, the Swiss National Bank stepped up with Sfr50bn
(£44bn) of funding, the equivalent of 6pc of its GDP, and double the amount it cost Gordon Brown to rescue Royal Bank of Scotland in 2008.
In this country, it is only a few months since the Bank of England had to rescue the gilts market during the LDI crisis, and while in the end HSBC was persuaded to buy Silicon Valley Bank UK, no doubt some officials had drawn up a Plan B that involved taking it into some form of public ownership. True, there is some debate among the monetary purists about whether the expansion of the Fed balance sheet last week amounts to quantitative easing (QE). Likewise, in a seminar room you could probably hold an interesting discussion about whether the money wired across to the clowns running
Credit Suisse is an expansion of the monetary supply or not. But that is splitting hairs. In the real world, the central banks have dramatically eased policy, and created lots of new money. The only real question is what impact that is going to have.
All that extra money is going to change the economy in three main ways. First, huge sums of money have been injected into the system, and it is only a matter of time before it emerges somewhere. It might be the stock market, it might be property, or it might be consumer spending. It does not make much difference. Wherever it is, it will add to demand, and drive prices up.
Next, central banks have effectively back-stopped bank losses. It doesn’t matter if you park deposits in risky assets because, despite all the lectures on moral hazard, you will always get the money back. The result? It won’t happen right away, because the last week has sobered everyone up, but over the medium term there will be a lot more risky lending.
Finally, interest rates won’t rise as quickly as was expected, and might even be cut. The markets have already scaled back expectations for higher rates, and by itself that will reduce the cost of borrowing. Credit and mortgages will be cheaper, adding to demand. The net result is not hard to forecast. A lot more money will be
available, but without any extra supply of goods and services – and we all know where that leads.
Over the past year, the Fed, the Bank of England and even the European Central Bank (ECB) have been steadily reversing QE programmes launched more than a decade ago. They have been raising interest rates, with the ECB pressing forward with another half point rise on Thursday even in the face of market turmoil, and at the same time winding up QE, and steadily taking back at least some of the money that flooded into the system over the last decade. With inflation running at 10 per cent or more they didn’t have much of a choice.
And yet, in the space of a single week, that has been abandoned. They have started printing money like crazy again. A temporary measure? Well, perhaps. But they said that back in 2008 and it carried on for another decade. Central bankers have short memories.
It is now clear that weaning all the major economies off printed money, without a crash or two along the way, and without a lot of pain for both consumers and businesses, is going to be very, very difficult. We learned that the hard way in the chaotic 1970s and 1980s and, while we could have learned the lessons of those miserable decades, this week made it clear we are going to have to learn it the hard way all over again.