There was an interesting article hidden in the depths of yesterday’s US print edition of the Wall Street Journal titled, Could Japan’s Central Bank Run Out of Bonds to Buy? This is not as far out as it sounds. Of course, the question arises from the massive amount of “quantitative easing” Japan’s central bank has undertaken in the name of driving demand in a sluggish economy. The USA has done the some thing, the U.K. And Europe too. It has been the second weapon of choice for central banks once interest rates hit rock bottom, or even gone negative.
There is not much research that proves that QE actually drives economic demand. In fact, there is ample evidence that QE does not drive demand in an economy. In fact recent data points to how firms report that their treasury departments do not seek new investments to drive growth if interest rates are rock bottom or cash is cheap; they fund their plans that are based on other factors to do with their industr. These same firms have though sold bonds and acquired loans in order to drive M&A and larger share buy-back schemes. Thus the invester class has gotten much richer while the rest of the middle class has not.
Such massive amounts of bond buying has created huge market distortions. The interest rate at which sovereign governments can offer bonds remains depressed as central banks swallow up larger and larger amounts of bonds. Such a large buyer in the market should crowd out private sector demand for the same bonds. To help spread the impact central banks, as in Japan, have expanded the definition of what it is the central bank can acquire in the name of QE, even to the point of including shares.
In a nutshell QE has not resulted in the behavior central banks sought. And now we are in a pickle. Central bank balance sheets are ballooning, and just as the business cycle passes its peak, central banks have little wiggle room to help smooth the downswing: interest rates remain rock bottom (for the US, they are a smidgen above rock bottom) and balance sheets are full. Even in the US, words of “normalization” does not yet include the Fed selling off its war chest of invested bonds. Such offloading will take years since its impact on the market will be huge: it would drive up the need for bond issuers to offer higher returns in order sell them.
So the question asked by the WSJ is not fanciful. It is a sad reflection of the times we are in. 2016 will be a challenging year for central bankers – as well as for the rest of us. The bad news for us is that we don’t get the chance to write a book after the story has been completed and make a million from that effort.
Happy New Year to you!