Pumping cash into the economy was meant to make us all better oﬀ. Instead the money got locked into stocks and bonds to enrich the wealthy, while austerity made everyone else poorer
The editor of this esteemed publication recently asked me to answer the following two questions: Where has all the QE money gone? And does it matter that government debt is rising?
Let me start with a story. During the depths of the recent economic crisis in Ireland, the village pub was struggling to keep going. As the landlord sat worrying where the money would come from, a German tourist stopped by. He asked if they had accommodation, and the landlord said there were two rooms upstairs. The German gave the landlord a €50 note to reserve a room while he fetched his wife to view them. The landlord was delighted and immediately took the banknote round to the local butcher, to whom he owed €50. The butcher was equally pleased and took the cash round to his builder, to whom he owed €50, who in turn gave it to the undertaker as payment towards his late father’s funeral. The undertaker took it back to the pub and handed it to the landlord to pay his bar tab. The German and his wife came down the stairs, said they didn’t like either room, and the landlord handed them back the €50 note.
That was how quantitative easing was meant to work. The theory held that if you pumped money into the economy through QE, then the money would quickly circulate round the whole economy, making everyone better oﬀ. It was printing money, pure and simple. It was legitimised as monetary magic by central banks freeing up money through buying back bonds. At the time, every single economist expected inflation to be the main risk – and central banks said that even that would be a good thing, because inflation would be a sign economies were working again.
What central banks missed was the risk that the money did not circulate but instead got stuck in the system. What would have happened if the Irish landlord hadn’t been able to give the German his €50 back? And that is indeed what happened. Instead of the QE money being circulated, it was quickly sequestered into the financial asset system – locked in and invested in stocks and bonds. Rather than circulate the money, the banks and funds used it to buy more bonds to sell back to central banks – which caused interest rates to tumble and bond prices to rise, making all investors holding bonds wealthier. Low interest rates did not incentivise investment in productive capacity; it simply fuelled investments in stocks and bonds. The owners of financial assets got richer from QE. Economies hardly benefited.
Falling interest rates meant investors could borrow money more cheaply, which they did. Private equity owners saw the opportunity for their companies to borrow loads of money, meaning they could pay themselves higher dividends – which is why Pizza Express is going to default. Company executives in listed companies saw the same opportunity – leveraging their companies up by raising more and more debt to buy back their stock – which is why there will be a massive rise in defaulting companies when rates normalise. The result was that stock prices rose, and senior executives got bigger and bigger bonuses because they were (apparently) such excellent managers that the stock prices of the companies were rising (!).
As interest rates fell, more and more money piled into financial assets: bonds and stocks, on the expectation that lower rates are good for bonds and good for business. The fact that companies were not investing their money in real assets such as infrastructure or new factories or in creating valuable new jobs didn’t seem to matter. With bond yields so low, more and more investors bought equities because although they might have been riskier, they gave higher dividend yields. (If you are wondering where the next financial crisis will come from… take a guess.)
At the same time, governments around the globe started to worry about their debt. They figured investors would panic if they borrowed too much, so they all started austerity programmes, cutting spending on police and other services and slashing state benefits. As the rich owners of capital assets got richer and richer, the workers found themselves paid less and less, forced into gig-economy jobs with fewer rights and protections, and the most vulnerable in society started to fall through the cracks. Government ministers congratulated themselves for their tough counter-cyclical policies – they were generally idiots.