EKIP– Expert Club for Economics and Politics A Different Opinion
This text was originally published in the collection " 2020: Inside and Beyond "
Every intricate story has to start somewhere. In the case of the super-massive printing of money, that moment is 2008, and the starting point is the United States. To get to the answer to the question of why central banks are printing more money today than at any other time in history, and what that means for the global economy and us as individuals, the story could start with at least a dozen other events – the Dotcom Crisis, the Bretton Woods Conference, the Great Depression, the dollar’s de-gold standard in 1971, and others.
The global financial crisis, which began with the bankruptcy of Lehman Brothers in the US in 2008, has the advantage of being fresh enough in most people’s minds to recall, while also marking a pivotal moment in the escalation of monetary management problems. An escalation that has itself been further escalated by the current economic crisis caused by the coronavirus, and has become a story about a lot of money – much of it freshly minted.
Incentives – how did it get here?
In late November 2008, the US central bank, the Federal Reserve (Fed), announced that it would begin buying up debt issued by government-sponsored companies, along with various mortgage-backed securities, on the secondary market. In March of the following year, the program was expanded to include US Treasury bonds. Thus, the world’s largest central bank began a policy of so-called “quantitative easing” (QE). If all this confuses you, don’t worry – it is largely designed to sound complicated. In simple terms, these complex terms mean that the Fed begins printing money en masse to plug holes – and since money printing turns out to be almost unlimited, new and new holes appear. The cycle repeats itself, and everywhere in the world.
The Fed has conducted three consecutive quantitative easing programs. The Bank of England, the central bank of the United Kingdom, also began a similar program in March 2009. The Bank of Japan followed suit in October 2010. The European Central Bank (ECB) did so in March 2015, and the People’s Bank of China four months later. The Bank of Japan further expanded its mandate and began buying up stocks on the stock exchange, intervening whenever indices fell by more than 0.2% by mid-day. In 2012, following Mario Draghi’s famous line, “whatever it takes,” the ECB initiated its own direct monetary transactions and began buying up government debt of eurozone countries in order to artificially lower interest rates on their debt and thus save the eurozone from disintegration.
All this hyperactivity is leading to unprecedented imbalances. However, because most people don't understand exactly how central banks and currencies work, and because, at least on paper, they are anti-crisis measures, these moves go largely unopposed.
Back in 2017, long before COVID-19, central banks set a record for “stimulative” monetary policy. That year, they poured over $2 trillion of artificial liquidity into global markets, mainly through asset purchase programs. A year later, China’s central bank began “supporting” its banking sector and added hundreds of billions of dollars in liquidity. Fast forward another year and Fed Chairman Jerome Powell is backtracking on plans to normalize interest rates, instead of raising them, cutting them further in order to boost lending even more. At the same time, the ECB is further lowering interest rates in the eurozone, which have already been in negative territory for years – i.e. banks are paying to hold their required reserves at the central bank, which forces them to take on even higher risks when lending to end customers. Money printing in the eurozone is starting up again after being suspended for just a few months.
In mid-September 2019, the so-called repo market for short-term loans between US banks crashed and the Fed restarted its extraordinary repo operations for the first time since 2009. Just a month later, US central bankers began buying bonds at a pace of $60 billion each month, thus supporting the growing budget deficits of the world's largest economy. At the same time, the eurozone is practically heading towards stagnation or economic contraction – Germany narrowly escaped a technical recession, while Italy and France ended the last quarter of 2019 with a decline of 0.3% and 0.1% of GDP, respectively.
All of this is happening before COVID-19 even appears on the radar. And as you might expect, the pandemic is driving central banks into even greater frenzy. Were it not for the aggressive interventions of the previous year, 2020 would have started with the global economy in dire economic straits, even without the pandemic. The months leading up to the outbreak of the infection show that key global economies are still not over the 2008 Global Financial Crisis, and the effect of the radical measures taken by central banks to deal with that crisis is already running out in the last months of 2019. The strong painkiller dulls the symptoms, but the disease returns with renewed vigor.
Convenient COVID-19 and the new offensive of central banks
The reaction of spring 2020 cannot be seen as a phenomenon determined by new circumstances, but simply a faster development of processes that have already begun. Processes of central banks that are running ever harder to stay in one place.
The pandemic proved convenient for central banks, firstly, because it saved them from having to explain the failure of the policies to deal with the crises initiated after 2008. In addition, it gave them carte blanche for an even more serious radicalization in the tools used. Quarantines and restrictive measures, combined with the resulting mass fear, led to a sharp limitation of economic activity, an instant drop in supply, job losses and problems with loan repayments. Certain sectors such as automotive, tourism, trade, etc. suffered damage from a decrease in demand or a complete inability to work. Securities markets experienced severe crises, while corporate and government debt yields soared and subsequently fell - again due to central bank intervention. American stock markets experienced a severe collapse, while the eurozone approached the danger of a new "Greek" scenario, this time in Italy.
According to the forecasts of the Organization for Economic Cooperation and Development, in 2020 the world GDP will fall by 4.9%, with the decline being unevenly distributed, and given the difficult last months of the year, this forecast may turn out to be too optimistic. Many southern countries of the eurozone could realize a correction of more than 10%, and Argentina, South Africa and Mexico will be similarly hit. The US economy will shrink by 3.8%, while only China will grow by 1.8%. And all this – after a whole year of aggressive interventions by all the major central banks and governments around the world.
To achieve even these less than impressive results, central banks have effectively taken over key financial markets in 2020. The Federal Reserve has become the mainstay of the US government bond and corporate debt markets, as well as short-term securities. The ECB has expanded its asset purchase program (APP) by €120 billion until the end of the year and created the extraordinary “pandemic stimulus program” (PEPP) worth €1.35 trillion – both targeting public and private assets. The Bank of Japan, like the Fed, has announced unlimited government bond purchases, while the Bank of Canada has created its first asset purchase program with a lower limit of C$5 billion per month. The global economy is being flooded with unprecedented liquidity from newly printed money, with calculations by the Bank for International Settlements showing that the top five central banks will increase their balance sheets by between 15 and 23% by the end of this year alone.
All of this is happening because the environment is now such that a correction in any market would be politically and socially unacceptable. Without this being officially announced, the mandate of central banks has been expanded to not allow any economic or financial constraints or losses, even when this would be normal or necessary for the subsequent recovery.
Large-scale asset purchases by central banks have taken the lead in their toolkit, as the traditional main tool – interest rate policy – continues to take a back seat. The explanation is simple: the effectiveness of lowering interest rates becomes lower the closer they are to zero, and even more so when they are below it. In response to the pandemic, the Fed and the Bank of Canada lowered their rates by 1.5 percentage points, the Bank of England by 0.65 percentage points, the central banks of Russia, South Korea and Australia lowered them by 0.5 percentage points, while the People’s Bank of China only needed a 0.3 percentage point cut. The ECB lowered its main deposit rate from -0.4% to -0.5% back in September 2019, when it also resumed money printing, which it expanded further at the end of 2020.
The pandemic has also brought about an expansion of central bank intervention in the real economy. Almost all major central banks have undertaken significant initiatives to provide direct credit to households and non-financial firms. According to calculations by the Bank for International Settlements, direct financing measures for the non-financial private sector during the COVID-19 crisis will increase central bank balance sheets by an average of 6.4% of GDP, while similar measures during the 2008 crisis resulted in an average increase of only 2.5%. In fact, this is one of the new and unexpected trends – central bankers are developing an appetite for the activities of traditional commercial banks.
The tranquility of the currency board
Against this backdrop, Bulgaria, for now, seems like an island of calm. Through the currency board system, the Bulgarian National Bank (BNB) is limited in undertaking all the new aggressive policies that are observed in most of the rest of the world. By definition, the possibility of stimulating with monetary interventions is limited, and by definition, the connection with the fiscal is also severed, since the BNB cannot buy government securities even on the secondary market.
The reserves, amounting to 56 billion leva, which provide the board are the largest in the 140-year history of the BNB and are invested in AAA assets, which in no way can be compared to the low-quality bonds on the ECB's balance sheet, for example. In fact, the entire fiscal discipline that the government is so proud of stems from the fact that there is no possibility of monetary support for the budget from the central bank, respectively, the government must show discipline or it will be locked out of the international debt markets.
With the entry of the lev into ERM II and membership in the Banking Union, the risk of abolishing the currency board by introducing the euro increases. Bulgaria will lose the advantages of its current monetary system and will participate, together with the other eurozone countries, in the coming era of loose public finances and central banks subordinate to politicians, with all the resulting risks for the economy and financial stability.
Inflation around the corner
The situation thus traced and described raises the question of what can be expected in the future. Spanish economist Daniel Lacalle recently commented that “today’s monetary policy is like the behavior of a reckless driver who is driving at two hundred miles per hour, looks in the rearview mirror, says to himself ‘we haven’t crashed yet, let’s accelerate’ and gives it more gas.” The acceleration is there, but it is unclear where central banks will try to turn the car and how far they will actually take it.
The first major case study since the initial liquidity injection after 2008 is inflation. Economics textbooks tell us that creating a new money supply on such a scale is bound to lead to a depreciation of money. At the same time, official consumer price indices continue to be closer to deflation than to hyperinflation. The debate between inflationists and deflationists is in full swing, including purely theoretical questions about the extent to which inflation, as Milton Friedman put it, is a “purely monetary phenomenon.” But even if the debate were limited to consumer price indices, which are a measure of inflation, we have enough evidence to doubt that the consumer basket accurately reflects the reality of the average consumer’s life.
In the Wall Street Journal, David McIntosh argues that inflation in the sense of higher prices is already here (or at least in the US), but only for the products and services we need during the pandemic. Things we use – like pajamas, books, medical services – jumped between 4-9% in August, while others we don’t need – like airline tickets, hotels and formal suits – experienced price crashes of -5% to -25%.
The negative effects of newly created money in the last 10 years or more are also related to the formation of new price "bubbles" in the stock markets, in the real estate sector, healthcare, education, etc.
Another theoretical explanation for hidden inflation is that while prices naturally rise, new technologies in production make them cheaper and ultimately the nominal price for the end customer remains the same – but there is no real growth in purchasing power, in fact, the opposite. This also explains why property prices, for example, continue to rise, even during a pandemic – because there is no technological support to pull the base down.
Regardless of when the trillions of newly created money will turn into inflation that can be detected by statistical indices, the distortions in the world economy due to aggressive unorthodox monetary policy are already here. Negative interest rates make saving an impossible task for the average person, encouraging him to take his money out of the banks, keeping it in cash, or investing it in the hyper-speculative stock markets. These stock markets are full of more and more zombie companies that are actually in various forms of bankruptcy, but exist only thanks to the enormous support of central banks. On the other hand, this same cash is becoming a problem for today's central bankers, because cash is "under the mattress" and cannot stimulate stagnant economies, especially in the eurozone.
Another problem for central banks is that commercial banks, which already have inherited problems with the quality of their loan portfolios from the previous crisis, are now starting to protect themselves from credit risk by tightening lending conditions despite government stimulus. With delayed lending, economies will have difficulty overcoming the severe part of the crisis. This will lead to expectations for more central bank stimulus, which will, however, become less effective and even harmful.
How the story ends – towards financial socialism
In an attempt to overcome these problems, central banks around the world are moving ever closer to full-blown financial socialism, similar to that of Modern Monetary Theory (MMT), a theory according to which governments can print their own money. Here, freedoms from the perspective of the individual are left in the background. Elements of MMT are already visible in some projects in the early stages of development. For example, all major central banks are already testing new electronic money (Central Bank Digital Currencies), through which cash can be banned, commercial banks can be bypassed and direct payments can reach every citizen without intermediaries. In this way, the system of the so-called "unconditional basic income", fully financed by issuing new money, will be effectively created. The inflationary potential in such a situation is visible, but, as is evident from the recent statements of the Federal Reserve, inflation is a goal that is already openly sought.
Central bank digital currencies are particularly interesting from the perspective of the hypothesis that they are an attempt to achieve what quantitative easing was intended to achieve, but on a larger scale. First, these new currencies could accelerate the velocity of money (a low velocity of money is sometimes interpreted as a cause of low inflation).
Digital currencies will also further merge fiscal and monetary policy, bypassing such “problems” as the need for taxation, debt issuance, and monetization.
Last but not least, through direct banking from central banks to consumers, combined with the elimination of cash payments, the entire payment system can be brought under control and monetary policy can be carried out on a new level – directly into the accounts of economic agents. A completely possible scenario, even if it sounds like a dystopia.
In fact, as Professor Nikolay Nenovski theorizes, the world is already moving towards some form of reproduction of the Soviet financial system, but in an electronic and cashless form. The effective merger of the fiscal and central banks through the monetization of huge amounts of new debt and institutionally implies further steps in this direction. Some indications suggest that it is possible to hide inflation through the prices of goods and services, typical of the socialist system, or, as Professor Nenovski says, to create suppressed inflation, visible mainly in the financial, debt and money markets.
On the other hand, in some countries on the world's economic periphery (such as Argentina, Uruguay, Angola, Venezuela, Zimbabwe, Algeria, Nigeria, Congo, Ethiopia, Sudan, Iran, Pakistan, Uzbekistan, Belarus, Lebanon) inflation is fully noticeable in price indices, and in places it turns into hyperinflation. Nenovski himself makes a forecast for the development of these processes and says that hidden and suppressed inflation in developed countries and open inflation in developing and peripheral ones leads to a strengthening of the monetary hierarchy and to the emergence of the need for a new Bretton Woods-type conference to regulate the disintegration of the monetary system into national segments.
Regardless of the path that will be taken, both politically and technically, thanks to years of unorthodox monetary policy, the world is currently moving towards another reconfiguration of monetary regimes. What is worrying is that the actions of central banks and international specialized institutions point to an attempt to create an even more dysfunctional and centrally planned monetary system – which will make history even more complicated.
