Don’t do QE: ex-Fed official

Posted by in Development, Economics

The senior official who oversaw the Federal Reserve’s biggest quantitative easing program has warned Australia against going down the same path, arguing that QE subsidises banks and corrupts financial markets with little benefit for the general population.

Andrew Huszar, now an academic at Rutgers University, said Australia would be “very ill-­advised” to go down the same path as the US, Japan and Europe in creating money electronically to buy bonds, in order to keep downward pressure on long-term interest rates.

“It’s not a tool that benefits the general population much, but rather overwhelmingly the financial sector and the wealthy; the cost-benefit analysis is totally skewed,” he told The Weekend Australian in New York.

“And it’s worse than that because it undermines the urgency to actually do more serious structural economic reform in a country by artificially pumping up financial markets.”

Mr Huszar was lured back to the Federal Reserve in 2009 after a stint on Wall Street to oversee what ended up being a $US1.25 trillion buying spree of mortgage-backed securities, the biggest component of the first of the Fed’s three rounds of quantitative easing.

All up, they have increased the Fed’s assets by $US3 trillion to more than $US4 trillion ($5.2 trillion), or about 25 per cent of US GDP, since 2008.

Reserve Bank governor Phil Lowe appeared to rule out unconventional monetary policies such as QE or negative interest rates in his first testimony before the House of Representatives economics committee this week.

But new research presented at the Peterson Institute in Washington DC last week concluded Australia and Canada had “plenty of scope” for quantitative easing, noting Australian dollar stocks and bonds amounted to more than 200 per cent of GDP.

The Reserve Bank had assets of $63 billion in August, while the ­federal government alone had outstanding debts of $436bn.

Mr Huszar said he was “dismayed” by announcements since June by the Bank of England and the European Central Bank to expand quantitative easing.

“Mark Carney is a former (Goldman Sachs) banker so I’m not surprised he would embrace a tool so enthusiastically requested by Wall Street,” he said, arguing that QE was a huge backdoor subsidy to the biggest banks.

“We have a very dysfunctional banking system around the world, and unfortunately central bank tools work through that sector. It’s inevitable they will be gamed,” he said, adding that highly leveraged mega-banks were largely viable and profitable because of implicit guarantees from taxpayers.

“The Fed drove down the yields on mortgage-backed securities to almost the same as the US government bond yield, but banks continued to lend to households for housing at no less than about 3.5 per cent,” he said.

“Banking is oligarchic, so they just enjoy bigger margins. Rather than use the new reserves they have been given for making loans, if anything, they have mainly piled into fixed-income securities and profited from capital gains from the boom in asset prices and the carry trade.”

Mr Huszar’s comments follow research by the Bank for International Settlements, which estimated dealer banks enjoyed a £1.85 billion ($3.16 billion) subsidy from the BoE’s first two rounds of QE because they could consistently buy newly issued bonds from the Treasury and sell them back to the BoE, a guaranteed buyer, at a higher price.

Former deputy governor of the bank of Japan Kazumasa Iwata separately said the same phenomenon was occurring in Japan, whose central bank had undertaken the most ambitious QE program of all, its balance sheet having risen from about 20 per cent of GDP to more than 70 per cent since 2009. “Japanese taxpayers are, ultimately, subsidising bonuses and bank profits. But this is not easy to see,” he said.

“The Bank of Japan purchases massively every month to attain the target and the private banks know the Bank of Japan will have to buy at much higher price.”

Mr Huszar said the Fed had been diminished as an institution by QE. “When central banks start playing a larger role, they increasingly solicit more informal feedback from bankers, and start to see the world through their eyes.”

Economic theory assumes higher consumer price inflation is associated with lower interest rates. The RBA has cut its policy rate 325 basis points since late 2011 to 1.5 per cent, a record low, over which time annual inflation has fallen from more than 3 per cent to 1 per cent.

The scope and efficacy of monetary policy is increasingly dividing experts. Former Fed economist and chief economist of Brevan Howard Jason Cummins launched a stinging attack on central bankers in Washington DC last week, likening them to the royal court at Versailles before the French Revolution. “You are not going to have independent central bankers in the next 10 years if you keep on this path,” he said.

Adam Creighton AFR/Bloomberg 24 Sept 2016