Lords of Finance Redux

Forget the G7, Watch the C5

Martin Wolf endorses Adam Posen’s call for quantitative easing at the Bank of England, and then goes one better, calling for direct monetary finance of government spending, i.e. helicopter money.

Problem is, the world doesn’t want pounds, it wants dollars. But the Fed has no intention of meeting that demand, ergo we are seeing dollar appreciation as rising demand meets rigid supply. For lack of gross dollar flow from the US “bank of the world”, the world is insisting on net dollar flow from US trade deficits, which of course only exacerbates the underlying global imbalances.

Once upon a time, the Fed’s QE2 brought appreciation of the Brazilian real, as well as gold and US equities. More recently, the Fed’s failure to mount QE3 brought just the opposite. But the Fed’s hands were tied, and those who expected it to act otherwise were not paying attention.

The challenge now is apparently to mount a global QE3 without involving any expansion of the Fed’s own balance sheet.

The Swiss National Bank is showing us how it can be done. Committing to prevent appreciation of the Swiss Franc beyond 1.2 Euro, the SNB is in effect committing to printing CHF liabilities to buy Euro assets, expanding its balance sheet in the process. This is QE, and it was already happening even before the formal announcement. Recently released figures show the SNB balance sheet expanding from 250 billion to 366 billion CHF in the month of August alone.

We don’t know exactly what the SNB is buying—the breakdown of SNB assets by currency is reported quarterly not monthly. But we do know that the ECB is selling in order to make room on its balance sheet for the peripheral bonds that it is buying, so we might as well assume that the SNB is buying what the ECB is selling. That means that the SNB QE is economically equivalent to ECB QE, if we think of SNB liabilities as effectively Euros on account of the peg.

This is Euro QE, not Dollar QE, but it does show how dollar QE could happen on the balance sheets of other central banks. The C5 (Bank of England, ECB, SNB, Bank of Japan, and the Fed) have publically committed to unlimited dollar lending. They can only deliver on that commitment if they are at the same time committing to support one another’s dollar borrowing.

From this point of view, the main point of Operation Twist must be to provide $400 billion more Treasury bills, to buyers everywhere but in particular to banks and central banks for whom Tbills are reserves. Dollar credit expansion can happen on balance sheets outside the US, but only if unconstrained by dollar reserves.

Liaquat Ahamed reminds us how central bankers failed to save the system the last time policy makers froze up. It looks to me like they are determined not to fail again this time. For lack of political leadership, we are getting QE3. For lack of the Fed’s own balance sheet we are using the balance sheets of the other central banks.

Forget the G7, watch the C5.

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