Printing Money
How does endless spending create an investment void in the real economy?
Amidst the 2020 global pandemic, governments scramble to find cash. With interest rates already at record lows, central banks in advanced economies launch another round of quantitative easing (QE).
QE, the endless supply
Usually, when the government needs to spend more than it receives in taxation, it sells bonds to private sector investors, insurance companies, and super-funds. By adopting QE, the government simply gets the central bank to buy government bonds. QE is essentially creating money, stimulating the economy by buying long-term bonds which injects money into the economy and suppresses long-term interest rates.
Japan was the first country to pioneer its QE program in the late 1990s. Those that followed suit were the European, British, and American central banks in the wake of the global financial crisis (GFC). Combined, these central banks have injected $13 trillion into their economies in the decade preceding the crisis. With Japan having the highest debt-to-GDP ratio in the world at 253% and with QE accounting for over 30% of the UK’s national debt, QE is fuelling debt issuance.
Pre-2008, the world saw to it that governments spending more than they received in taxes created the risk of inflation. In response, central banks raise interest rates to counteract inflation. Post-2008, the world saw a sudden disappearance in inflation, keeping interest rates low, which keeps the cost of servicing debt manageable.
Manageable debt or not, it doesn’t seem justified to continuously use QE as a short-term means to prop up the economy. Given that the economic growth preceding it is just enough to repay the minimum of debts to survive. A country is said to overcome its debt problem if its nominal growth, real growth plus inflation, surpass debt payments. History tells us that growth has never reached the same levels before the 2008 financial crisis. This is seen in the graph below.
The reason being that QE never enabled enough growth to achieve an actual recovery. There is clearly an investment void in the real economy.
The void
Low-interest rates make it easier for companies to borrow money and raise capital. As a result, a low-cost financing environment encourages blind optimism and excessive speculative behaviour. According to Gu Qingyang, an Economics professor at the National University of Singapore, this leads to a rapid expansion of debt and adds to the market risks. Reserve Bank of Australia (RBA) governor, Philip Lowe, pointed out a year ago that “monetary policy cannot deliver medium-term growth” and “we risk just pushing up asset prices.” Instead, in a growth-challenged and low-inflation world economy, investment in infrastructure and structural reform would be more effective.
A year into Lowe’s statement and Australia has adopted QE for the first time. In addition to buying government bonds, the RBA is also lengthening liquidity it offers to commercial banks with repurchase agreements where commercial banks temporarily swap collateral in return for RBA cash. Subsequently, with this easier access to cash, corporate behaviour is changing. Over the last decade, there has been enough debt, banks, and debt buyers in the world to allow companies to stay on life support.
Chamath Palihapitiya, CEO of Social Capital in the US, uses the term “zombie companies” for companies that are declining in growth. He claims that companies are profiteering in the short term by issuing stock buybacks. To put it into perspective, in the aftermath of 2008, the S&P 500 spent 7 trillion dollars in the form of paying dividends to shareholders or buying back their stocks. Those expenditures represented more than 90 cents of every dollar of profit.
Looking at the sentiment in Australia, a year before the pandemic, Treasurer Josh Frydenberg urged corporate Australia to invest in growing businesses rather than share buybacks and special dividends. A 2019 treasury report found that $29 billion has returned to shareholders in the form of buybacks and special dividends compared to an average of $12 billion over the previous four years, a 140% increase. Treasury research also reveals that 95% of Australian companies have done little to improve their productivity in 15 years, while special dividends and share buybacks worth billions have become the norm.
This behaviour has left many companies unprepared for the pandemic. It’s not that debt is stagnating growth; it’s the fact that debt is so cheap that companies have become complacent. They engage in short-term behaviour, giving handouts to those who are at the top, allowing next to nothing to trickle down. To overcome this dilemma, a redirection of monetary stimulus is required. Investing in long-term innovation, technology, research and development is a more appropriate stimulus tool. We can’t rely on QE forever.
