So, The Financial Times has finally questioned the wisdom of using QE to purchase good assets. You’d have thought that someone would have noticed the effect by now: new money for old assets just pushes up their price. To hope it creates a “wealth effect” and engenders confidence is a bit perverse.
If bank lending is critical to economic growth, as I argued in these pages yesterday, the biggest problem is what to do when irresponsible bankers have taken advantage of unreliable political, economic and regulatory indicators and lent stupidly. The Western response is familiar: declare all bankers reprehensible and tell them to find enough capital to match the losses that will materialise in their portfolios if the economy doesn’t recover. In other words, deleverage.
China does it differently. In 1998, non-performing loans made up some 38 per cent of Chinese bank assets. Bankers’ behaviour wasn’t an issue, as they’re state owned. The country printed enough money to buy the non-performing assets off the balance sheets of the banks, at par, and squirrel them away in asset management companies. China is patient. It knows that, provided growth returns to the economy, value will return to the assets. But growth cannot return to the economy as long as the assets clog the banks’ balance sheets.
We do recognise this process in the West – we call it “Troubled Asset Relief”. It tells us that QE only works if it is used to buy bad assets. But if you start arguing about the price, in a crisis, you quickly run out of time, which was why Troubled Asset Relief Programme funds went towards recapitalising the banks instead.
If you have cash to buy assets in a crisis, you will make a lot of money. After 1998, China did not go into a recession. Graphs of what happened to the Chinese economy after 1998 are quite instructive. Imagine what those non-performing assets were worth a decade later. And if you think this doesn’t work in the West, google “Maiden Lanes Transactions” to find out what happened to the toxic assets taken off the AIG balance sheet by Fed “loans” (credit creation anyone?). In the AIG case, the beneficiary was the US taxpayer. Tim Geithner, former US Treasury secretary and central banker, had already noted in June of 2011 that the US taxpayer had made $12bn in profit from the bailout of the US banks.
Getting the rubbish off the balance sheets of the banks is undoubtedly critical, but China has also had a consistent policy of expanding the capacity of the banks to create credit. The central bank does this by reducing the ratio of reserves that banks have to hold in proportion to their assets. Recently, the People’s Bank reduced the Reserve Ratio Requirement by another 0.5 percentage points, the fifth such movement in a year.
In the West we’ve been trying negative interest rates, and we remain obsessed with price rather than volume. If China is right, and the European economy could be saved by clearing bank balance sheets and increasing their capacity, why don’t we do it? The problem is that getting the banks functioning again also gets bankers functioning. And since you’ve saved them from the consequences of their irresponsibility once, they’ll assume you’ll do it again. It’s called moral hazard. The Western perspective sees no way out of it: most official attempts to manage risky lending scream in the face of free market ideology. Central banks are deeply leery of being put in charge of the credit cycle. And trying to limit lending into specific asset classes, like property, which usually causes the trouble, is often dismissed as social engineering or state planning. Anathema. Indeed, it’s the kind of thing China might do.
The Financial Times came up with a couple of policy alternatives, but they aren’t much better. The Bank for International Settlements has already illustrated the folly of negative rates; and Helicopter Money is such an obscenely stupid idea that even consenting adults should be banned from discussing it in private. There is a viable alternative. But we’ll save that for next time.