The Guest Blog

Guest Blog: Money-Printing Has Reached Its Limits

Moorad Choudhry |Treasurer, Corporate Banking Division, RBS

Given that title inflation has been with us since the 1980s, in everything from estate agents’ property descriptions to job titles for students in summer jobs frying hamburgers, we should not be surprised that “printing money” in the 21st century is referred to as “quantitative easing”.

The Federal Reserve decides how much money needs to be printed each year and the Bureau of Engraving and Printing does the actual printing. So how do they swap in the new money? When the Fed gets a cash deposit from banks, it reviews all the currency using special currency processing and authentication machines. Generally, those reviews result in the conclusion that one-third of the currency is unfit for future circulation. The currency that’s deemed unfit is shredded and the bills are replaced
Photo: Alex Wong | Getty Images

Ordinarily something to avoid at all costs (the experience of the Weimar Republic, Argentina in the 1980s and Zimbabwe for most of its history should act as kryptonite to any central bank superman thinking of applying QE), post-2008 the risk was of deflation , not inflation .

Then QE made a lot of sense because once deflation takes hold it turns into a vicious spiral that is difficult to break out of: drastic potential outcomes call for drastic measures, and printing money fitted this bill. If not necessarily an inspired move, it was certainly a sensible one.

That was in 2009. Three years later, what risks are we facing? Well not deflation it appears, but we are still in more or less the same space, with stagnating economies in the EU (Germany excepted) characterized by high unemployment , falling business investment and moribund real estate markets. So presumably time for some more QE, as the Bank of England announcedlast week?

Not necessarily. There is only so much a government and a central bank can do to assist recovery, and after that it’s a question of sitting back and letting events take their course. Governments throughout the EU can still do more, of which more anon, but the amount of firepower left to be deployed by central banks is now negligible.

QE works (in theory) by channeling funds from the central bank through to commercial banks when the former buys government bonds from the latter, using money it has created to do this. The cash left with the commercial banks can then be fed through into the wider economy, although banks may also simply hoard the cash or put it to use elsewhere.

It is difficult to gauge the impact of QE with any real confidence because one cannot be certain what would have happened had there been no QE; consequently its performance with respect to its primary objective—releasing funds to the small business sector—is difficult to establish.

So that being the case, why do more of it? Enlarging QE depresses the long bond yield still further, which is bad news for savers and not necessarily good news for borrowers if they are not accessing the lending marketsin any case.

This turns into another classic “supply side” issue, but if governments wish to tackle the availability of credit, surely a more direct mechanism to this end is better than the indirect mechanism that is QE? We noted that drastic measures are called for, perhaps governments should set their central banks up to lend direct to the SME sector? Too off the wall? Not at all, it was done before in the UK in the 19th century.

The point is, the supply side of the economy is collapsing under the weight of its own bottlenecks; monetary policy alone clearly isn’t enough. We need to do more to tackle labor market constraints for a start, and if any other supply side problems are continuing to act as a drag on growth, we should be addressing them directly—not by circuitous routes.

Printing money is a blunt instrument to tackle recession and will be difficult to unwind without market disruption (imagine a single player holding over 30 percent of any market, how stable are things going to be when it decides to sell off its holdings?). There is only so much QE can do to assist economic recovery, and in both the US and the UK it does appear to have reached its limits already.

The author is Professor Moorad Choudhry, Treasurer, Corporate Banking Division, Royal Bank of Scotland. The views expressed in this article are an expression of the author’s personal views only and do not necessarily reflect the views or policies of The Royal Bank of Scotland Group plc, its subsidiaries or affiliated companies, or its Board of Directors. RBS does not guarantee the accuracy of the data included in this article and accepts no responsibility for any consequence of their use. This article does not constitute an offer or a solicitation of an offer with respect to any particular investment.