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Though it wasn’t the first time, and not among the majors, still New Zealand’s Reserve Bank (RBNZ) earlier this week found itself unable to complete a full QE operation. The monetary authority had recently gone back to quantitative easing because it complained about rising bond yields in the country’s government bond market. Higher rates, it is claimed, threaten economic recoveries.

To alleviate the speculated defect, a central bank purchasing the offending bonds – driving up their price therefore their rates down – seems the perfect antidote. After all, the entire premise of QE is reducing interest rates.

In this particular instance, on Wednesday RBNZ went to collect bids for its preannounced processing. It was offering to buy up NZD 120 million of government debt maturing in April 2025. Banks on the islands submitted bids to sell only NZD 92 million, and only NZD 52 million of those were actually accepted.

Badly busted QE; banks wanted the securities more than they wanted to sell them to the central bank.

A big reason why is that bond prices there, as in other places around the world, have been surging again. Whereas rates had been going up as reflationary optimism injected inflationary expectations across the world, since the end of February bond markets have flip flopped, of sorts, with at least rising uncertainty and perceived global risks much of which focused around the Asia/Oceania part of the world.

While you can argue that the recent downturn in global rates is temporary, and thus needs the steady and less short run-focused hand of a central bank bid behind it, in truth in almost every case this is what ends up happening; a contradiction that has infected QE since before its beginning.

Successful breakthroughs are heralded regularly especially upon their anniversaries when at least fawning media coverage mentions the innovation surrounded by throngs of well-earned kindness. No such luck for QE’s inventors, no celebratory pieces this week marking the occasion.

Those inventors would be the Japanese, of course. While the theory had been proposed earlier, by Milton Friedman among others, it was the Bank of Japan back on March 19, 2001, twenty years ago last week, which took the first step. Not only were officials faced with the challenge of economic causes leading them toward such drastic action, they didn’t really know how or what QE should look like in practice.

In the mainstream view this stuff is still made to sound so very simple and easy. On QE’s very first day those twenty March’s ago, CNN (and every other news outlet) claimed, “The BOJ's move injects a large amount of money into the Japanese economy -- known as quantitative easing.” The media still writes the same thing every time another QE rolls off a seemingly boundless assembly line.

But what did the Japanese themselves really think about all this back in March 2001? Not this at all.

To begin with, the vote taken that day by BoJ’s nine governing members wasn’t unanimous, the final decision passed with eight for and one against. The lone dissenter, Eiko Shinotsuka, had even managed to force her objection into the official minutes (which isn’t a word-for-word transcription, more like a sanitized, stylized summary of discussions) and it was an absolute doozy:

“Ms. Shinotsuka voted against the above proposals for the following reason. Given that the Bank had consistently been against adopting a quantitative target on the grounds that the relationship between quantitative indicators and developments in the economy was not stable, the issue of changing the Bank's monetary policy had not been sufficiently discussed.” [emphasis added]

Though it happened in private during a Federal Reserve discussion nine months earlier, you can absolutely hear Alan Greenspan’s “proliferation of products” discussion echoed loudly in Shinotsuka’s objection: we can’t define money and haven’t been able to in decades, and that is why we stopped targeting specific money quantities, but now we’re just going to go back to it anyway with the one form we know isn’t conclusively monetary?

The fact that this “had not been sufficiently discussed”, in the official recollection of Ms. Shinotsuka’s words, is a huge red flag – one implicating obvious desperation. They didn’t know what else to do, so they flung QE against the wall hoping it would stick.

The reason Eiko Shinsotsoka always gave for her dissent was that low interest rates punished savers, especially pensioners. As she had said when voting against ZIRP two years before, maybe monetary policy should be focused on rates going the other way. Why trade decent interest rates for a policy totally untried when yields were already low and going lower?

Hardly the scientific image presented by the banner quantitative easing.

To that end, in the debate which preceded the vote, no one could say for sure just what the “right” quantity should have been. The eventual proposal which the governing committee adopted, made by BoJ’s Chairman Masaru Hayami, simply read, in part, “For the time being, the balance outstanding at the Bank's current accounts be increased to around 5 trillion yen, or 1 trillion yen increase from the average outstanding of 4 trillion yen in February 2001.”

Rather than target a specific overnight money rate, as the Bank had done for decades, they would retry targeting a specific quantity of bank reserves (“the Bank’s current accounts”). In March 2001, the quantitative part of QE was figured out to be a curiously even ¥1 trillion.

Why exactly ¥1 trillion? A round number seems more random than if they had literally calculated ¥1.023689 trillion or something like that. The latter would have been much more consistent with the precision implied by the program’s name. An even trillion is clearly a number just pulled out of thin air – as the discussion indicates.

They didn’t really know if this, or any other number, would add up to actual easing. It had been widely known throughout the 1990’s, Japan’s so-called Lost Decade, the economy had run up against a seemingly unsolvable banking problem attributed to a surplus of non-performing loans (NPLs) that had been built up on balance sheets from Japan’s hugely expansionary period during the seventies and eighties.

Furthermore, given the rigid Japanese business culture, banks had apparently resisted canceling NPLs out by booking losses and forcing humiliating defaults on customers with strong ties. Untold amounts of academic and policy ink had been spilled on “bank reform”, which had actually begun in earnest in 1997 and 1998 – “cleaning up” Japan’s banks with balance sheet actions including government capital injections.

By March 2001, there still hadn’t been any movement in lending, other than the same post-bubble cutting back. Thus, presented with more deflation as a global 2001 recession took hold of Japan, the QE proposal was a stab-in-the-dark at a number believed “big enough” (the real core QE component) to affect behavior. And even then, they weren’t sure it had much of a chance:

“Many members pointed out that the effectiveness of monetary policy was being undermined by the fact that the credit creating function of financial institutions was not operating sufficiently. They therefore concluded that in order to enhance the effectiveness of monetary policy and put the economy back on a sustainable growth path, it was crucial that firms and financial institutions disposed of their nonperforming assets drastically…”

Again, none of this is truly quantitative other than the sense they’ve randomly selected a specific number that officials hoped large enough though for reasons that are left to the public’s collective imagination seeded by a compliant financial media writing story after story about “money injected into the economy” - when neither part of that phrase is actually true. These are nothing more than bank reserves not money, and they don’t go anywhere or do anything let alone directly impact the real economy unless the banks accede.

But while BoJ’s “many members” pointed this out before voting in the affirmative in March 2001, it turns out they were right about banks coming up short but wrong about why; it hadn’t been the NPLs after all.

In the wake of Japan’s QE1 and then QE2 (as I always write, if you have to do it more than once it can’t have been “quantitative”, not really, which only raises legitimate suspicions about its presumed “easing” properties) which had quickly followed, over the entire middle 2000’s Japanese bank balance sheets were cleaned near spotless of so-called troubled assets, yet lending continued to decline anyway.

Total reserves had been approximately ¥4.4 trillion in February 2001, expanded to ¥27.5 trillion by the middle of 2004 when QE was first “tapered.” Total bank lending during those years dropped by more than 10% regardless; another 10%, that is.

Eiko Shinotsuka had been correct, for once, in that the relationship between mainstream definitions of money and bank or economic variables like lending and inflation had yet again proven “unstable”, to put it mildly. But even at its start, the rest of the BoJ committee had been more upfront about what QE was really supposed to do – it was the furthest from “money printing.”

Expectations. Emotional Effects. Etc.

There was the “commitment effect” (I'm not making this up), for one:

“Members generally agreed that whatever monetary easing measure the Bank decided to adopt, (1) it was necessary to make a strong commitment in terms of policy duration in order to ensure the ‘commitment effect'…”

…which had been meant to shore up other means for psychological manipulation:

“One member proposed that in the current environment where reducing interest rates would have only a limited effect on the economy, the Bank should consider increasing the amount of government bonds it bought outright, in order to affect the public's expectations and underline the Bank's commitment to the targeted interest rate in terms of duration.”

Why had “the current environment” of early 2001 left interest rates with “a limited effect on the economy?” Simple: reducing the overnight uncollateralized call rate down to nearly the zero lower bound in the years before then hadn’t worked, and after having been pushed right to it by ZIRP there was no longer any room for more rate cuts to signal to the “public’s expectations” about central bank intended “easing.”

Bond purchases – now being targeted to a specific reserve quantity – were, they reasoned, needed to show the Japanese people and Japan’s businesses (forget the banks) the Bank of Japan was still enabling economic recovery by doing something. In this craven view, and the bastard theory drawn from it, it didn’t matter what was being done so long as anythingfinancial-ish could be put forward for broadcast.

And the media then, as now, fell right in line.  

When you break down QE in this way, its results, lack of results, really shouldn’t be surprising. In study after study, performed by the friendliest cheerleaders for the technique, the conclusions are framed as if “inconclusive” when by being inconclusive they conclusively show the trick doesn’t work. Ever.

There are dozens of these, and they all sound the same. Here’s one from the IMF published back in 2012 which merely mimics the original objections put forward at QE’s very beginning:

“Research on the effectiveness of earlier quantitative easing has yielded mixed results, with most pointing to limited effects on economic activity. While most papers found evidence that quantitative easing helped reduce yields, its effect on economic activity and inflation was found to be small. The reasons cited included a dysfunctional banking sector, which impaired the credit channel…” [emphasis added]

The most that can ever be tied to QE is “helped” “reduce yields.” That’s a curious way to sound about what’s supposed to be its chief (meaning only) contribution; helped?

In other words, falling rates correlate with QE’s if only because rates are already falling by the time central banks get around to conducting these programs. And if yields are already dropping as things get bad enough to convince central bankers to unleash their psychology, what good are even lower interest rates than the low rates bad things have already brought up?

Circling back to New Zealand, this is just their argument for the idea in 2021:

“The evidence shows LSAP proved effective in providing much needed support, lowering long-term interest rates and exchange rates, and underpinning economic growth and inflation. Studies found the government bond purchases worth 10 percent of GDP have, on average, lowered 10-year government bond yields by around 50 basis points.”

Understand what, after two decades of experience, central banks worldwide are attempting to claim here. I recently summarized this view in this way:

“The official response – in public – is that, yes, rates have dropped on their own but QE made them go (a relatively tiny bit) lower than they otherwise might have. This is the monetary policy equivalent of ‘jobs saved’, a manufactured counterfactual attempting to salvage something more relatable (to the average person) than the even-more-made-up term premium argument.”

As I also noted, in private they wonder aloud why the central bank is buying government bonds that the market is already bidding up. The only answer is to signal some sort of made-up accommodation somehow supposed to cancel out the negative factors already driving up those market bids for the same assets; that rates going lower because of troubling monetary viciousness are magically transformed into virtuous stimulus because a central bank (arguably) made them go a tiny bit lower than they would have anyway.

It's not circular logic; just plain illogic, flat out stupid.

And why, after two decades, in every jurisdiction to where this disease of rationalizing spreads there ends up being a far greater number of QE’s than any inflation rate. There’s no money, there’s no printing, the quantity of a specific accounting fiction is made up from guesswork, and all the easing amounts to is forced happy thoughts that don’t even make sense in the falling rate environment into which they fall.

In New Zealand this week, government bond rates fell sharply leading to the busted QE operation. Once again, banks want the bonds they were bidding up already before the central bank decided to buy. The dollar has turned noticeably higher, too, against the New Zealand dollar as well as several others like the Aussie dollar and, most importantly, China’s yuan. Central banks want to keep rates low, for all the wrong reasons, and now the market seems poised to do it for them (again); reflation’s perhaps pushed back to its edge.

Because, whether Japan or anywhere else, remember what Eiko Shinotsuka had reminded her peers twenty years ago: central banks don’t do quantities of money because they can’t. The reason they can’t is the same reason why the Bank of Japan worried it was being undermined back at QE’s first start. In the end, they simply hoped they could fool the world.

When all is said and done, it is the banking system – not the central bank - which determines the ultimate outcomes. There’s twenty years of established, empirical evidence. After all, who do you think it is buying all these safe, liquid bonds, driving down rates, in the first place? As history has shown, once the banking system determines the direction, central bankers are merely along for the ride. 


Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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