By Thierry Mezeret, Professor or Finance, Audencia

We are living in extraordinary times, and monetary issues are as much affected as anything else. We are witnessing a combination of unorthodox monetary policy – with Central Banks (CBs) buying large amounts of bonds (Quantitative Easing, or QE), and expansionary fiscal policy – with governments spending large amounts of money, money that they don’t have and therefore have to borrow. Monetary policy (CBs managing interest rates) and fiscal policy (governments balancing their budget) are distinct. They can be, and have often been, activated independently from each another, but work best when applied together, with the former facilitating the latter. But seeing them coalesce today to generate unprecedented, even unlimited, amounts of stimulus raises the question: ‘aren’t CBs directly financing governments by printing money out of thin air, and who will be the winners and losers’? 

The line that separates CBs supporting the economy through QE from CBs financing governments directly (i.e. ‘monetizing debt’) is very fine indeed, and many experts disagree which side we are on today. Most Germans – though not yet the Chancellor – are clearly convinced that the ECB is already monetizing debt, befitting their usual profound aversion to anything that could push inflation out of control. Although it is hotly debated today, four factors support the argument that we are still on the ‘support the economy’ side of the line and have not gone into full debt monetizing mode. They can be summarized as follows:

Firstly, the decision to purchase government bonds with QE is each country’s own CBs’ decision, and so far, they have not been forced by their governments to do so. Governments can’t just choose to ‘print money’ as and when needed, e.g. to give to nurses or policemen. They can only borrow, increasing debt, with the risk that lenders would one day decide not to lend anymore. This is not simply a theoretical risk, it happened to Greece in 2011. Governments thus still have their hands tied by fiscal discipline.

Secondly, CBs purchase bonds directly from investors, not from governments. So technically, CBs do not buy newly issued bonds on the primary market, but debt that already exists. Admittedly, when CBs announce they will buy unlimited bonds on the secondary market, they remove the risk for primary lenders, so it weakens that argument a lot – the German opponents of QE construe it as the European Central Bank (ECB) implicitly financing governments and thereby overstepping its mandate.

Thirdly, QE is meant to be temporary. At some stage, CBs will stop buying new bonds (this already happened in 2013 in the US and in 2018 in the Eurozone) and governments will have to repay their debts. The experience since 2008 does not indicate how and when that would be done, but on the one hand, bonds have 30-year terms and can always be renewed, so governments have time; and on the other hand, such a massive injection of liquidity should create inflation, which would mechanically erase some of the debt. This has unfortunately not happened since 2008 and this uncertainty about repayment is a heavy point of concern. But nevertheless, CBs do not give money to governments, they only advance it for a very long time. And there is an argument to say that 30 years or more leaves plenty of time for growth to return and generate the fiscal revenues needed to repay the debt – while it is admittedly questionable why it would work for a country like France that hasn’t balanced since 1974…

This point is crucial – when presenting QE as a non-permanent injection of cash into the system, CBs send the message that they control the process, and that helps mitigate QE’s ultimate risk – hyperinflation.

Finally, the danger of a CB creating money out of nowhere to permanently finance a government is that of a debasement (a sharp fall in the value) of the currency and an ensuing bout of hyperinflation. Economic agents then tend to replace their worthless currency with a ‘hard’ one (usually the US Dollar, or “dollarization”) whose value is expected to remain stable.

In today’s world, this is unlikely to happen anytime soon, for two related reasons. First, everyone understands why governments need to borrow so much and that CBs are the only place where so many bonds can be purchased. The current surge in debt is not due to countries’ inability to manage their economies efficiently, but to an external ‘act of God’. Rather than being a sign of economic mismanagement, this increased debt represents the governments’ duty to support their economies. Therefore, we should not expect investors to lose confidence and aggressively sell any particular country’s currency. Rather, we might well see the advent of a ‘new normal’, where investors worldwide accept a debt to GDP ratio of 100% as fiscally prudent, vs. 60% or 70% previously. At least, until the situation regularizes, which may well take 30+ years. Secondly, since every country is engaging in massive QE, there is no dollarization possible. Losing trust in the Euro for fear of its debasement and switching to USD would not make sense, since the FED is doing exactly the same as the ECB (other currencies are hardly an alternative, due to the limited size of their capital markets).

When it comes to naming winners and losers, it is fair to say that everyone would be a loser if governments and CBs did not do what they are doing now, given the magnitude of the economic shock. The winners might be the countries able to use that extra budgetary room to invest and create the conditions for future growth, preferably a sustainable one. This will allow their debt to be repaid quicker, thereby reinforcing investors’ trust and allowing further debt to be issued as and when needed, as in the case of Germany. The losers will be those who cannot restructure their economies enough to generate the repayment capacity, as has happened in France.

CBs will be neither winners nor losers, they will simply carry these bonds for decades before being repaid. But not being mandated to generate a profit, it does not really matter to them – all CB profits are paid to governments anyway. The real danger would be for them to lose their independence – an unlikely prospect for the ECB, whose statutes are enshrined in the Maastricht treaty.

Again, the implications of these measures are hotly debated and opinions far from forming a consensus, so the above should just to be taken as one possible view only…