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‘The problem with Quantitative Easing is that it works in practice but it doesn’t work in theory’, dixit Ben Bernanke, previous chairman of the Federal Reserve. And he isn’t wrong because these special ‘tricks’ generally don't have the desired effect without creating negative consequences. Ever since QE started, we have been telling you the majority of the cash that has been pumped in the system hasn’t reached ‘the common man’, nor ‘the companies’. Indeed, banks have been able to borrow cheaply and get rid of distressed assets, but the spillover effects on the ‘real’ economy would be barely noticeable.
And that’s not surprising, the next schematic image, courtesy of the Bank of England, shows you how Quantitative Easing actually works. As you will immediately notice, there are several points in between the moment the asset purchase program starts, and when ‘spending and income’ is being impacted.
Source: Bank of England
So before the freshly printed billions hit the common man in the street, it will impact and be impacted by different substations, and all of these substations will reduce the impact of the potential change for the end station, the consumers and their spending pattern which should lead to economic growth and a higher but manageable inflation rate.
The Bank of England has now also published a working paper wherein the Central Bank tries to identify and quantify the impact of the worldwide QE programs. And the direct impact is much lower than you’d think. According to the official BoE research, the 375B GBP QE program of the Bank of England reduced the yield on the government debt by just 0.25%, whilst in the ECB’s case, the Quantitative Easing program which was announced in early 2015 had an impact of 0.3-0.5% on bonds all across Europe.
Source: Bank of England
What’s really interesting is the fact the investigation confirmed there’s no real advantage for the corporate bond yields. Sure, they decrease as well, but not noticeable faster or lower than the corresponding yields on government debt, as the spread between government debt and corporate debt remains the same. It is however, very interesting to note the category of securities which is impacted the most, are the high yield bonds.
Of course, that’s not really a surprise because in a low-yield environment there’s a flight towards assets with a higher return to make up for the difference in expected ROI’s. The next schematic overview confirms the impact on high yield bonds has been huge.
Source: Bank of England
Does this indicate a QE is actually pushing people to make unsafe investments? Yes, the data are pointing out this is indeed the case, and semi-junk bonds generated a particular amount of interest in the past few years and investors seemed to have been focusing on yield rather than on the yield/quality ratio.
The past few years were a paradise for companies to issue debt, and its underwriters were probably throwing big parties every Friday of the past several years. Just have a look at how the snowball of debt has continued to grow. The next image explains it all.
Source: Bank of England
Indeed, the debt levels are exploding, and in the past few years, the total amount of debt issued by non-financial entities has threefolded (!!) compared to the pre-Global Financial Crisis period.
Let’s sink that in for a moment. Before the crisis, companies were issuing on average $400B of bonds per year (in the US and the UK), but this amount has almost tripled in 2016 since the various Quantitative Easing programs have startes, less than a decade later. It’s amazing to see how the debt pile continues to increase year after year, as these numbers are just taking bond issues into consideration and don’t include credit facilities or term loans issued by banks.
Seriously, does anyone still think this will end well?
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