The Coronavirus crisis will devastate the world economy. In addition to the human costs, the virus will lead to a precipitous fall in economic activity as workers are in lockdown, global supply chains are interrupted and businesses face bankruptcy. The impact is likely to be much more severe than the recession in the aftermath of the Global Financial Crisis in 2008. The IMF is now forecasting a drop in global growth of 3%, a prediction that seems rather optimistic.
The state intervention in the economy is unprecedented both in scope and size, with large parts of the world economy now on welfare and governments running up debt at rates never seen in peacetime before. To facilitate the explosion in public spending, central banks have predictably stepped in as willing buyers of government debt, extending quantitative easing (QE) programmes and thereby guaranteeing the ability of governments to continue to access financing at rock bottom interest rates. But QE was never designed as a means of financing government deficits. In theory, it is a temporary policy by which to increase the money supply in order to provide liquidity to financial markets and reversible by selling the government debt back into the market once markets have recovered. That is the fundamental difference between quantitative easing and debt monetization, where money is printed and donated to the government to spend. The government debt sits as an asset on the balance sheet of the central banks, offset by a liability in the form of the reserves that was created out of thin air and given to the banks to pay for it. However, of global central banks so far only the US Federal Reserve has attempted any reduction of their balance sheet and that short-lived, unsuccessful attempt came to an end amid concerns of the negative impact on equity and bond markets. Instead, central banks have been ‘rolling over’ their investments, ensuring that governments never actually have had to pay the debt off.
There are three big problems with QE. First, an increase in the money supply creates inflation. Inflation can of course mean many things. Inflation of wholesale or consumer prices, asset prices or monetary inflation, defined as an increase in the supply of money and the definition favoured by Austrian economists. And while inflation hasn’t shown up in official consumer prices, asset prices from equity and bond markets to property have exploded. More money chasing the same amount of goods will lead to increases in price levels and as prices do not rise homogenously and instantaneously across the economy, some will benefit and others will suffer. The last decade of QE has clearly benefitted the owners of assets while real wages have experienced sluggish or negative growth.
Second, with no plausible exit strategy, QE is nothing more than deficit monetization and as such is taxation by stealth, the commandeering of economic resources from the private sector. By not repaying the borrowings, the state will not have to forgo spending in the future to spend more today and as no new resources have been created, the state will consume a larger share of the available resources. Besides the fact that this opaque appropriation of resources does not pass muster from a democratic standpoint, resources are of course best left in the private sector, which leads us to the third problem.
QE leads to a sub-optimal allocation of resources, as political, not economic considerations come to the fore. In a free market, capital flows to those projects that meet real demand. In a political economy, capital will be allocated to projects that meet political objectives. Take bailouts of industries impacted by Coronavirus: public money will fill the gap left when private capital has shown to be unwilling to invest in an industry because the business case is unconvincing, perpetuating a suboptimal allocation of capital. For example, bailed out airlines will ensure overcapacity in air traffic when much demand has clearly evaporated, with taxpayers picking up the bill to cover the inevitable losses.
Quantitative easing has become a panacea that central banks willingly roll out to facilitate continued government deficit and underwrite asset markets, but the accompanying economic distortions damages the economy it was supposed to support. By allowing governments to keep spending and propping up stock markets, the policy hides the underlying problems while allowing imbalances to build up. As so often when state institutions intervene, the cure is worse than the disease.