HEARD ON THE STREET
August 26, 2012, 4:11 p.m. ET
Central Banks' Incredible Lightness of Easing
By RICHARD BARLEY
"Lower for longer" is the market mantra on interest rates, thanks to central banks' extraordinary responses to the global financial crisis. But from the perspective of central-bank balance sheets, the corollary is "larger for longer."
Five years into the crisis, the exit for central banks from their stimulus efforts is nowhere in sight and even may be getting further away.
There are few signs of hawkishness. The Federal Reserve's minutes suggested a good chance of further monetary-policy action, although recent economic data may have dulled the case for it..
The European Central Bank may be poised to engage in large-scale government-bond buying to cut the funding costs of Spain and Italy. The Bank of England is on its third round of bond buying, known as quantitative easing, raising total gilt purchases to £375 billion ($593 billion). It may yet do more. And the Swiss National Bank is printing Swiss francs to stop the currency from appreciating and to stave off deflation.
But, as central banks decide whether to print even more, their balance sheets already have swollen to enormous levels. The Bank of England leads the pack: Its balance sheet of £385 billion is 4.7 times the size it was in May 2007. The Swiss National Bank isn't far behind, with an expansion of 4.1 times to 435 billion Swiss francs ($453 billion).
The Fed has seen assets swell 3.2 times to $2.8 trillion. And its composition is almost unrecognizable, with holdings of Treasurys maturing in more than five years at $1.1 trillion, from $156 billion.
The ECB is a relative laggard: Assets at €3.1 trillion ($3.88 trillion) are just 2.6 times the size they were in May 2007. Purchases of Spanish and Italian debt, even at the short end of the maturity curve, could change that. Combined, the two countries have €585 billion of outstanding securities with maturities of under two years, including bills, according to Barclays.
The economic impact of quantitative easing and other extreme policies remains murky and is generally discussed in terms of avoiding worse outcomes. But some strange results are emerging.
In the U.K., the fund that holds the gilts under the bond-purchase program had £20.7 billion of cash sitting on deposit at the Bank of England as of February, thanks to coupon payments. Unlike interest payments to other investors that get reinvested, that money isn't going anywhere.
The Fed, meanwhile, is handing over its interest income to the U.S. government, making for a circular arrangement in which the central bank effectively helps the government fund itself by printing money to buy huge volumes of Treasurys in the secondary market, before paying the interest it gets on these bonds back to the government.
The Congressional Budget Office, in fact, is figuring on even higher payments of interest from the central bank to the Treasury in 2014-2016 as it expects more bond buying.
But extreme policies also carry risks. The Swiss central bank sustained heavy losses in 2010 and the first half of 2011 after piecemeal currency intervention failed to prevent the Swiss franc from rising.
And the ECB narrowly escaped taking losses on its holdings of Greek government bonds when the restructuring came. Both of those have raised fears that extreme central-bank policy could be a source of great damage, potentially even requiring recapitalizations and limiting room to maneuver.
Still, central banks aren't like other banks when it comes to losses. Swiss National Bank Chairman Thomas Jordan argued in 2011 that even a short period of negative equity would be tolerable. Central banks can't become illiquid, and, over time, their ability to finance themselves effectively for free—through the issuance of irredeemable, noninterest-bearing bank notes—should create a structural profit.
But the biggest oddity about extraordinary central-bank policy is, perhaps, also the greatest danger: how swiftly market participants have come to accept such actions as normal.
Quantitative easing, a shocking development when first implemented, has now become mainstream. Central banks may face a serious struggle if their aggressive moves ever succeed in normalizing Western economies, and they have to call time on extreme policy.