On 2 September 1995 the world’s biggest financial newspaper, the Nihon Keizai Shimbun of Japan, led its Saturday edition with a piece by Richard Werner, a young German economist working at an investment bank in Hong Kong. The article addressed what everyone was talking about: the recession. Japan had risen from the devastation of the Second World War at great speed, becoming the second-largest economy in the world, but during the 1980s a huge asset bubble had developed. When it popped, Japan’s economy fell into a severe, protracted slump. In his article, Werner suggested a cure: a new kind of credit creation by the central bank. He called it ryōteki kinyū kanwa, or “quantitative monetary easing”.
In the decades that followed, Werner has watched as different versions of his idea have been applied around the world: in Japan in 2001, then in the US and Europe in 2008, and at a still greater scale in 2020. The total credit created by central banks through quantitative easing, or QE, is now more than $30trn.
In the process, QE has quietly become the defining idea of our time. For the past 15 years, every major development in our economy and the cultural superstructure that rests upon it – the explosive growth of social media and Big Tech, the property boom, the gig economy, Elon Musk, cryptocurrencies, fake news, overpriced coffee, Brexit, woke capitalism, Donald Trump and yes, perhaps even Prince Harry and Meghan Markle – can be related to the huge sums of new money that have disrupted every major economy.
In recent years the idea of the “widening gyre” – the loss of consensus, polarisation, the culture wars – has been part of the political conversation. QE is not just part of this situation: it is the gyre. It is the invisible gas that raises the temperature.
We have been living through a two-decade experiment enacted by largely unknown people whose power we underestimated. But attempts to end the experiment have been volatile; our politics is now, more than ever, dictated by fluctuations in the markets QE was supposed to control. We are about to find out if this great engine of inequality and stagnation can ever be wound down.
Richard Werner arrived in Tokyo at the peak of the Japanese economic bubble, in the summer of 1989, to start a postgraduate fellowship at the Development Bank of Japan. Looking back on that time from his office, a handsome red-brick building overlooking the cathedral green in Winchester, he told me about his frustration with the mathematical models and “theoretical games” of equilibrium economics, in which demand and supply balance each other out, and markets are rational and perfectly informed. This approach, which persists today, seemed to him to bear little resemblance to the real world. Werner preferred economic history. Theory tended to suggest the price of money shaped an economy, but in practice, Werner thought, what mattered was how much of it there was to go around.
By the end of the 1980s, Japan’s money was everywhere. Between 1970 and 1991, Japanese foreign investment had grown by 100 times. As the largest net investor in the global economy, Japan bought US computer companies and movie studios, Van Gogh’s Sunflowers, and the skyscrapers of New York City and Los Angeles. Pervasive in the culture of the time – in Blade Runner, Michael Crichton’s Rising Sun and even John McTiernan’s Die Hard – was the idea that the future belonged to Japan. Werner’s research focused on a simple question: where was all that money coming from?
It was a puzzle that couldn’t be answered by interest rates, which were higher in Japan than the US – meaning money should have been heading into Japan, not leaving it. “None of the theories worked,” Werner told me. But he was sure that Japan’s vast capital outflows were connected to the other great mystery of its economy: “I thought, it’s connected to the bubble.”
The bubble touched everything. When a young couple applied for a mortgage to buy their first home in Japan in the late 1980s, they were typically offered twice the value of the property. A golf-club membership could cost $3m. An airport-sized piece of central Tokyo had a greater land value than the whole of Canada. It was common for people to talk about the country’s “excess money” over dinner; in one Osaka restaurant the market predictions of the owner, a former nun called Nui Onoue, made her for a time a celebrated stock-picker, so much so that financiers loaned her hundreds of billions of yen to invest.
Werner spent months interviewing people in the Japanese financial sector, and what he heard shocked him. In bank branches, loan officers told him “wild stories” about “chasing customers, begging them to borrow money”. They acknowledged what they were doing was “crazy”, but said: “We were ordered to do it.” Werner spoke to their managers, who told him much the same thing: “Well, crazy days, we were really chasing the borrowers,” but they had no choice. Headquarters told every branch to fulfil quotas for new loans. He then went to the strategic planners at the banks, who wrote the quotas, and they too shrugged at the madness of it all. A senior strategist at a commercial bank told him that he was also given a quota, to extend as much lending as possible to anyone who would take it.
Werner began to think he had uncovered a huge corporate fraud; at some level, orders were being given to create large quantities of new loans. He still becomes animated when he talks about it today, thrilled by the magnitude of what he found. “Who’s behind this?” he asked contacts. “Is it the CEO of the bank?”
“Oh no, no. They’re not involved in these things. The Bank of Japan told us to do this.”
Werner had discovered a secret that was integral to the Japanese economy. The secret was called “window guidance”. In the postwar period, Japan’s central bank had been given unprecedented control over the country’s finances. In any modern economy, almost all the money that is created is done so by commercial banks issuing new loans, and the willingness of banks to lend is a key element in the health of the system. Japan’s central bank had been ordering its lenders to create money, and it was now happening at a terrific rate.
This intervention had begun as a brilliant idea, the source of the postwar boom: banks had been told to lend for investment in the real economy, and Japan’s industrial sector had been flooded with new money to make goods for export. Window guidance put a Sony television in every living room in the Western world, a Nintendo console underneath it, and a Toyota parked outside. But while Japan encouraged credit creation for economic growth, it suppressed “harmful credit, for asset purchases and consumption” – so cheap money flowed into factories, but not into mortgages or car loans. As a result, people’s wages grew, but their house prices changed little, and inflation did not rise.
For decades, the economy flourished under this quiet subterfuge. Then something went wrong: in the 1980s, the Bank of Japan began telling banks to issue loans for everything, especially land. The loans were no longer directed only at economic growth but at assets – house prices, stock markets – which began inflating at an alarming rate.
When Werner saw what was happening he realised it would not end well. Japan’s banks – which then accounted for nine of the ten largest banks in the world by assets – were overexposed to the inflated value of all the loans they’d extended. In a 1991 paper, he predicted that the moment banks slowed their credit creation, asset prices would fall, and the financial system that had come to depend on high asset prices would find itself in deep trouble. A banking crisis was imminent.
Werner’s warning was not popular with the Bank of Japan. He remembers the outcry from asset managers still telling their clients to invest in an ostensibly booming country, and back in Oxford – his face fell as he remembered the shock – he was called in to see his supervisor, whom he said had been pressured to demand that he stop “causing trouble”. He did not have to wait long to be vindicated: in late 1991, Japan’s economic miracle came to an end, and its Lost Decades began.
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That odd phrase, “easing”, comes from Richard Werner writing his article in Japan, where the word kanwa was already used to describe the relaxation of monetary policy. As Werner saw it in 1995, the Bank of Japan had pushed commercial banks to create an asset bubble – but as it could print its own money, it could buy out the now-devalued property loans that had (under its watch) inflated the bubble, freeing banks to lend to businesses. It could take the “non-performing assets” out of the system. It was, he told me, “only an accounting problem”.
When the Bank of Japan eventually implemented QE in March 2001, it took a different approach. Like everyone else, it recoiled at the idea of buying the junk out of the economy, so instead it bought up safe financial assets (government bonds) while flooding commercial banks with money to start lending again. The idea with this type of QE is that it’s like lowering interest rates, but more so.
The basic concept is that interest rates speed up or slow down an economy. Businesses run on borrowing – the Bank of England (BoE) estimates large UK employers are about £1.2trn in debt – so if the economy is cooling, the Bank can lower rates, and employers can build more factories or hire more people. At the same time, people can afford bigger mortgages or car loans, so spending goes up. Prices and wages might then start rising too quickly – if so, the Bank can raise rates again, everyone tightens their belts, and inflation is controlled. In Britain, the Bank of England is tasked with raising or lowering rates to keep inflation as close to 2 per cent as it can.
The principle behind QE is that in a crisis, even if interest rates are already at zero, there is another authority capable of setting interest rates: the bond market.
We may talk about “the stock market”, but most of what’s traded on the world’s financial markets is not shares but debt. Around $130trn in debt is currently being traded. Much of this is bonds, which are agreements to borrow money, pay it back on a certain date, and to pay a regular “coupon” until that date. Bonds are how institutions borrow from financial markets. They’re also traded, and as they’re sold on from investor to investor, their prices and “yield” – the return on owning a bond – change. This yield dictates what prices new bonds can command; the market for old debt sets the price of new borrowing.
Because governments are the biggest and most reliable borrowers, the most fundamental debt that is traded – and by which the price of everything else is reckoned – is government bonds. If you can manipulate the price of government debt, you can change the price of everything from corporate bonds to stocks to houses and cars.
QE proposes that because a central bank such as the BoE (owned by the government, but separate from it) can “print” as much money as it likes, it can buy so many government bonds that their prices will go up, which pushes down the yield on that debt: the cost of borrowing for everyone in the market will fall. This is what the Bank of Japan did in March 2001, and the BoE in March 2009.
This also has another, very significant effect: normally, big investors such as pension funds would pour money into government bonds because they’re safe. But QE lowered the returns on government debt, pushing investment towards other things, such as stocks. “You just have to increase the price of safer assets,” Frances Coppola, who worked in banking for 17 years before writing a book about QE, The Case for People’s Quantitative Easing, explained to me, “and investors will diversify into riskier things.” This combination of cheaper borrowing and more attractive risk, central bankers thought, would increase business investment and stimulate the economy back to growth.
They were wrong. Not only did QE fail to stimulate growth, but it created inequality of a kind not seen for generations, a polarised politics – and another huge asset bubble.
In 1995, as Werner was writing his piece for the Nikkei, a new faction was taking hold in American politics that would impose QE upon the world for years to come. The Republican congressman Newt Gingrich had just become Speaker of the House of Representatives. He brought with him a loathing for public expenditure and a new, more reckless politics. That autumn, in a fight over the federal budget, House Republicans engineered a deadlock in which the American government shut down for a total of almost four weeks.
Bill Clinton prevailed in that battle, but when the Democrats returned to power under Barack Obama in 2009, the Tea Party Republicans once more demanded cuts to public spending. To win the fight they committed to a new strategy: they refused to approve the yearly increase in America’s debt ceiling, threatening a default on the US government bonds that underpin the global financial system. Had the US defaulted on its debts, the ensuing crisis would have made even 2008 seem trivial; the Republicans got their way, and fiscal policy was constrained by a new Budget Control Act.
In the UK, the politics was different but the end result the same: the Conservative-led coalition elected in 2010 embarked on a programme of aggressive cuts to public spending, ostensibly to pay for the clean-up after the 2008 crash. On both sides of the Atlantic (and later, in Europe) central bankers now decided that rather than being the careful guardians of the interest rate, they had a responsibility to stimulate their economies against the damage being inflicted by politicians.
Mohamed El-Erian, who was chair of Obama’s Global Development Council from 2012 to 2017 and is now president of Queens’ College, Cambridge, was at the Jackson Hole conference of central bankers in 2010 when Ben Bernanke, the then chair of the Federal Reserve, made this explicit. “Bernanke gets up and says that he would start using unconventional policies – QE and very low interest rates – not just to normalise markets, but to pursue economic objectives.” With government spending constrained, El-Erian told me, “there was a view that while Congress gets its act together, someone’s got to try to stimulate the economy. And the biggest problem is, there isn’t enough demand in the system. So – let’s flood the system with money.”
The logic seemed sound: part of the reason Americans weren’t spending was that almost a third of US mortgages were still in negative equity. Bernanke and others knew that QE pushed up asset prices, and they reasoned that if the value of Americans’ investment portfolios and houses rose, the “wealth effect” would take hold – they’d buy more stuff because they thought they were rich – and businesses would make more things to sell, invest more, hire more, and everything would be OK again.
Politicians agreed. As he welcomed the new governor of the Bank of England, Mark Carney, in his Mansion House speech in 2013, George Osborne made a declaration that was just as clear as Bernanke’s: the first and most important thing that would stimulate Britain’s flagging economy was not the government, he said, but “active monetary policy”.
But the wealth created by QE stayed where it was. QE, says El-Erian “was very good in boosting asset prices. It wasn’t very good in boosting economic activity. And it had massive distributional effects.”
“QE, by its very nature, increases wealth for asset holders generally,” explains Coppola. “Suddenly, we had these markets where everything was rising all the time. Anybody who was holding stocks and bonds was doing well… but also we saw appreciation in other asset classes, like art and fine wines, and, of course, property.”
Research published by the Bank of England in 2012 found that in just three years QE inflated the wealth of the top 10 per cent in Britain by up to £322,000 per household. It has continued to line the pockets of asset owners around the world, in still greater volumes, for more than a decade since.
In retrospect, Osborne and Bernanke were either naive to think that the people enriched by the wealth effect would splurge it on consumer goods, or they were happy that rising asset prices were good in their own right (Tory voters do love rising house prices). Statistics showed an employment rate well above that of previous recessions, but the work on offer was changing: as companies such as Uber and Deliveroo arrived on a QE-powered wave of technology and investor confidence, the new jobs were “part-time, self-employed or zero-hours”, says Coppola, with many of them in hospitality. The problem was not unemployment but underemployment, and as workers competed for more shifts in lower-skilled work, wages stagnated. In terms of real spending power, the average British worker’s pay is yet to recover.
As QE drove inequality, it polarised politics. Across Europe, America and Britain, swathes of society were not in a position to profit from the wealth boom when it arrived, and were “left behind” – not by globalisation, but by finance. But because it’s hard to get angry at complex central bank policies, the people in these areas got angry at something more familiar: other people.
The votes for Donald Trump and Brexit were, says Coppola, a “loud reaction to this technocratic elite, that said it could fix everything by doing QE, and that the central banks could do it all”. In the American Rust Belt and the coastal towns of England, people raged at jobs going to China and homes going to immigrants, “without really noticing that, actually, that might be because the government hadn’t invested in any of these things”.
Meanwhile, politicians such as Trump and Nigel Farage were helped to spread their message by another product of QE: social media.
The rush of new money in financial markets gave Big Tech the power to buy up competitors such as Instagram, WhatsApp and DeepMind, but the underlying business of Facebook and Google remained based on a single business – advertising – and this business set about taking over the world. Companies that had relied on selling trusted information to people (such as local newspapers) were replaced by companies that could compete more successfully for people’s attention, and sell it to the highest bidder. A new economy of attention arose, and with it an ever more emotive public conversation. The internet became a machine for turning distraction and polarisation into investor returns.
And with financial markets brimming with risk-seeking money, a new business model emerged. Venture capitalists could back companies that might not make any profit for years, decades even: all they had to do was get the company to an initial public offering (IPO) of its shares and investors would flood in, and the equity of the original backers would soar in value. In 2019, the taxi company Uber filed an IPO with a warning that it might never make a profit; investors bought $69bn in shares on its first day.
This trend became more pronounced after the huge QE programmes of 2020 – when central banks once again stabilised financial markets, now panicked by Covid, by buying huge quantities of government bonds. On this occasion, financial markets were made even more excitable by tens of millions of retail investors, who – using apps such as Robinhood and eToro, which allowed them to trade fractions of shares with no fees – began gambling on the rising markets. During the summer of 2020 a phrase, repeated in endless memes, became their creed: “Stocks only go up.”
So much QE had now been done that the laws of physics seemed reversed. The less sense something made, the more likely it was to attract money. Hertz, the car rental company, declared bankruptcy; investors piled in, sending its stock soaring. GameStop, a struggling chain of videogame shops, triggered financial activism that cost short sellers who had bet against it almost $20bn and forced the closure of two hedge funds. Special purpose acquisition companies – vehicles to invest in businesses that might not even exist – were launched. Dogecoin, a cryptocurrency devised as a joke, had a dollar-equivalent money supply greater than that of Estonia. An NFT (a web link) attached to a digital picture of a rock sold for $1.7m.
Which brings us to Harry and Meghan. The Sussexes would doubtless have found love and fought with their families, whatever the economic conditions. But Harry and Meghan the media franchise – the $100m juggernaut of monetisable self-pity – made its fortune producing content for the technology companies Spotify and Netflix.
From the 2008 crisis to the point at which the Sussexes’ $100m deal with Netflix was announced the market capitalisation of Netflix grew a hundredfold, to over $200bn. Netflix could pay an extravagant sum to the prince and princess of first-world problems because it could sell its stock at $500 a share and raise tens of billions through issuing bonds.
The Sussexes’ Spotify deal was wound up this summer; one executive called them “grifters” – a now common insult which refers to people who lack the talent to achieve their own success, but achieve it by exploiting the attention economy. The truth is that QE created a worldwide economy of grifters – celebrities, influencers, crypto evangelists, populists – who harnessed its effects.
The true creature of the QE world is Elon Musk, whose skill at offering risk to investors far outweighs any prowess he might have as an engineer. By 2021 Musk had been charged with securities fraud and ran a car company that had, to that point, made a net loss from selling cars; the market made him the richest man in the world. Musk’s wild, unrealisable promises and his obsessive desire for attention or outrage are the formula for success in the QE economy.
This is why, with his QE riches, Musk bought Twitter: he knows his ability to command attention is central to his wealth and power. Like Jeff Bezos, who owns the Washington Post and was a passenger on the first private space flight, or Sam Bankman-Fried, briefly one of the biggest political donors in America before his crypto empire collapsed, Musk has been thrust into a unique position of power by QE. A chart of political donations by billionaires in the US shows a huge rise from 2010, as QE gave them the extra money to contribute and a reason to do so. The rest of society desperately needs functioning capital markets and sane monetary policy. The billionaire class wants the party to continue.
The revolution began quietly: on 7 March 2022, the Bank of England allowed £28bn in UK government bonds (known as gilts; they were once gilt-edged slips of paper) to “fall off” its balance sheet – meaning that when the bonds matured, it didn’t buy new gilts to replace them. The long project of winding down the Bank’s £895bn balance sheet was under way. The era of quantitative tightening, or QT, had begun – but few outside the Bank took much notice. Most people were more interested in the Bank’s raising of the basic rate of interest; mortgages and other borrowing were getting more expensive by the month. But QT would not stay quiet for long.
Six months later, Liz Truss and Kwasi Kwarteng announced a plan to grow the economy with a programme of tax cuts, funded by new borrowing. The government borrows money by selling bonds and Truss planned to issue more than £60bn in new debt in the first year of her plan. The accepted narrative about what happened next is that this “spooked” the market for these bonds – No 10 was planning to sell too much debt, without a credible account of how it would improve the economy that underwrites it.
But Truss and Kwarteng were also doomed to fail by the Bank of England, which also planned to sell very large amounts of gilts, at exactly the same time. Perhaps Truss and Kwarteng didn’t ask the Bank – with which they had a combative relationship – about its plans; perhaps they did, and failed to understand the implications. They soon found out. The day before Kwarteng announced his short-lived economic plan, the Bank began selling off the gilts it had bought during QE.
As in any market, the huge surge in supply caused a collapse in prices. Pension funds also began selling off gilts as they scrambled for liquidity in a tilting market. Mortgage rates began to climb. The Bank was forced to intervene to avert a chaos it had itself at least partly created, and did so in a fairly limited way, lurching back into QE mode and giving the government just two weeks of extra liquidity. Truss became Britain’s shortest-serving prime minister, outlasted in Downing Street by the contents of her fridge.
This was a profound turn for our democracy: a prime minister who had at least been selected by her party to take the economy in a specific direction had been deposed by monetary policy. She was replaced by a centimillionaire who openly thanked “the UK bond markets” for installing him as leader. Andrew Bailey, the governor of the Bank of England, was asked by a Bloomberg economist what role he had played in this: “Of course we didn’t depose Liz Truss,” he answered. “I would never do something like that.”
On 4 October, as Sunak told the Conservative Party Conference about the “long-term decisions” he would make to “fundamentally change our country”, the yield on a 30-year gilt rose past the level it had hit during the Truss experiment, taking the cost of long-term borrowing to its highest level since 1998.
Sunak and Hunt have not calmed the markets with a new programme of fiscal discipline, because spending plans were not the cause of its distemper. It is the prospect of a QT future – years of higher interest rates, and the selling-off of the assets accumulated by central banks – that is raising the yields on government bonds around the world. Yields on US Treasuries have spiked, too, as have German and Italian government bonds.
The risk now is that central banks enter a dangerous competition, in which they over-tighten monetary policy to protect their currencies. “In theory, all central banks selling off their stocks of government bonds, all at the same time, is sovereign debt crisis territory,” says Coppola. “We don’t want to go there.”
QT may in its own way become as disruptive as QE was: the risk that was sucked out of financial markets has to be carefully reintroduced, and casualties – of which Silicon Valley Bank (which collapsed last March) is just one early example – are inevitable. One investment class currently delivering high returns is the “catastrophe bond”, which pays out when other assets collapse. The super-bubble created by a decade and a half of cheap money must be deflated with care.
To do so will be expensive, especially in Britain, thanks to a piece of accounting done at the very beginning of the QE era. In 2009, the government knew that the Bank of England would actually make money from QE – by creating new reserves at low rates, and using the proceeds from them to buy gilts at higher rates – and it was agreed that this “excess cash” would be handed to the Treasury. This was a huge money-spinner for the government, adding more than £120bn in receipts between 2009 and 2022. However, in order to get its hands on the money the Treasury also had to indemnify the Bank against losses when higher rates arrived, which it is now doing at an even greater price: in July alone, the government had to pay the Bank £14.3bn to cover its QE losses. One estimate puts the cost at £170bn over the next decade.
If Labour wins the next general election, this is what it will have to contend with: not just the long tail of austerity and the pandemic, but the cost of the epic number-fudging that the Conservatives deployed to pretend that austerity, Brexit and other aspects of their ideology did anything other than damage the economy.
This will require a bold response: as Jeremy Hunt and Rishi Sunak have shown, grey-suited fiscal discipline is not enough to appease financial markets that have been handed political power by QE. The wealthy want their free money back, but governments must resist them. “We got hooked on a finance-dependent growth model, which has run out of steam,” Mohamed El-Erian told me. “You can’t allow yourself to be held hostage.”
[See also: This isn’t a “mild” recession]
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This article appears in the 28 Feb 2024 issue of the New Statesman, The QE Theory of Everything