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8 October 2017

How the world’s greatest financial experiment enriched the rich

Western governments have printed trillions of dollars to boost their economies. While the asset-rich have reaped the benefits of QE, millennials and the poor have lost out.

By Christopher Thompson

“Give me control of a nation’s money and I care not who makes its laws” – attributed to Mayer Amschel Rothschild

The most powerful place in Europe is not the boardroom of its biggest company, the trading floor of its richest bank, or even the Bundestag chambers of Angela Merkel. It is a nondescript room on the seventh floor of the European Central Bank (ECB) that, overlooking a former wholesale meat market, resembles a suburban call centre: bare walls painted dull white, floor-to-ceiling windows and open-plan desks littered with headsets, computer monitors and little else. Secrecy is paramount: there are no mobile phones, all telephone conversations are recorded and notepads are not permitted to be taken outside. Nicknamed “the Kitchen”, it is where 20 traders help create €3bn a day at the stroke of a keyboard in the greatest financial experiment ever undertaken.

Since the beginning of the global financial crisis in 2008, the major central banks have been endowed with unprecedented clout. They can cause economies to contract or expand, create or destroy millions of jobs and violently change the flow of trillions of dollars sluicing through the world economy with a single public statement.

Once caricatured as little more than glorified bean counters, monetary authorities in the West have turned on its head the adage by Mervyn King, the governor of the Bank of England from 2003 to 2013, that good central banks should aspire to be “boring”.

The fortified entrance of the ECB in Frankfurt, Germany’s otherwise drab financial capital, bears testament to this role shift. Screened off the main road by concrete blast barriers similar to those used to protect foreign embassies in the Middle East, it is guarded by a phalanx of dark-suited security men wearing secret-service-style earpieces, who chaperone visitors along a row of X-ray machines. In the front courtyard is a metal sculpture in the shape of a shrub with golden leaves. Critics have labelled it the “money tree”, the implication being that central bankers think they can fix the global economy by conjuring cash from thin air, in quantities that would make Croesus blush. That is exactly what they do.

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In a little under a decade, central bank “kitchens” in the US, Europe, the UK and Japan have inundated financial markets with more than $8trn using a system dubbed “quantitative easing” (QE). This equates to around $10,000 per man, woman and child in the countries whose currencies they guard.

The Bank of England, whose own kitchen began creating hundreds of billions of pounds in March 2009, has justified its powers in the starkest terms: “Without the Bank’s [actions], most people in the United Kingdom would have been worse off. Economic growth would have been lower. Unemployment would have been higher. Many more companies would have gone out of business. This would have had a significant detrimental impact on savers and pensioners, along with every other group in our society.”

If you work in finance, or one of its distributaries in law, accountancy or consulting, then this tsunami of money has undoubtedly been very good news. Thanks to central banks’ money spigots, rising property, stock and bond markets have helped global private wealth grow by two-thirds since 2008 to $166trn, according to the Boston Consulting Group.

“Banks have been the biggest beneficiaries,” Paul Marshall, co-founder of Marshall Wace, one of Europe’s biggest hedge funds, wrote in the Financial Times in September 2015. “Asset managers and hedge funds have benefited, too. Owners of property have made out like bandits. In fact, anyone with assets has grown much richer. All of us who work in financial markets owe a debt to QE.”

But for many, especially young people with few assets, this era of unprecedented central bank largesse has been characterised by job insecurity, rising house prices, sluggish real wages and widening inequality between the “1 per cent” and the rest.

The adverse consequences of the ongoing QE programme are now increasingly being recognised, including by its architects. Alistair Darling, the Labour chancellor of the Exchequer when the policy was introduced in the UK, wrote in September that it was meant as a “short-term shock therapy”. “QE is not a long-term remedy for a chronic problem.” Nicholas Macpherson, the permanent secretary to the Treasury from 2005 to 2016, was even more blunt, tweeting: “QE like heroin – need ever-increasing fixes to create a high. Meanwhile, negative side effects increase. Time to move on.”


Quantitative easing’s name is derived from the huge sums of money it involves. Once a quantity is released into the market, there is downward pressure – the “easing” bit – on borrowing rates. This is due to supply and demand. If you took a hot-air balloon filled with bundles of £50 notes and proceeded to dump them across the countryside, the cost of borrowing should decline because there would be more spare cash sloshing around than before. This is a bit like what central banks have been doing, except the primary recipients are City fund managers, not village yokels, and the amounts involved would capsize your balloon basket. In the UK alone, there is about £1.2trn more money in circulation than there was a decade ago, according to Trading Economics, a research firm.

The logic behind QE is as follows. A central bank, which alone has the power to create (and print) money, wants to spur inflation, so that companies will be encouraged to borrow money and invest it, creating jobs. One way to do this is to lower the cost of borrowing. The hope is that access to cheaper credit will mean that banks are more willing to lend and consumers and companies are more likely to borrow and, therefore, spend and invest. The theory is that this generates economic activity. As more money is created, more money circulates in the system, and the cost of borrowing it falls. Prices should also rise, but (one hopes) not too high. Western central banks set a target for annual price increases of around 2 per cent. If inflation undershoots the target, companies may prefer the safety of hoarding cash and are less willing to invest. If it overshoots, then prices become volatile, weakening consumers’ power to buy things. The primary job of all central banks is to maintain this fine balancing act called “price stability”.

David (“Danny”) Blanchflower, an economics professor, sat on the Bank of England’s Monetary Policy Committee (MPC) that introduced QE. “In 2008, we had to get borrowing rates down to save the economy. But how much money do you create to get interest rates down by a quarter of a percentage point? Is it £50bn or more? We had no idea of the amounts needed. It was a bit ‘suck it and see’,” he told me.

Since then, the cascade of new money through the financial system has had two major consequences. The first is that the price paid to borrow it – expressed as the interest rate on a loan – has plunged to the lowest in history. The Bank of England’s  base rate presently stands at 0.25 per cent. In the eurozone, the ECB has instituted a negative interest rate of 0.4 per cent. By, in effect, charging banks to hold their surplus cash at the central bank, the ECB is trying to encourage banks to lend it out instead.

Because money is so cheap, borrowing has gone up – massively. Global debt has increased by $70trn to more than $225trn in a decade. This is over three times the value of humanity’s annual economic output, an “all-time high”, according to the International Monetary Fund (IMF).

The Bank of England’s note printing room in 1854, as portrayed in the Illustrated London News

Although QE is colloquially described as “printing money”, thanks to technology central banks don’t actually need to print hard cash. Nowadays, most money is electronic, represented by figures showing the balance of an online bank account. Once a computer produces them, the bounty can be transferred across cyberspace.

Central banks don’t just hand over this money regardless. They do it by buying bonds, most of them issued by governments, from financial institutions such as pension funds and insurance companies, which hold them as investments. “Bonds” are just tradable pieces of debt – their name implies a promise to pay someone back (“My word is my bond”) – which offer an interest rate and repayment of the original amount borrowed, just like a loan. Because governments issue so many of them to fund their budgets, bonds are the biggest traded financial asset. A few years ago, it was estimated that the global bond market was equivalent to $100trn, or twice as big as global stock markets.

Imagine you have some spare wealth (just imagine) in the form of government bonds. Thanks to QE, increased demand has helped push prices up. You decide to cash in and sell these assets to the central bank. Afterwards, you have to decide how to spend the proceeds in order to generate another profit. You could buy more bonds, or shares on the stock market, or sink it into property – anything that you are confident would provide a greater return over a given time than the assets you just sold.

This is the second major consequence of QE: financiers have used the new-found money to go shopping, all at the same time. Suddenly, demand for assets significantly exceeds supply. This pushes up the value of investment assets – including shares, which have surged to record highs despite weak economic growth, and bonds, and also fine art, London property and vintage Château Lafite.

“QE is designed to raise asset prices and that’s what it’s done,” Danny Blanchflower told me.

But as things get more expensive, the projected profit on your investment goes down. Investors who want to maintain a higher return are forced to look for riskier investments – such as lending to small businesses. Defenders of QE would point to this “trickle-down” effect: a positive wealth shock for those who work in financial markets in turn supports spending and confidence in the real economy, where businesses buy and sell things. For instance, as borrowing costs decline, so should the monthly interest payments on your credit card and mortgage. This leaves more money for you to spend or invest. In theory, the trillions that central banks inject into the market through their bond purchases should slosh through the economy as they are lent and re-lent, lifting all boats.


Those who foresaw the effects of QE were handsomely rewarded. Five years ago, the Singapore-born Nikhil Srinivasan managed €450bn from a neoclassical building in Milan that was overlooked by the thrusting spires of the city’s Gothic Duomo cathedral. As the chief investment officer of Generali, one of Europe’s biggest insurance companies, Srinivasan and thousands of investors like him habitually invested in bonds across the eurozone. That is, until they became worried about whether they would get their money back.

A debt-to-GDP ratio is a rough measure of affordability, comparing what a country owes with what it produces. By this yardstick, eurozone governments such as Greece, Italy and Portugal owed more than their annual economic output. When they tried to borrow from financial markets, investors demanded a much higher rate of interest to compensate for the increased risk of non-repayment.

As the probability of defaults increased, panic ensued. The prices of the indebted governments’ outstanding bonds – hundreds of billions of euros’ worth – plunged. Banks that were big investors in government bonds faced huge losses. With their external financing, in effect, cut off, all but the most credit-worthy governments were left without the means to fund their budgets.

“It was like a rerun of the financial crisis all over again,” Srinivasan told me. “For us, it wasn’t a question of if the central bank would act, but when.”

Srinivasan wagered that the only way to save the region from collapse would be for the ECB to intervene directly in the market and buy for itself the governments’ bonds that nobody wanted.

One consequence of such action would be to stabilise prices – especially of the most indebted governments – to reflect the ECB’s demand, which, in theory, was limitless. So Srinivasan set out to buy the riskiest, longest-dated bonds he could find from countries with the biggest government debt loads. If prices rose, he stood to gain a windfall; if they didn’t, he would be fired.

At the time, Srinivasan didn’t have to travel far for the kind of bonds he needed. He found them just down the road from his office, in Rome. Making what he would describe as the boldest bet of his professional life, he called up an incredulous Italian treasury and asked if it would like to borrow half a billion euros for 50 years. “They were surprised. No one else seemed to have come forward with a request to lend for such a long period,” he said.

The Italian government agreed to pay him 5 per cent interest per annum – equivalent to €25m – on the bonds it gave him, a generous sum that reflected the fact that there were few other lenders. A month later, he called back and lent it another half-billion euros, this time for 30-year bonds.

“The market thought we were a bit crazy,” he said. “We felt the ECB had no other choice than to intervene directly in the bond market – so very early we put our money where our mouth was.”

When the ECB announced its QE buying programme at the end of 2014, bond prices rose sharply as investors hunted for assets. The value of Srinivasan’s investments increased by more than half, netting his employer a handsome paper profit. As the cash kept flooding in, however, assets quickly became much more expensive. A new problem arose – one that most people wished they had. What to do with all that money?

Around €500m can be found 1,100 kilometres from Milan, two storeys underground, in the form of concrete foundations at 20 Fenchurch Avenue in the middle of the City of London’s old financial district. Generali, which has received more than €8bn from the ECB’s money kitchen, decided to invest a chunk of its QE proceeds on building a giant office block to take advantage of the UK capital’s soaring property prices.

The Bank of England had already helped turbocharge the UK property market with its own QE programme, designed to breathe life back into the economy after the crash: between 2009 and 2012, it pumped £375bn into financial markets while cutting borrowing costs to their lowest in history. European buyers got in on the act, too, and poured their idle billions into bricks and mortar, pushing up prices further. Unsurprisingly,  the boom in London property values is the fastest on record.

It is a similar story in Tokyo, New York, Paris and Frankfurt. Property values have boomed in all financial centres – and, to a lesser extent, in smaller cities – as QE recipients have invested in homes and offices.

Rapidly increasing house prices wouldn’t matter so much if earnings had more or less kept pace. But they haven’t. The average house price in the UK has increased to six times earnings, compared with a historical average of 4.5, according to the building society Nationwide. In Belgium, New Zealand, the UK, Australia, Canada, Sweden and Norway, house prices relative to incomes are at least a fifth dearer than their historical averages, according to the Organisation for Economic Co-operation and Development (OECD). In those cities with large concentrations of financial workers – in effect, QE punchbowls – the multiple is usually much higher. For property owners, this has been a bonanza. For young people, who have lower home-ownership rates, it has been a disaster.


Alberto Gallo, a Goldman Sachs alumnus who nowadays manages a $750m hedge fund called Algebris Macro, doesn’t exactly fit the social-justice-warrior archetype. I came across the 34-year-old Italy-born economist when, as a reporter, I covered bond markets at the Financial Times in 2013 and 2014.

Back then, as financial markets were in a state of near frenzy at the prospect of the ECB’s buying programme, Gallo stood out. While peers would write emails to clients (and journalists) telling them how best to profit from the ECB’s money pump – in sum: buy pretty much any bond – Gallo would fire out jarring missives warning about QE’s “collateral effects”. Foremost among them was worsening inequality and a widening generational divide as asset prices – such as apartments in his Pimlico neighbourhood in London – began to spiral upwards. Put simply, this benefited asset-rich older generations at the expense of asset-poor young people.

“QE leads to a misallocation of resources by distributing wealth to those with assets. Those without assets, such as young people, lose out on a relative basis,” he told me in April, in between bites of penne al ragu at his office near Piccadilly’s Burlington Arcade. “We’re now looking at the first generation since the Second World War that could die poorer than their parents – the exception being if you have rich parents to inherit assets from. QE leads to more inequality between generations, but also within generations.”

According to Gallo, QE is an extreme manifestation of a much older problem of debt-based economic growth. In the post-1945 period, Western economies could borrow and rely on expanding populations and rising productivity to generate economic growth. Debt could be paid down over time. Presently, Western population growth is lower, productivity has flatlined, and post-2009 economic recovery is one of the weakest on record. But instead of pursuing fundamental economic reforms to try to jump-start growth and pay debt down, governments and central banks have loosened the credit spout even further. The result is that debt has expanded faster than national economies.

A classic example of this was the British government’s “Help to Buy” programme. Instead of reforming Britain’s sclerotic housing market, Help to Buy offered subsidised lending. As cheap credit helped buoy record prices, first-time buyers faced a kind of Faustian pact: take advantage of low interest rates and take out a bigger mortgage than anything your parents or grandparents dreamed of; or spend up to half your income – and quite possibly more – on rent with little prospect of savings or wealth accumulation.

In a twist on Marie Antoinette’s words that showed her disregard for the peasants, Raghuram Rajan, a former chief economist at the IMF, has described such policies as “let them eat credit”. Debt allows people to maintain their ability to buy things that they couldn’t otherwise afford. You can discern this easily enough from the recent warnings about UK consumer debt: combined outstanding car loans, credit-card balances and personal loans have increased by a tenth over the past year, far outstripping the rise in household incomes.

But no politician, Rajan argues, wants to face the tough reality of declining growth, or an economic crisis in which voters will have to cut back their consumption. Allowing more people to borrow to buy a house, a car, a holiday or any other asset, let-them-eat-credit policies are an easy way temporarily to boost the economy, postpone fundamental economic changes – and win votes.

“Businesses and homeowners become dependent on cheap credit,” Gallo says, “and the asset bubbles created mean you get caught in a kind of ‘QE infinity’ trap: you can’t turn off cheap credit without fundamentally shocking the financial system, so you prolong it instead. An addiction to cheap credit is a fundamental flaw in our economic system.”

Like all addictions, the big question is whether the habit can be kicked.


Chris Salmon, the strategic brains behind the UK’s QE operation, grapples with this precise problem. The man whose signature, as former chief cashier of the Bank of England, appears on millions of banknotes, sits in a high-ceilinged office in the gilded heart of the City, incongruously surrounded by stark, black-and-white prints of derelict British factories. To understand the outsized role that the Bank’s QE programme has played in the UK economy, look at the balance sheet. Before the financial crisis, when Salmon was private secretary to Mervyn King, the Bank of England’s assets and liabilities totalled around 5 per cent of the UK’s annual economic output. Thanks to QE bond purchases, they have swollen to nearly a quarter of GDP. As a senior Bank official put it: “QE is like blowing up a balloon. We are concerned about letting it out slowly.”

The Bank is right to be anxious. Of all the world’s major central banks to have embarked on QE, only the US Federal Reserve has announced a plan to wind down bond purchases and trim the size of its balance sheet. It plans to do this by letting the existing bonds it bought mature. In the case of government bonds, the government will, in effect, be repaying its own central bank the money it borrowed. By contrast, the UK’s “balloon” has inflated. Following the Brexit vote and the threat of an economic downturn, the Bank voted to increase its balance sheet by an additional £70bn of bond purchases – including, for the first time, those issued by companies.

The Bank of England’s buying was carried out in a secret room on the first floor, reached by windowless, stone-clad corridors that give the impression of walking towards a fortress turret. The process took around six months via thrice-weekly auctions, each beginning at 2.15pm and lasting no more than 30 minutes. Sellers – banks operating as intermediaries for clients such as hedge funds or insurers – submitted their best offers and a computer ranked them by price. Those deemed to be good value received the money in exchange for the bonds. These purchases ended in March this year – the target of £70bn having been reached. But the Bank of England is also working on a project entitled “Low for long”, which tries to project what the future economic implications are of more prolonged QE and ultra-low interest rates.

“It’s clear that our balance sheet will be permanently larger,” Salmon says. “We will be in a world where QE is a more permanent part of our machinery.”

The implications of more or less unending QE – on tap whenever the central bank needs it – are not just economic. As inequality between the asset-rich and those without assets grows, so does the potential for populism. The rise of Donald Trump in the US, the Brexit vote and Jeremy Corbyn in the UK, Marine Le Pen and Jean-Luc Mélenchon in France – all can be at least partly attributed to QE’s collateral effects.

“We have no idea how to extricate ourselves,” Blanchflower says. “You teach a child to ride a bicycle with training wheels and you withdraw them too soon and they fall. The fear is that the economy has become so dependent on QE that you cause a recession by withdrawing it.”

Defenders of QE point out that by keeping borrowing costs low for governments – and thus, by proxy, for banks and consumers – central bankers have helped us all avoid another worse economic fate. In a speech last year, Gertjan Vlieghe, an external member of the Monetary Policy Committee, which votes on QE, acknowledged that homeowners have done particularly well thanks to the Bank’s extraordinary monetary stimulus. However, he added: “If the aim is to make housing more affordable, raising interest rates and causing higher unemployment and lower wage growth is likely to be counterproductive… with lower income growth and higher mortgage costs reducing, rather than increasing, affordability.”

In sum, it is the job of central banks to meet their inflation mandate and help grow the economic pie generally. It is the government’s job, Vlieghe says, to decide “how to divide it up”.

Meanwhile, interest rates remain stuck at historical lows. Despite some signs of better economic momentum, debt levels continue to climb. On some measures, global growth would have to triple simply to pay the interest on our collective tab. “The problem,” said Glenn Stevens in his final speech as Australia’s central bank governor, “is that there is a limit to how much we can expect to achieve by relying on already indebted entities taking on more debt.”

And the money keeps flooding in. The current rate is around $131bn per month from European and Japanese central banks. On 4 September, the Bank of England restarted its QE purchases again. It regularly must do this to reinvest the proceeds from maturing bonds into new bonds to maintain the size of its balance sheet.

Well-heeled investors who have already benefited so much from the fruits of the money tree will carry on feasting. Like many grandees of large financial institutions, Srinivasan quit his job to work for a big hedge fund. Nominally based in London, he has unwittingly become a kind of globetrotting QE consigliere, on hand to advise wealthy clients about how to squeeze out financial returns in an era of rock-bottom interest rates and extremely dear asset prices. Allowing himself a moment of relaxation one evening at the Dover Street Arts Club, a private members’ enclave in Green Park, London, he reclined into an armchair, ordered a hot water and lemon, and reflected on nearly a decade of the most extraordinary monetary policy in history.

“At the moment, it’s like drinking wine at a party,” he said. “You know you’re going to get a hangover the next day but you keep drinking anyway, trying to put it off.” 

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This article appears in the 04 Oct 2017 issue of the New Statesman, How the rich got richer