In last week’s ‘3 Longs & 3 Shorts’ we had quoted the great strategist Russell Napier’s point of view that in the decades ahead Western Central Banks will deliberately keep interest rates (short term and long term) below the rate of inflation (i.e. negative real interest rates) thus allowing their sovereigns to: (a) borrow money for free to finance their ageing societies; and (b) erode the real value of their vast national debt in real terms. Hence, as per Mr Napier, there is no real risk of QE coming to an end any time soon even if inflation zips up. In fact, Mr Napier says that Western Central Banks will be happy to see high inflation alongside near zero nominal interest rates.
In his Gold Standard blog, Anantha Nageswaran cites a recent piece that Ann Pettifor wrote for Prospect magazine where Ms Pettifor makes the same point – that QE is not going to end anytime soon – albeit for different reasons.
Ms Pettifor says that thanks to QE, the shadow banking system (i.e. what we call NBFCs in India) has become the biggest financier of the financial system and hence of the Western economies: “Today one asset management firm, BlackRock, manages in excess of $8 trillion of the world’s savings. Such companies have outgrown the capacity of “main street” banks to provide services. No traditional commercial bank could absorb these sums; few governments are willing to guarantee individual accounts of more than $100,000. ….Like pawnbrokers, who practised an earlier form of unregulated credit, shadow banks exchange the savings they hold for collateral. … Replete with cash, they can provide “liquidity” on a vast scale to businesses or investors who need it….private financiers rely heavily on government bonds as the safest collateral for their repo trades….
… It is estimated that two out of three euros borrowed through shadow banks are underpinned by the collateral of sovereign bonds issued within the Eurozone. Any decline in the value of government bonds as a consequence of shadow banking activity will influence the government’s cost of borrowing, and—ultimately—fiscal decisions….Which brings us back to quantitative easing—the remedy that central bankers reach for in the face of this recurrent threat.”
As Mr Nageswaran explains, “In other words, without QE, the shadow banking system will cease to exist. If it ceases to exist, then the real economy crashes. So, central bankers can assuage themselves by saying that by providing the liquidity that the leveraged shadow banking system needs, they are indirectly supporting the real economy or preventing the real economy from collapsing.”
Ms Pettifor goes on to explain that the only way Western Central Banks can end QE is if they are willing to completely deconstruct their financial systems and then rebuild them. However, this is a massive endeavour and the West will need politicians with immense amounts of courage and intelligence to be willing to try something like this: “Whenever the vast shadow banks wobble, there is the threat of a disastrous contraction of the credit for the real economy, which could bring everything crashing down. As long as the system is allowed to stand, there is no alternative to taxpayer-backed central banks rescuing private markets.
The only way to call time on QE, if that is what we truly want, is to deconstruct and then reconstruct, regulate and stabilise the whole financial system, so that the extraordinary privilege of credit creation is always balanced by a responsibility not to take undue risks. And if footloose capital responds by skipping across borders and away from oversight, then we may also need to look at controls on that front too. Only then will the world stand any chance of kicking the QE habit, address those dangerous imbalances and finally escape this grim shadowland of money.”
Mr Nageswaran concludes by saying that he doubts any Western politician would have the courage to call time on QE and then rebuild the Western financial system: “…on their own, central banks will be afraid to do the job of deconstructing and reconstructing. It is a political project because, in reality, it would amount to cutting both shadow banking and central banking to size. That is why central bankers would resist it actually. Ending the last forty years of financialisation will also end central banking as it has evolved in the last forty years. Central bankers will go back to operating in the shadows, if shadow banking were to be ended!
Will politicians be up to the task? I doubt.
The risk is that, in doing so, the ‘House of cards’ aka ‘the real economy’ will collapse. No one wants it on their watch.”

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