The politics of quantitative easing

3 July 2018 by Rodrigo Fernandez , Pablo Bortz , Nicolas Zeolla

A new age of debt crises in emerging economies is on the horizon. Debt levels have been rising across developing countries since the 2008 global financial crisis, on the back of favourable monetary policies in developed economies. The end of Quantitative Easing (QE) programmes and the rise in interest rates in developed economies are creating the conditions for a perfect storm. After a period of capital flows moving into developing countries, capital will be going back to developed economies. This will leave behind a predictable pattern of debt crises – with potentially devastating consequences.

This new report analyses the problems that monetary policies in developed economies pose for developing countries. Given the history of debt crises in emerging economies, with profound and long-lasting socio-economic and political consequences, we must be alert to signs of another emerging debt crisis.

Urgent action is needed to address this problem, including:
- reversing the global trend of liberalising capital controls
- introducing an internationally accepted debt restructuring arrangement
- preventing the abuse of debt crises by imposing a market-led restructuring programme.

What is QE?

Quantitative Easing (QE) is a monetary policy established by central banks in which newly created money is used to buy state debts (so-called ‘sovereign bonds’) or to buy corporations’ debts (‘corporate bonds Corporate bonds Securities issued by corporations in order to raise funds on the Money Markets. These bonds resemble government bonds but are considered to be more risky than government bonds and other guaranteed securities such as Mortgage Backed Securities, and therefore pay higher interest rates. ’). The QE programmes were initiated to stabilise and revitalise the global economy after the 2008 financial crisis. From 2008 to 2018, the US, Japan and the Eurozone increased the money supply by US$12 trillion dollars through QE programmes.

However, QE has several negative consequences: it fuels wealth inequality; it increases the systemic risks of the global financial system, and it perpetuates an unsustainable debt-led economic model. This has a particularly severe consequence on emerging economies and the poorest developing countries.

QE has led to an increase in capital flows into developing regions and correspondingly a rise of foreign debt. For example, the stock of international bonds from Latin America and the Caribbean region increased from US$297 billion in 2009 to US$757 billion in 2017. In the Asia and Pacific region, the stock of international bonds increased from US$253 billion in 2009 to US$637 billion in 2017. Once the period of QE ends, these capital flows may reverse, leaving behind a stock of unpayable debts.

Consequences for developing countries

In the 1980s we saw debt crises in many parts of the developing world. This was followed by ‘Structural Adjustment Structural Adjustment Economic policies imposed by the IMF in exchange of new loans or the rescheduling of old loans.

Structural Adjustments policies were enforced in the early 1980 to qualify countries for new loans or for debt rescheduling by the IMF and the World Bank. The requested kind of adjustment aims at ensuring that the country can again service its external debt. Structural adjustment usually combines the following elements : devaluation of the national currency (in order to bring down the prices of exported goods and attract strong currencies), rise in interest rates (in order to attract international capital), reduction of public expenditure (’streamlining’ of public services staff, reduction of budgets devoted to education and the health sector, etc.), massive privatisations, reduction of public subsidies to some companies or products, freezing of salaries (to avoid inflation as a consequence of deflation). These SAPs have not only substantially contributed to higher and higher levels of indebtedness in the affected countries ; they have simultaneously led to higher prices (because of a high VAT rate and of the free market prices) and to a dramatic fall in the income of local populations (as a consequence of rising unemployment and of the dismantling of public services, among other factors).

Programmes’ of the World Bank World Bank
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

and the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
: in exchange for debt relief, indebted countries had to pursue austerity policies, privatise state enterprises and liberalise their economies. In the 1990s, global financial markets were further liberalised, creating opportunities for speculative funds to take advantage. This resulted in new debt crises in regions like East Asia. Recently we have also seen the handling of the Greek debt and the severe adjustment package imposed upon Greece.

The QE programmes have placed the financial world in a new phase, leading to the severe risk of another round of debt crises. The surplus of capital and low interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
are leading to a rise in capital flows to developing countries. This money – in the form of buying government and corporate bonds – has gone to both states and private companies. In contrast to earlier decades, many of these bonds are held by institutional investors Institutional investors Entities which pool large sums of money and invest those sums in securities, real property and other investment assets. They are principally banks, insurance companies, pension funds and by extension all organizations that invest collectively in transferable securities. such as private pension funds Pension Fund
Pension Funds
Pension funds: investment funds that manage capitalized retirement schemes, they are funded by the employees of one or several companies paying-into the scheme which, often, is also partially funded by the employers. The objective is to pay the pensions of the employees that take part in the scheme. They manage very big amounts of money that are usually invested on the stock markets or financial markets.
, instead of private or government-backed banks. These investors look to these emerging economies because they can expect higher returns. However, as this money can be easily withdrawn due to the lack of capital controls, this results in ever larger and more aggressive fluctuations of cross-border capital flows. The money can flow in and out within seconds if the yield Yield The income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value. is bigger elsewhere.

This rising tide of capital flows, in particular in emerging economies, could result in a new period of ‘lost decades’, provoked by debt crises. The International Monetary Fund (IMF) has already issued a warning about very high debt levels for low-income countries. Many companies have very high rates of indebtedness. When investors in developed countries decide to withdraw their investments in emerging economies – due, for example, to higher interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rates – these companies may go bankrupt, which can result in a downward economic spiral.

In need of new debt restructuring mechanisms

The global financial architecture needs to be transformed to accommodate restrictions on capital movements and arrange for the bankruptcy of national states, or sovereign debt Sovereign debt Government debts or debts guaranteed by the government. restructuring mechanisms (SDRM). The absence of an SDRM has led to an unacceptable breach of democratic processes over the last four decades. Developments in Greece since 2010 serve as a reminder of how in the absence of clear guidelines and obligations with respect to human rights and democracy, creditors can make a whole country pay the price.

History has shown that sovereign debt crises are a mechanism for generating private gains and public losses on a large scale. These crises have been exploited for market-oriented social and economic adjustment programmes since the 1980s. Given the increasing concentration in the market power of large multinational corporations, banks and financial institutions since the 1980s and in the face of growing global wealth inequality, this mechanism that feeds on crises must be addressed by an SDRM as a matter of urgency.

Discussions about both capital controls and SDRM as policy tools have been on the table for more than 40 years. It is high time to take a serious look at these ideas in the light of growing global liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. propelled by QE policies. As the world enters a post-QE period, the global financial context seems to have become more destructive for developing countries than ever before. Now is the time for a new push towards establishing SDRM principles and for re-regulating capital movements.

What to do?

This report contains several detailed recommendations including:
- Central banks need to be more accountable and democratically governed.
- The mandate of the European Central Bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

European Central Bank
The European Central Bank is a European institution based in Frankfurt, founded in 1998, to which the countries of the Eurozone have transferred their monetary powers. Its official role is to ensure price stability by combating inflation within that Zone. Its three decision-making organs (the Executive Board, the Governing Council and the General Council) are composed of governors of the central banks of the member states and/or recognized specialists. According to its statutes, it is politically ‘independent’ but it is directly influenced by the world of finance.
) (with a sole focus on price stability) should be broadened to include inclusive and sustainable environmental, economic and social goals.
- If QE is applied, there should be mechanisms to stop undue outflows to other economies (controls on outflowing capital). The price for the unintended effects should be paid by the country that implemented the QE instrument.
- Such mechanisms could include: third country cross-border transaction taxes; increased risk assessment methodologies before buying debt from developing countries; debt restructuring clauses in corporate bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. contracts; supervisory intervention and caps on high exposure through asset Asset Something belonging to an individual or a business that has value or the power to earn money (FT). The opposite of assets are liabilities, that is the part of the balance sheet reflecting a company’s resources (the capital contributed by the partners, provisions for contingencies and charges, as well as the outstanding debts). managers to over-indebted countries.
- QE should come with conditions for banks, financial institutions and corporations whose assets are being bought by central banks. Such conditions could include lending or investing in the real economy in a socially and environmentally sustainable way and a ban or cap on speculative trading Market activities
Buying and selling of financial instruments such as shares, futures, derivatives, options, and warrants conducted in the hope of making a short-term profit.
with the extra cash.
- If corporate bonds are part of the purchasing programme there needs to be an independent oversight mechanism.
- Capital controls for specific capital flows and re-regulating financial markets must be central issues in reforming the international financial architecture, to defend economies against the negative consequences of market-based finance and the speculative and herd-like behaviour of financial markets.
- Existing bilateral and multilateral trade and investment treaties need to be reconsidered. Their one-dimensional focus on the free movement of capital should be replaced by the right to a flexible use of capital controls adapted to the country and context.

Want to know more?

This report provides an in-depth analysis. It aims to inform non-governmental organisations (NGOs), academics and activists about the potentially harmful consequences of QE policies for developing countries. The authors – Rodrigo Fernandez, Pablo Bortz and Nicolas Zeolla – argue for a renewal of long-standing efforts to establish defence mechanisms in the current global economy to prevent future debt crises. Much of the groundwork has already been laid by NGOs, academics and activists working on international debt issues over the past three decades. QE requires an urgent acceleration of efforts to avoid past mistakes.

Download Report Quantitive Easing web

Source: SOMO



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