A recent speech by the man many expect to become the governor of the Bank of England, Adair Turner, has created a stir among central bankers that the Bank of England, and potentially the Federal Reserve, will make the government bonds they have bought simply disappear.
The plan sounds genius. Just cancel the billions of dollars of government bonds central banks have bought with the money created through the process of quantitative easing (QE).
Since both the central bank and the borrowing authority are in effect institutions of government, there is no apparent loser in this bond cancellation scheme in the private sector. So what’s the harm in them simply making debt disappear, especially if it can magically reduce overhang of public debt which threatens to weigh down sluggish economies?
The reason such a plan has created fear is because it removes the age-old discipline required by a nation that borrows money: it must service its debts and obligations, and manage its economy accordingly. Gavyn Davies, from the Financial Times, calls this the “restraining effect" of debt.
By issuing government bonds to fund deficits, private sector savings are absorbed, reducing demand, while a future path of interest rates is set. Also, if the public knows the government has future debts, it expects taxes in the future and so keeps consumption in check, managing inflation.
Then there’s the matter of the central bank solvency. If it cancels its debts, it will have more liabilities than assets on its balance sheet – and will need to be recapitalised.
Another reason the plan is dangerous is that it has the potential to erode trust in these institutions. For every future expense, a dollar or a pound could be conjured up, and what’s the intrinsic value of something so abundant? The very value of the currency, which is absolutely and entirely a function of the trust placed in these institutions, is gambled on the plan.
Other commentators say the idea constitutes nothing more than a paper shuffle. The bigger question is whether it’s the central bank or the government that oversees the program.
Lord Turner’s contemplation of such an extreme solution means that nothing is sacred in monetary policy as the path further into the unknown is explored.
That is utterly terrifying, not because it’s such a dangerous idea that could destroy faith in the very concept of money, but because it might be the best one we’ve got.