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Whose QE Was it, Anyway?

CAMBRIDGE – Between 1913 (when the United States Federal Reserve was founded) and the latter part of the 1980s, it would be fair to say that the Fed was the only game in town when it came to purchases of US Treasury securities by central banks. During that era, the Fed owned anywhere between 12% and 30% of US marketable Treasury securities outstanding (see figure), with the post-World War II peak coming as the Fed tried to prop up the sagging US economy following the first spike in oil prices in 1973. We no longer live in that US-centric world, where the Fed was the only game in town and changes in its monetary policy powerfully influenced liquidity conditions at home and to a large extent globally. Years before the global financial crisis – and before the term “QE” (quantitative easing) became an established fixture of the financial lexicon – foreign central banks’ ownership of US Treasuries began to catch up with, and then overtake, the Fed’s share.

The purchase of US Treasuries by foreign central banks really took off in 2003, years before the first round of quantitative easing, or “QE1,” was launched in late 2008. The charge of the foreign central banks – let’s call it “QE0” – was led by the People’s Bank of China. By 2006 (the peak of the US housing bubble), foreign official institutions held about one-third of the stock of US Treasuries outstanding, approximately twice the amount held by the Fed. On the eve of the Fed’s QE1, that share stood at around 40%.

Spanning a decade (2003-2013), QE0 was the most sustained and uninterrupted surge in central banks’ purchases of Treasuries on record. It is difficult to determine the extent to which the Fed’s QE1 during the crisis owed its success in bringing interest rates down to the fact that it was being reinforced by what foreign central banks worldwide – notably in Asia – were doing simultaneously. It is instructive, however, that the Fed’s next two policy installments, QE2 and QE3, were not matched by large foreign purchases and appeared to have only modest effects in financial markets.

After the turmoil of the 2008 crisis subsided, a variety of indices of financial conditions displayed comparatively low levels of volatility (by historic standards) through the spring of 2013. But that spring bloom of stability soon faded. A combination of falling oil and primary commodity prices, an over-ripe business cycle, and the Fed’s announcement of its intent to start “tapering” its asset purchases brought the decade-long boom in many emerging markets to an end. Since then, growth in these economies has slowed markedly, their stock markets have slumped, capital outflows have escalated, and many of their currencies have crashed.

In tandem with this grim turn of events, numerous emerging-market central banks reversed course and began selling US Treasuries. We would not know about these sales, however, from the Fed’s quarterly report of the Financial Accounts of the US: Around the time official sales commenced, the Fed stopped reporting US Treasuries held by foreign official institutions (a series of data that had been available since 1945). The report now shows only the aggregate figure, which combines central bank holdings with those of the private sector.

Fortunately, the US Treasury still publishes the information. As of the end of 2015, the share of Treasuries held by foreign central banks is more than 1.5 times what the Fed holds. But this figure is significantly down from its peak and, with capital outflows from China and elsewhere showing little signs of abating, is now trending lower.

The fitful and disorderly unwinding of QE0 is most likely overwhelming the effects of reassurances by Fed officials that they will maintain a large balance sheet. Indeed, tighter liquidity conditions and increased volatility in financial markets are the byproduct of the reversal in the long cycle of foreign purchases.

The unwinding of QE0 does not necessarily imply a decline in the rest of the world’s appetite for US Treasuries. In times of financial turbulence, US Treasuries have historically been a safe haven for private flight capital. But the change in ownership taking place now does carry implications for financial stability. The change from the steady (and often predictable) purchases of the foreign central banks of the 2003-2013 era to the less predictable hands of private investors, who are more sensitive to changes in rates of return, is likely to be the signature of this stage of the global cycle.

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Carmen Reinhart is Professor of the International Financial System at Harvard University’s Kennedy School of Government. 

By Carmen M. Reinhart

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