Last week we explored a topsy turvy world that quantitative easing (QE) could cause, with the lowest bond yields potentially occurring in the highest inflation economies. We noted that this would be the death of the bond vigilantes, as they are overwhelmed in their attempts to force higher bond yields by the ammunition of the printing press being put to work in government debt.
This begs the question – if the bond vigilantes are dead, who will take their place to enforce discipline?
The sequel to the bond vigilantes could well be the currency vigilantes. QE aims to produce a low interest rate environment with a traditional level of inflation by having negative real yields all the way along the yield curve. However, before you get there the currency vigilantes could well turn up to break up the QE plans. If the authorities are actually or are merely threatening to print money, then economic agents should act vigilantly and avoid this new money by exchanging it for other currencies or assets. It’s the rational thing to do.
It appears that the currency vigilantes may have started already. Economic agents are dumping the QE currencies ahead of the switching on of the printing presses, and that can be seen by their desire for unprintable gold, commodities, domestic companies with foreign (non-QE currency) earnings, and currencies that do not have trigger happy central bankers poised by the printing presses. This has potentially important implications for asset prices, but also threatens a stable QE process. If there is a huge flight from a QE currency, domestic inflation could become rapidly explosive with no immediate growth benefit, so throwing up even more policy challenges.
The bond vigilantes could well be removed from the equation by QE. But in order to effectively implement QE – as desired by any member of the magnificent G7 who tries – this policy might well find its ability to enforce its domestic monetary policy destroyed by the currency vigilantes.