Central Bank Buying of Corporate Bonds

The Bank of England (BOE) recently announced a cut in its key interest rate, along with a new round of so-called quantitative easing.  This is nothing new amongst major central banks over the last several years.

The only major central bank with a tight monetary policy right now is the Federal Reserve.  It ended its QE3 program in October 2014.

One thing that caught my attention in the BOE’s announcement was what it will be buying.  Included in its asset purchases is corporate bonds.

Historically, central banks have bought government debt.  In the case of the U.S., the Fed’s policy was to buy U.S. government debt in the form of Treasuries and bonds.  It was only until after the fall of 2008 that the Fed went outside of this historical norm and started purchasing mortgage-backed securities (MBS).  The purchase of MBS was a pure bank bailout.

Now the BOE is buying corporate debt, and not just its own government’s debt.  This just further distorts markets and resources.

It is bad enough when these central banks tamper with the money supply and interest rates.  The buying of corporate bonds just adds to the cronyism and corruption.  At least in this case it might be a little more obvious.

These central banks have literally unlimited amounts of money.  That is how they purchase these assets.  They create money (or digits) out of thin air.

When you have a major central bank buying corporate debt, it is really going to drive prices in the market.  The interest rates on corporate debt should go down.

It would be hard to imagine that there won’t be any favoritism/ cronyism from such a setup.  Imagine if the Fed had such a program.  Any time a politically favored company had any trouble, the Fed could just buy corporate debt from the company to keep it afloat.  This could include car companies, financial institutions, “green” companies, etc.  The companies with the most lobbyists and political connections never have to worry about going under.  The Fed could just always buy more debt to keep operations running.

And if a company is not in favor, then the Fed can just let it sink.  It can pick the winners and losers.

This would be a terrible misallocation of resources.  It would allow for virtually endless bailouts.  It means that companies could operate at a loss and continue to keep their doors open.  They would be just like government entities in a sense, where there is no profit or loss system.

The Fed is not doing this now (except with the banks in the form of interest on reserves), as it is keeping its monetary base flat and just rolling over maturing debt.  But if the economy stumbles and the Fed announces another round of QE, it would not be surprising for the Fed to include this in its arsenal.  It is an easy and direct way to bail out any company that it wants to help.

The Bank of England may just be doing a test run for the other central banks right now.  It is just more potential cronyism that we have to look forward to in the future.

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