An expensive way to speak truth to financial markets What has been achieved by the Federal Reserve's $80bn-a-month bond-buying spree, and similar programmes elsewhere? The usual answer is that a tide of cheap money has brought down yields on safe assets, forcing investors to take risks in search of higher returns. The reality is different. The circumstances that forced central bankers to resort to this policy are the very conditions under which it cannot work. True, asset prices have risen. That is not surprising: by printing money, central banks have in effect been signalling their intention to keep interest rates low for a long time. But a bond-buying programme is an extremely costly way for central bankers to communicate with markets. No wonder Mark Carney, the Bank of England governor who last year introduced a policy of offering formal guidance on the future path of interest rates, is searching for signals less fraught with risk. Since 2008, the Fed has been buying bonds from the public with newly created cash in excess of $3tn, tripling the value of the assets it holds. The balance sheets of the European Central Bank, Bank of Japan and Bank of England have increased by similar proportion - though the expansion occurred over a longer period in Japan and the ECB has preferred to issue long-term repurchase agreements to banks. The first round of QE that began in November 2008 was an ad hoc affair - less the product of theoretical calculation than of policy makers" desperation to unfreeze markets that were close to seizing up. Central banks bought mortgage-backed bonds and other financial instruments that were viewed with suspicion by investors who had lost confidence in the ratings agencies" assessments of credit risk. Measures of market stress that spiked dangerously in October 2008 had turned sharply lower by March 2009. Later rounds of QE were much larger, and carefully calibrated according to the tenets of portfolio balance theory. They were also largely impotent. It could not have been any other way. Central banks focused on buying long-dated government bonds, which according to the theory should force investors to turn to long-term corporate bonds. This was intended to push down yields and encourage corporations to finance new investment with borrowed money. The measure of this policy's success is not its effect on borrowing costs (which have duly fallen), but how much corporate investment activity has increased. The trouble is that, in the stormy market conditions that forced central banks to try this heterodox policy, investors and corporates want to hold more cash and have little appetite for new capital investment. Far from increasing capital investment to get rid of cash, as the theory predicts, banks and corporates have been hoarding money. Non-financial corporations held an unprecedented $1.79tn of liquid assets at the end of 2012. Cash balances are trapped in a broken system. Many commentators believe that prices are rising because assets are being snapped up by an army of flush investors. The reality is more mundane. In response to good news, market-makers lift prices to flush out willing sellers. Trading only takes place when there are disagreements over where the price should be. Asset values have risen, but only as much as we should expect from the effect of future cash flows being discounted to the present by near-zero levels of interest rates. This is reflected in the fact that, even as prices have soared, low trading volumes indicate that relatively few assets have changed hands. The Fed is now reducing the pace of its asset purchases, a development known as "tapering." This gradualist approach is intended to prevent markets from taking fright at the sudden withdrawal of central bank liquidity. Yet even a small change in the pace of easing could be interpreted by investors as a signal that central bankers have changed their future plans. This could prove far more significant than the direct effect of the creation of new money, which is relatively modest. If unorthodox monetary policy is to be unwound without creating turmoil in markets, central bankers need a credible way of communicating their intentions - and a better understanding of what their bond-buying has achieved. The writer is emeritus professor of Gresham College and chairman of Intelligence Capital