Quantitative Easing – The Dragon Eating Its Own Tail

Quantitative easing (QE) is usually described as a technical tool of modern central banking, but it has quietly reshaped how the global debt system works. Instead of just nudging interest rates, central banks now create money and buy government bonds on a massive scale, supporting a world where governments, markets, and citizens all owe money to one another in an ever-tighter circle.

This article is largely inspired by Yanis Varoufakis’s talk ‘Every Nation Is in Debt… So Who’s the Lender?’ which you can watch here.

Before the age of QE

For most of the post‑war period, central banks guided the economy primarily by moving short‑term interest rates. Raise rates to cool inflation, cut them to stimulate borrowing and spending. Commercial banks and capital markets did almost all of the credit creation, and central bank balance sheets stayed relatively small. Government borrowing relied on private investors buying bonds, with only limited, routine buying and selling by central banks in the background.

By the 1990s, this model began to strain. Japan’s property and stock bubble burst, its economy slid into stagnation and deflation, and interest rates were pushed down to zero. With the old lever “maxed out” and prices still falling, the Bank of Japan started experimenting with what would soon be called quantitative easing: deliberately expanding the monetary base and buying more government debt. After 2008, the same problem went global. Once the financial crisis hit and rates in the US, UK, and Eurozone crashed to (or near) zero, QE was rolled out as the new emergency tool.

How modern QE works

In a QE programme, a central bank creates new money electronically and uses it to buy large quantities of government bonds and sometimes other assets. The goal is to push down long‑term interest rates, keep markets liquid, and make it easier and cheaper for governments and banks to borrow during crises. This is not about finding existing savings; it is about expanding the central bank’s own balance sheet and swapping newly created money for existing assets.

In theory, once stability returns, the central bank can reverse the process: stop buying, gradually sell some of the bonds back to markets, and let the created money be withdrawn. In practice, unwinding has been slow and partial. After the global financial crisis and again during the COVID shock, balance sheets were expanded to such a size that large parts of the state’s debt are now effectively held by its own monetary authority.

Who really lends to governments?

Look closely at who holds government bonds and the picture becomes more circular than it first appears. A big slice is held by central banks and government funds such as social security and public pension schemes. Another large portion belongs to domestic investors: banks, insurance companies, pension funds, and investment vehicles that manage the savings of households. Foreign governments and investors also buy in, especially those running trade surpluses who park their excess earnings in “safe” bonds.

In other words, citizens are on both sides of the ledger. As members of the public, they benefit from government spending financed by debt. As savers, they rely on that same debt as a supposedly safe asset in pensions, insurance, and savings products. Through QE, the central bank sits in the middle, creating money to buy the bonds that anchor this whole structure.

The debt cycle and the human cost

Once debt is in place, it gathers interest. As the stock of public debt rises and interest rates move up from ultra‑low levels, the interest bill grows quickly. That bill has to be paid from taxes or cuts elsewhere. Money that could fund schools, hospitals, infrastructure, or climate adaptation instead flows to bondholders as interest. For many developing countries, this has turned into a trap: they now spend more on servicing external debt than on health or education, and in some cases send a large share of export earnings abroad just to stay current.

This is where the “cycle” becomes clear. Higher debt leads to higher interest payments. Higher interest payments widen budget deficits. Larger deficits require more borrowing, which increases the debt again. At the same time, the assets created by this process are disproportionately held by wealthier households and institutions, so stabilising the system through QE often boosts asset prices and widens wealth gaps, while the tax burden and service cuts fall more heavily on those with fewer assets.

A system that feeds on itself

Why does this arrangement persist? Partly because it solves real problems for the current setup. Aging populations and large savings pools need safe assets. Trade‑surplus countries need somewhere to park accumulated foreign earnings. Central banks need a deep supply of government bonds to operate monetary policy. Government debt, supported by QE when needed, provides all of this.

But this solution comes with a built‑in fragility. The whole structure rests on confidence: that governments will honour their debts, that central banks will keep inflation under control, that currencies will hold their value. History shows that when confidence breaks in one corner of the system, crises can spread quickly. As total debt rises and interest costs climb, the room for error shrinks. The dragon keeps itself alive by eating more of what supports it: future incomes, public goods, and social cohesion.

The open question is not whether this can continue forever—it cannot—but how it changes. Societies can try to steer a gradual adjustment, reforming how money is created, how crises are handled, and who bears the costs. Or they can leave the current cycle to run until it breaks, and let the adjustment arrive in the form of a crisis that forces abrupt, painful choices.