Quantitative Easing II – Why I’m worried
In as much as George Osborne has a “plan B” for the UK, this is it – continue to cut spending and hope that Merv and the MPC will take up the slack by printing more cash to stimulate demand.
I am deeply concerned by this strategy.
In April last year, as QE 1 began I wrote a long post setting out my views on the money, credit and the likely impact of the policy, a policy that really was a leap in the dark.
I was half right. QE did have relatively little effect on the actual real economy.
I suspect, given my views on credit, that the bank lending channel is one of the more important ways that monetary policy effects the economy. I also suspect that the bank lending channel is currently blocked. If I am right, QE will see an extra £75bn pumped into the economy (as gilts are taken out and cash put in through central bank purchases) and, probably, a £75bn rise in the money supply. The worry is that this will have little effect on the actual economy.
However I was also complacent.
So, should we try QE? Of course. Either it works and provides a stimulus that prevents, or lessens, a slide into deflation or it doesn’t and nothing happens. Either way it does not cause hyper inflation as some seem to suggest.
I entirely (a big failure) neglected to consider the effects on asset prices. In my defence I was working as a fund manager at the time – I had watched the near implosion of the global financial system from a ringside seat and was all too aware of what has happening in the economy, in the banking system and in the wider markets. I convinced myself that against such a backdrop, surely a bout of money printing wouldn’t lead to an asset price boom? Surely fund managers wouldn’t committ money to equity markets whilst the real ecoomy remained on life support? Surely banks, in midst of a the burstng of a real estate bubble, won’t start lending against still over-valued property again?
I was wrong.
By the October of 2009 I was concerned.
For all the talk of green shoots, we still have rising unemployment and collapsing investment levels. What little ‘growth’ we are seeing is the result of companies rebuilding inventories (which will be temporary in the absence of private sector final demand) and government spending.
And yet despite this, asset prices are rising. House prices are up 3 months in a row. The FTSE 100 has rallied a massive 46% since March.
Now as someone who works in fund management, maybe I should just keep quiet and be thankful. Rising asset prices are good for my clients and good for me.
But I do have to question what is causing this? Irrational exuberance on the likely strength of any recovery? A side effect of quantitative easing? Future inflation worries? An excess of global liquidity, which is simply being used to purchase assets rather than help the real economy?
The economy needs to be rebalanced. But not in way that favours holders of assets over the real economy. This is raising serious questions about the manner in QE is pursued, something I shall return to in a further post this week.
I returned to the topic with another post in which I advocated using QE to finance a new National Investment Corporation.
Let’s be clear about what’s happening here. The original intention of QE was to increase the amount of money circulating in the economy and bank lending. This isn’t really working (with the important caveat that things would probably be even worse without QE). So now QE is aiming to prop up the economy via the mechanism of raising asset prices.
This allows corporates to issue bonds cheaper (in effect borrowing money whilst side stepping the banks). It also allows companies to re-capitalise themselves by issuing fresh equity cheaper. Both of these effects are helpful.
But a deliberate central bank policy to raise asset prices also poses questions. What are the distributional effects of this policy? Again let’s be clear, the policy of the Bank is to raise the raise the price of assets – this necessarily favours the wealthy over the poor and increases inequality.
For how long can asset prices be artificially supported? Do we risk a new bubble?
Economically how does this policy help the economy re-balance, how does it help small and medium sized businesses that can’t access the equity or corporate bond markets?
I’m a long term supporter of policy of low interests to encourage investment. (See this very long post if especially intersted).
A deliberate policy of low interest rates, aiming to increase the volume of financial capital and fund the ‘green stimulus’ that we desperately need, is achievable. But simply giving money to finance capitalists – essentially the current policy of quantitative easing – will achieve nothing more than supporting asset prices. What is called for is Keynes’s ‘somewhat comprehensive socialisation of investment’, with the ultimate goal of the ‘euthanasia of the rentier’. A social democratic economy requires that finance is challenged directly.
And this is why I’m worried – we are about to do it all over again – hand over billions of pounds to finance capital and keep out fingers crossed that some of it leaks into the real economy.
I’ve got a long essay in Renewal on this topic (here, but not free online – you should all read Renewal though, it’s excellent). I’ll finish with an extract from it:
A Tale of Two Economies
Perhaps the most vivid example of the decoupling of physical and financial capital identified by Keynes can be found in the period from March 2009 until March 2010, the year of quantitative easing. The Bank of England’s decision to essentially print £200 billion of electronic money and inject it directly into the financial system by buying government bonds from banks.
During that year lending by UK banks, themselves the recipients of much of the £200 billion, to financial companies rose by £81.0 billion whilst lending to non-financial firms contracted by £21.4 billion pounds, whilst the financial sector found itself with ample liquidity, the real economy was starved of credit.
The results were striking. Unemployment, by the International Labour Organisation definition, rose from 7.3 per cent to 7.7 per cent – an extra 200,000 people out of work. Business investment, the primary driver of future prosperity, fell by 7.7 per cent. Industrial production recovered by a modest 0.6 per cent. The real economy struggled forward in March 2009 – March 2010 with sluggish growth, falling investment and rising unemployment.
In the financial sector things were very different. The FTSE 100 index of leading shares rose by a staggering 44.7 per cent. House prices (as measured by Halifax) rose by 5.5 per cent. Bonuses returned, with an estimated payout of £6 billion to staff, up from £4 billion in 2008.
Although a temporary tax was charged on bank payrolls (raising £2.5 billion pounds) little attempt was made to ensure that the £200 billion of ‘new money’, created by the State, found its way into the real economy. Gordon Brown announced the creation of a new National Investment Corporation in his 2009 conference speech although nothing of substance emerged from this. Even nominally state-controlled RBS continued to make excessive payouts to staff in the ‘Global Markets’ division. In short little attempt was made to challenge the power of finance capital, despite the mess it had made of the economy and the near universal public distaste for bankers evident throughout 2008-2010.