This weekend, with the Greek Parliament staging a dramatic “make-or-break” vote on monetary union, it would be easy to lose sight of what’s happening in the UK. Events in the eurozone are dramatic, to say the least. Those who talked breathlessly of “a resolution” are being forced to think again. During the first five weeks of 2012, granted, global equities posted their best opening to any year since 1987. Was this the start of a genuine recovery, though, or just a Suckers’ rally?
The answer could hinge on what’s now taking place in Athens. Or, at least, if the deal finally forged between private sector Greek creditors, eurozone governments and the European Central Bank isn’t absolutely credible, the recent rally could quickly go into reverse.
Eurozone authorities have staged four “last-ditch” summits over the last year, each of them producing a “rescue package” which the markets have promptly rejected. So “something big” now needs to happen, if we’re to see a lasting shift in investor sentiment.
As this Greek drama unfolds, let us not ignore the significant news from the Bank of England last week. Members of the Monetary Policy Committee agreed to expand the UK’s “quantitative easing” program by another £50bn, taking the cumulative total to £325bn.
Back in March 2009, when QE began, the UK’s base money supply was equal to 7pc of annual national income. The increase since then has been absolutely enormous – an additional 15pc of yearly GDP. British monetary policy, to say the least, is in uncharted waters. And yet there are many who advocate that the Bank should do at least £500bn of QE.
This column has criticized QE since the policy was launched. My original objection was the sophistry of the Bank’s claim that the UK faced “an impending deflationary spiral”, unless it took the extremely radical step of creating virtual credits ex nihilo, then using them to buy-up government debt.
This always was, and still is, a tawdry way of recapitalizing bombed-out banks by the backdoor, so they can try to avoid the painful but necessary step of writing down losses and restructuring. QE has also regularly being used on both sides of the Atlantic to give equity markets a boost, another reason it’s so popular “in the City”.
QE has also facilitated circular financing, with the state effectively borrowing from the state, so allowing the UK government to dodge the really big fiscal decisions. The Coalition talks a good game on “austerity”. When debt interest costs are included, though, government spending is still going up.
This is true even though QE is suppressing official borrowing costs, by keeping demand strong. Yet very little of that demand is coming from genuine buyers exercising their independent judgment. Since early 2009, the Bank of England has bought more than half the £475bn of IOUs sold by the UK government. Another £100bn or so were bought by high street banks either owned by the government, and/or forced to buy more in the name of “macro-prudential regulation”. UK pension funds, run by professional investors acting largely as they wish, have reduced their gilt holdings over the last three years.
So QE is designed to pump money into badly-run banks above and beyond the headline “bail-out” numbers. It also means the government can keep borrowing at historically high levels while not immediately feel the impact in terms of more punitive borrowing costs.
Some would describe these statements as “controversial” or even “alarmist”. I’d say, on the contrary, that we need to be honest with each other. I would also argue that the above description of the reasons behind the most radical monetary experiment in modern British history, unedifying as those reasons are, rings true to anyone who looks at the economic record objectively and who possess, as well as a general education, even a modicum of common sense.
The Bank of England, meanwhile, continues to maintain the fiction that this latest dose of QE, just like all the others, is part and parcel of its on-going and unshakeable mission to steer CPI inflation towards its target. “Without further monetary stimulus,” the Bank said last week, “it is more likely than not that inflation will undershoot the 2pc target in the medium term”.
Really? Over the coming months, with the VAT rise of January 2011 dropping out of the numbers, inflation may come down a bit. Or it would, if the price of oil and other commodities wasn’t set to remain firm. Even the International Monetary Fund predicts crude averaging $100 a barrel during 2012, with many commercial forecasters seeing prices much higher than that.
So it is a heroic (nay comical) assumption that it is only by implementing another huge expansion in base money that the UK can hit its 2pc inflation target by the end of 2012. But that is what the Bank expects us to believe.
I don’t lay the blame for this at the feet of the Bank of England’s in-house economists – several of whom are first-rate. The problem is that the Bank is being forced by its political masters to maintain the “inflation will fall sharply soon” mantra to try to justify QE. Yet QE has absolutely nothing to do with “tackling deflation”, being designed instead to buy time for executives and ministers who, for several years now, have lacked the courage and intelligence to grab a bad situation by the scruff of the neck.
Every single month in 2010, annual CPI growth was 3pc or higher – a level that used to be a big deal, seeing as it means the Bank Governor writes a public letter of explanation to the Chancellor. Throughout the whole of 2011, CPI inflation was at or above 4pc, reaching 5.2pc in September. But still the MPC told us, its ranks packed-out with external QE apologists, that inflation would “soon” under-shoot 2pc unless we saw “further monetary stimulus”.
Future inflation, not disinflation, is the problem the UK faces. For now, most of the QE “proceeds” are sitting on the balance sheets of banks pretending to be solvent. That’s why lending remains so low, and growth so sluggish, despite base rates being kept at 0.5pc since March 2009.
What happens to inflation when that massive increase in base money is leant out? What happens when the mask slips and the markets focus on “currency debasement”, which then pushes up imports prices as sterling falls? What happens when insatiable demand from the emerging giants of the East keeps oil prices elevated, even as the Western world slumps?
QE needs to end as it is entirely counter-productive. By printing virtual money, the Western world – the UK and US especially – have themselves pushed up commodity prices, so shooting themselves in the foot. By undermining competitors’ exports, and the value of the massive debts we owe, QE has stored up serious diplomatic resentment for the future. By slashing annuity rates, QE has undermined the retirements of those who worked hard and been prudent, so undermining the very fabric of what makes capitalism work.
We Brits may now be sitting and gloating at the eurozone. But when it comes to QE, our actions have been more extreme, and potentially more dangerous, than any other large economy on earth. This is a policy that will come back to bite us. Which is why, in the face of some of the most powerful vested interests on earth, the growing band of those who oppose it, must make their voices heard.