Quantitative Easing is prolonging the agony

Quantitative Easing is prolonging the agony

by Ewen Stewart
article from Thursday 23, August, 2012

BRITAIN HAS LARGELY been in the grip of ‘group think’ on Quantitative Easing until a couple of brilliant articles appeared on this website. The first by Mike Nevin explained clearly why QE is strangling the economy by ‘perversely reducing the amount of cash the corporate sector has to invest and pensioners have to spend.’ The second article, by Bill Jamieson simply entitled ‘the end of retirement’ draws on Nevin’s work outlining the attack on pension values that QE has directly caused with the subsequent negative impact on wealth.

The impact on savers, who clearly are the innocent victims of this financial crisis, cannot be overstated. Bank of England and Treasury policy generally, and in particular through the extensive use of QE, has directly led to a wealth transfer from savers to borrowers.

Surely it should not be the prudent and elderly that pay the price for excess Government and personal debt? This is a very poor moral message, and a very un-conservative one too.

In this article, however, I want to draw on another important negative implication of Quantitative Easing. Many commentators, this one included, believe that it was an excessive public and private sector credit and asset price expansion that led to this ‘Credit Crunch’ globally. It was a UK policy error, particularly from the central bank coupled with very significant rises in state spending (a similar delusion in other major Western countries, especially the US and Latin Europe was also evident) that was substantially responsible for our current woes.

This massive party resulted in an unsustainable housing bubble and an expansion of banking balance sheets – which led to an illusion of prosperity that was not based on real productivity increases. This was compounded by a massive expansion of the British state expansion that, as measured by public spending relative to GDP, was greater than the Barbour/Wilson illusion of the early mid 1970’s.

To put this state expansion in context, in 2000 HMG spent £363bn. This had risen to £703bn by 2012 but would have been only £544bn if public spending had risen in line with GDP. The growth of public spending over GDP growth during that 12 year period was thus a staggering £150bn pa (or around 10% GDP). Intriguingly, the UK’s budget deficit this year is likely to be around £140bn (don’t believe the Treasury’s forecasts). Further, in 2000 state spending to GDP stood at around 35% of spending, today it accounts for 48%. Although it is little appreciated, the growth in the state was far greater in the Blair/Brown years than under hapless Health and Wilson in the seventies.

What does this have to do with QE I hear you say. Well, in my view quite a lot.

Britain’s accumulated deficit is slightly over £1 trillion. The Bank of England’s QE programme is now well advanced in its goal of purchasing £375bn of UK gilts the size of which is conveniently close to the scale of borrowing over the last 3 or 4 years. Who would have bought these gilts and at what price, without QE?

In my view, although this would be fiercely disputed by the authorities, the debt is effectively being monetised. This policy clearly manipulates the yield curve lower thus distorting markets and reducing the necessity of governments to address this very substantial public spending crowding-out of the economy. It appears kind by apparently keeping ‘the show on the road’ but in reality it kicks the can down the alleyway. It helps crowd-out the private sector and partially explains the very weak growth performance of the UK over the last 4 years.

Ultimately QE is creating a treadmill that HMG cannot escape without ever more extreme measures.

Osborne has talked a good game of austerity. The reality is that public spending continues to rise each and every year this Coalition is in office. It is curious politics when you claim to be making cuts, but are not in reality.

Without QE, yields would be higher, set by free market pressures. This would force HMG to start to address what has been a tragic crowding-out of the private sector. This unsustainably large state sector is destroying British productivity and this false palliative of ‘free money’ just adds to the illusion. It is no surprise private sector investment is at a near all-time low.

QE is not a free lunch; quite the opposite. It merely is creating an illusion, a dangerous illusion at that. It is not only destroying the wealth of the prudent, as Nevin and Jamieson admiralty point out, but it also helps crowd out the private sector too, thus underlining productivity and rendering recovery even more distant.

Ewen Stewart is head of strategy at one of the UK's leading investment banks

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