The Federal US Central Bank began to taper Quantitative Easing (QE) last Wednesday, signaling the beginning of the end for cheap Government funding – and that economic recovery is underway, writes Ian Crowther. And although the UK and the Bank of England appear to be some way off making such announcements, inflationary pressure is beginning to rise.
In order to support the economy while society reigns in its personal debt, governments step in via Quantitative Easing to increase money supply and prevent a deflationary process unfolding. So the Bank of England buys Government bonds and floods the financial markets with capital in the hope this offsets personal debt repayments, while increasing lending, growth, employment, wages and Gross Domestic Product (“GDP”).
QE is also being used to keep interest rates low, without which our society would implode via wholesale debt default. Currently, a significant percentage of society cannot afford additional payments to service an increase in interest on their debt. This has been caused by Government policy not controlling credit expansion and banks continuing to lend increasing amounts of personal and corporate debt.
Little remains in the discretionary spending pot as wages in real terms are decreasing against price inflation, and savings from salary are non-existent now, according to the Council of Mortgage Lenders.
Cheap debt has inflated average house prices by 1.5 times the average salary over a 14-year period from 1999 to 2013. Banks take more risk to fund the increase in personal debt and build profits, whilst contemporaneously decreasing discretionary spending power in the economy.
Notwithstanding the above, we are now witnessing stock markets increasing again, confidence creeping up and a return to growth, albeit 1.5-1.9% in the last 12 months. How is this happening when we are all spending less each month and repaying debt?
Well, QE, described above, is merely exchanging the personal debt society is paying off at the bank for Government debt on the national balance sheet.
While this strategy provides stability, it is solving little else as funding and associated bank lending is not causing wage increases or solving unemployment in a meaningful way (part time roles and service based jobs, versus large firms making full time posts redundant). Moreover, the economy does not grow in line with the investment made, but climbs very slowly, despite the colossal amount of QE flooding the market. Therefore, is QE the correct strategy?
Importantly, personal debt saturation appears to have breached a ceiling in the UK where government stimulus appears not to be working in the same way as it has in previous recessions, thus indicating a major problem and the end of a credit super cycle; where society is unable to service anymore debt while the Government attempts to ramp a recovery.
Total money supply (known as M2) is currently indicating that cheap QE funding is not being invested by big business via capital expenditure to increase growth, employ more people and increase productivity. This shows that major shareholders do not believe that increasing demand, or indeed discretionary spending, is sufficient to warrant increased production.
Sterling also keeps appreciating to other leading currencies, so it becomes difficult for UK businesses to export comparative to European competitors. Currency markets are already pricing in inflation.
However – and this is more disturbing – we are seeing government QE fuelling confidence, and asset prices have begun to inflate again – housing and the stock market are examples.
In the last week we have seen gold prices deflating, indicating even more money will move into stock markets, with potential inflation ahead. Government QE could be developing another unsustainable bubble as investors rush in via the usual herd mentality, in a search for asset price appreciation.
This form of asset ‘speculation’, supported by cheap QE fuelled debt, (or schemes such as Funding for Lending) is predicated on prices continually rising, and when a tipping point is reached – such as when a government tapers QE to a specific level, inflation increases significantly or a leftfield market event occurs – the effect will be markets suddenly deflating again, prices crashing, more defaults and potential negative equity. A delicate balance it seems.
Markets remain concerned that if QE is reduced significantly, we’ll see a negative feedback loop, eventually leading to share prices decreasing to a level supported by fundamental business performance rather than technical QE-based speculation.
Moreover, with society still highly leveraged and UK Government debt at an all-time high (£1.47 trillion according to the ONS), who will come to the rescue should the current speculative bubble burst? Should we print more money via QE and continue increasing national debt?
What lies ahead may not be pretty. Questions must be asked as to whether the UK and global trading partners can continue with this stimulus fallacy and take a ‘tsunami-style shock’, much bigger than 2007?
The financialised world needs to be revisited as a matter of urgency, and rebalanced with long-term policy plans to rebuild industry and growth instead of flooding the market with cheap credit that stimulates not much more than speculative bubbles.
Government money could be invested into micro businesses, as an example, which would lead to investment and employment at lower levels, with cash flow beginning to circulate away from stagnant larger firms and back into the economy. Surely it is this type of investment the Government needs to be focussing on, as well as QE supporting larger firms.
Six-years after the financial crisis, and as a result of continued Government stimulus, markets are afraid that the UK and Eurozone are heading towards long-term government control of money supply and a constant struggle for growth versus inflationary pressure at the zero lower bound.
The QE phenomenon is comparable with the situation in Japan – where the same stimulus and recessionary environment has been ongoing for 25+ years with no sign of it ending.
One radical answer could be to reconsider de-leveraging personal debt via QE, and solve the crisis quickly. A ‘modern jubilee’ as Professor Steve Keen suggests, would increase disposable income without forgiving all personal debt; just enough to create discretionary spending, get cash flow moving again, and drive money back into the economy, instead of QE and cash being trapped in banks as society de-leverages. Banks would then have strict lending limits going forward to discourage debt saturation happening again.
From here, there would be an opportunity for money to flow back from the financialised world, so investors re-channel funds from banks and associated products back towards an inclusive long-term rebalanced industrialised economy that also develops smaller firms and micro businesses.
Government policy should reflect the above concept, or similar, and encourage this entrapped phenomena to end.