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Sunday, August 26, 2012

Quantitative Easing explained


Over the last few years there has been much talk about Quantitative Easing in the economic news. Most people have picked up the fact that it is a form of money creation, however there is still a lot of confusion about what it is for, and very limited public understanding of the wider economic consequences of pumping vast amounts of "new money" into the economy.

Many people think of Quantitative Easing (QE) as a form of money printing, however the QE apologist is always keen to point out that "it isn't actually money printing" because no new banknotes are actually printed up. They are presumably keen to make this point in order to prevent the public from making mental comparisons with hyperinflationary economies such as Wiemar Germany and Zimbabwe. The problem with this QE apologist argument is that it is nothing but a semantic defence: OK, there are no printing presses involved, but "magicing up" hundreds of billions with what is little more than an accounting trick is hardly any better is it? Someone at the Bank of England or the US Federal Reserve types a few numbers into a computer and voilĂ , they have tens or hundreds of billions in new currency to play with.

The idea behind Quantitative Easing is that the central bank uses this supply of newly created money to buy up government bonds and other financial sector assets such as gilts. The intended purpose being to drive down yields (interest payments) on government bonds and to provide more financial sector liquidity (the ability to immediately perform economic actions like buying, selling, or paying debt) by replacing financial sector asset holdings with cash.

Quantitative Easing is an unconventional approach that has been introduced in economies where the use of normal expansionary monetary policies has become impossible. The main reasons that normal monetary policies no longer work are that base interest rates have already been reduced to such an extent that it is not really possible to lower them any further (the Bank of England base rate has been held at the all time low of 0.5% for over four years). The traditional tool of reducing financial capital requirements (the small proportion of capital that a bank must keep in reserve when it makes loans) would be insane given that the neoliberal economic meltdown came about largely because so many financial sector institutions recklessly over-leveraged themselves betting on rubbish like sub-prime mortgages, Greek government bonds, Irish bank shares and Spanish property assets in the first place.


Essentially the maintenance of all time low interest rates and the creation of vast sums of "new money" can be seen as concurring policies, since both are controlled by the central banks. In the case of the UK economy, the Bank of England lowered interest rates in the wake of the neoliberal financial sector meltdown of 2007-08 and then began "magicing up" money once they couldn't slash interest rates any further. The obvious reason for the combined strategy of negative real interest rates policy (NIRP) and Quantitative Easing (QE) is to prevent the recklessly over-leveraged financial sector institutions collapsing into their own black holes of debt. Since 2008 the Bank of England has created £375 billion (as of August 2012) for distribution to the financial sector.

Quantitative Easing is only possible in countries that have not signed away their monetary autonomy. The central banks in the US, UK and Japan can control their own currencies, whilst Eurozone countries such as Spain and Italy have signed away the ability to adjust money supply to the European Central Bank. Take this comparison between the UK and Spain. Both countries suffered from broadly similar economic crises; recklessly over-leveraged banks, the implosion of "easy credit" backed property bubbles, rising levels of personal and corporate debt and rising unemployment and underemployment. The economic chaos in Spain has driven up the cost of government borrowing to practically unsustainable levels (6-7% interest) whilst the Bank of England have managed to entice investors to buy up British government bonds with the virtual guarantee that they will be bought up for cash via Quantitative Easing, a policy which has driven the yields on UK bonds down to all time historic lows.

The UK Chancellor George Osborne likes to boast that these historic lows in the cost of government borrowing have been achieved because "the market" has confidence in his barmy "cut now, think later" indiscriminate austerity policies. However the real reason that yields have fallen is that the Bank of England have Quantitatively Eased £375 billion into the economy in order to artificially manipulate interest rates on UK government bonds. Either Osborne is being utterly disingenuous, or he has very little idea of how the post neoliberal meltdown economy actually works.

There are stark warnings from history about the dangers of Quantitative Easing. Japan was the first major economy to try it out in the 1990s after the collapse of an unsustainable property boom. Since then the Japanese economy has stagnated and Japanese government borrowing has risen well above 200% of GDP. The economic stagnation since QE was introduced in Japan have led to the period being described as "the lost decades".

The Bank of England has been forced into taking the same kind of measures in order to prevent systemic collapse of the UK financial sector. Without QE and another £900 billion in direct government interventions (bailouts, nationalisations etc) several of Britain's largest banks would certainly have collapsed into insolvency, bringing down many other institutions with them. There is a strong case to be argued that this should have been allowed to happen in order to clear out the recklessly speculative banks and allow more prudent and competent financial sector institutions to increase their market share (creative destruction). QE (and the direct government bailouts) can be seen as a desperate attempt to maintain the economic status quo by postponing the inevitable financial sector collapse, a strategy often described by Max Keiser as "kicking the can down the road".

As with all economic policies, there are winners and losers. The Bank of England's own research estimates that QE has disproportionately benefited the wealthiest 5% of British households, with over 40% of the economic benefits of QE going to them. The fact that the extremely wealthy are the main beneficiaries of QE is extremely concerning, since the richest 5% are also by far the most likely to avoid paying tax on their gains by funnelling them through elaborate tax-dodging scams, meaning that much of this newly created money has already been siphoned directly out of the UK economy into tax havens such as the Cayman Islands or Liechtenstein.

Another problem with the already wealthy getting the lion's share of the economic benefit is that they have a much lower Marginal Propensity to Consume, which is a fancy way of saying that the rich spend a lower proportion of their wealth in the "real economy", so the economy would have benefited more had the benefit of QE gone to the poor and ordinary, rather than to the already wealthy speculator class.


Since the super-rich have taken a disproportionate amount of the benefit of QE, it is quite obvious that ordinary people are paying a disproportionate amount of the cost. There are several explanations, the main ones being wage deflation and capital value deflation. The simplest example to explain is the case of savers, who have seen returns on their savings plummet since 2008. The Bank of England admits that savers have lost £70 billion since 2008 due to low interest rates, but this is an extremely conservative estimate since it fails to take into account soaring inflation. Ordinary working people are also losing out since their wages are failing to keep pace with inflation. The prices of fuel, food, utilities bills and public transport have soared, whilst wages for the majority of workers have barely increased for several years.

It is absolutely clear that the beneficiaries of these twin policies of maintaining extremely low interest rates and "magicing up" £375 billion in new cash are the extremely wealthy and the reckless speculator class, whilst the losers are ordinary working people and prudent people like savers and pensioners. There is a growing body of evidence (which includes the Bank of England's own research) to demonstrate that the policies of Quantitative Easing and maintaining ultra-low interest rates are nothing but a scheme to transfer wealth to the super rich economic minority, the very people that caused the economic crisis in the first place with their reckless gambling.





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