The Gambler's Roll of the Dice

The news of the day is the latest bout of quantitative easing (printing money) by the Bank of England (BoE). The BoE has the following to say:

The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to increase the size of its asset purchase programme, financed by the issuance of central bank reserves, by £50 billion to a total of £325 billion.

In the United Kingdom, the underlying pace of recovery slowed during 2011, with activity falling slightly during the final quarter. Some recent business surveys have painted a more positive picture and asset prices have risen. But the pace of expansion in the United Kingdom’s main export markets has also slowed and concerns remain about the indebtedness and competitiveness of some euro-area countries. A gradual strengthening of output growth later this year should be supported by a gentle recovery in household real incomes as inflation falls, together with the continued stimulus from monetary policy. But the drag from tight credit conditions and the fiscal consolidation together present a headwind. The correspondingly weak outlook for near-term output growth means that a significant margin of economic slack is likely to persist.

CPI inflation has fallen back from its September peak, declining to 4.2% in December. Inflation should continue to fall sharply in the near term, as the increase in VAT in January 2011 drops out of the twelve-month comparison. Inflation is then likely to decline further as the contribution of energy and import prices diminishes, while downward pressure from unemployment and spare capacity continues to restrain domestically generated inflation.

In the light of its most recent economic projections, the Committee judged that the weak near-term growth outlook and associated downward pressure from economic slack meant that, without further monetary stimulus, it was more likely than not that inflation would undershoot the 2% target in the medium term. The Committee therefore voted to increase the size of its programme of asset purchases, financed by the issuance of central bank reserves, by £50 billion to a total of £325 billion. The Committee also voted to maintain Bank Rate at 0.5%. The Committee expects the announced programme of asset purchases to take three months to complete. The scale of the programme will be kept under review.

We are now in a situation in which we can see the following; record lows of interest rates over a sustained period, record government deficit spending and bout after bout of money printing:

And the latest bout of QE hits the pensioners who have been sensible enough to save:

Further QE is likely to spell bad news for people set to retire this year as annuity rates plummet, leaving pensioners facing high living costs and low returns on their savings.

Research from financial services company Hargreaves Lansdown found that a 65-year-old man with £100,000 could have bought a level income of £7,855 in July 2008, but someone in the same situation today would only receive an income of £5,923, a drop of just under 25pc.

Dr Ros Altmann, director-general of Saga, said the “short-term stimulus” of QE has “very dangerous long-term consequences”.

She said: “Buying gilts is not the best way to stimulate growth – it does, of course, help the banks, but it actually has side-effects that directly damage the economic outlook.

“Having more and more poorer pensioners and forcing companies to put money into their pension schemes, rather than their business operations, is a drag on growth, not a boost.”

She said tumbling annuity rates mean that “over a million pensioners will be permanently poorer for the rest of their lives, as they have bought an annuity at rates that have been artificially depressed by the Bank of England”.
“The impact of QE on pensions and pensioners will lead to lower growth, so we urge the Bank to consider different ways of using newly created money to try to boost the economy.”

Of course, it is not just pensions that are being hit by this latest bout of QE, but savers in general have been hit by high inflation and low interest rates. On the other side of the balance sheet, the debtors and profligate are given an easy ride, with high inflation eroding the value of debt, and low interest rates allowing lower repayment rates.What we have in current policy is a major failure. It is built upon an assumption that stimulating consumer demand through reduction in debt servicing costs and providing low interest rates to companies to allow for expansion will actually help the economy recover. It is apparent that it is not working. In fact, consumers and non-financial companies are reluctant to take on more debt (from Steve Keen):

And consumers are still saving:

Note from the first chart consumer debt remains relatively stable over the last few years, after a period of sustained growth. Consumers are not significantly de-leveraging, but they are not significantly growing their debts. In the second chart, the savings rate soars, but then declines before climbing again. What we are seeing is the conflict between the uncertainty about the future, and policy which is punitive to savers and encouraging debt accumulation.

The most interesting thing about the charts is that it shows that in order for the UK to return to so-called growth, it is necessary for consumers to stop saving and recommence debt growth. Of course, this is not real growth, but might be described as Ersatz growth. Returning to the balance of trade chart, we can see the nature of this Ersatz growth. Consumer debt growth saw a corresponding expansion of the deficit in the current account.What the current punitive policy seeks to do is to increase consumer debt levels, in order to import and distribute more goods and services, with the distribution of the imported goods and services seen as economic growth. Fortunately, so far, consumers have been reluctant to play ball, albeit that debt levels are still relatively high and remain relatively stable.

Money printing is just one element in the arsenal that has been deployed to ‘rescue’ the economy. The Bank of England just does not seem to understand that this can only lead to further inflation and a corresponding decline in disposable income for pensioners. However, it is not just pensioners that are seeing their disposable income declining, as wages are not keeping up with inflation.

I am afraid that I do not have a link, but I have previously noted that even the BoE accepts that their printing of money was a contributor to inflation, and the BoE has also acknowledged that disposable income has been squeezed between low wage increases and inflation. So why do they persist in the policy of printing money? Even on its own terms, the policy is counter-productive. The answer is that it is a means of keeping government borrowing costs down. As long as there is even a possibility of QE, the market for UK government debt is indirectly supported and when QE takes place that support becomes direct. In this case (yet again), the QE is taking place at a time of high inflation, and despite the requirement of the BoE to keep inflation rates within target. Once again, the QE is being enacted with a promise of a fall in inflation just around the corner. If you look at the chart for inflation and follow the link to the chart for QE, you will see that this is a pattern. In each case, the justification is that a fall in the rate of inflation is just around the corner, and the BoE claims that it is acting to prevent deflation.

It is also notable that as each bout takes place, the justification has come to increasingly include elements that fall outside of the BoE remit; the BoE increasingly justifies its actions on the basis of the general economic situation. The inflation story is increasingly threadbare, so the BoE shifts attention to other justifications.

However, there is a fundamental point here, and I return to my earlier discussion. Does all of this macro-economic stimulus look like it is working? However you might look at it, high inflation, squeezed disposable income, high and growing unemployment, sky-rocketing government debt, and a current account deficit does not appear to be sensible economic policy. It is very clear that the policy is not working. Of course, some would argue for even more QE, even more government expenditure is necessary. This is exactly the approach of the losing gambler. The bets become larger and larger in the hope that the losses from the previous bets can be made good.

There are two elements that are missing from the macroeconomic picture over the last few years. The first missing element is genuine austerity. For all the talk, it is simply non-existent. The government continues to gorge on debt even as the economy remains in dire straits. As I have argued in previous posts, implementation of austerity is necessary, but will see a dramatic shrinkage in GDP. The second missing element is real reform of the structure of the UK economy. I followed the tinkering of benefits reform with considerable interest. It was interesting to see how difficult it was to even tinker with with the system by putting a cap on benefits (e.g. see here). Although there are many ways of measuring average income, the measure just aimed to cap benefits at something approximating average earnings for a working person. Nevertheless, the controversy has raged around the measure (see here for my proposed benefits reform, which is now probably too late to enact).

In other words, the macroeconomic policy is one of continuing to roll the dice, and placing the bets that (somehow) it will all work out. I use this analogy because the whole point of betting is to get rewards without having to really work for them. It is counting on luck, not hard work to achieve a living and/or wealth. This appears to be the underlying approach of government; just keep on betting that there is a solution with no cost, and one that does not involve actually reforming to place the emphasis on the UK earning income. The solutions are not working, but more bets are placed that luck will come in and change everything, despite the evidence to the contrary.

My argument is simple; stop betting higher and higher and get out of the gambling game. Instead, address the underlying problem of the UK’s lack of ability to earn the income to which it aspires. It is very simple. The structure of the UK economy is the problem.

Note 1: Sorry for a somewhat rambling post. It was a post that developed as it went along, but I hope that it ‘hangs together’.

Note 2: The UK National Statistics used to be a great source of data and charts. A while back they changed the format of their data presentation, and it now takes dogged determination to find anything of value in the site. You have to dig, and dig and dig to find anything. It makes me wonder whether the easy access of data was considered to be problematic……? Curiously, government debt seems to be exclusively expressed in terms of % of GDP, with the OBR in particular preferring to use this presentation. I am sure that with enough time and effort, it would be possible to find the information, but it is very odd how it has become so difficult.

In light of this, I have used a variety of sources for charts, and apologise for not using ‘official’ charts. Of particular note is the Economics Help site, which provides a wealth of useful charts.

Read more at Cynicus Economicus