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05 February 2014

Is QE Sharpening its Teeth?



The world’s central banks – with the Fed, the Bank of England, the ECB and the Japanese to the fore – have been throwing a party for some of us for the last few years. It may not always have seemed like it, but look at the facts. After the world’s economies exploded in a mess of debt in 2008, we saw stock indices and asset prices take a tumble. Policy makers could have taken various roads to try and rebuild confidence and economic security, and indeed they did mix and match. If you were Greece, not a large or strong economy, you found yourself with an imposed technocratic (for which read ‘part of the complacent euro-bureaucracy’) government, a currency straitjacket, soaring unemployment and an increasing migration of the young and smart. Iceland? Well, there you found bankrupt institutions allowed to fail, some of those guilty gaoled and a massive depreciation; by now, though, a stabilised economy with the potential to grow.

Propping up Failed Institutions

But if you were one of the privileged, it wasn’t quite the same. Those governments - or strictly, their “independent” Central Banks – chose a different route. They decided that the best policy to follow was Quantitative Easing, or the same thing under another confusing name, which would allow them to prop up failed institutions by the simple mechanism of creating ever more money to keep them alive. At the same time, of course, they injected large amounts of taxpayer funds directly into the same institutions to bolster balance sheets ravaged by years of profligacy. Up to a point, it’s worked. True, Lehmann Brothers folded, as did Northern Rock in the UK, but the major banks were all saved (apologies to Lehmann: great name, big market presence but not quite in the Goldman Sachs/Morgan Stanley league and therefore not protected). Now, clearly, it would have been extremely difficult not to support such institutions, and I fully acknowledge that the Central Banks had to act quickly and decisively; the debate here is not whether or not QE was necessary – that’s now a discussion for historians and theoretical economists. What is relevant now outside academia are the effects of the policy.

Asset Price Party

And that’s why I say we’ve all been treated to a party. Since the crisis, and I would argue principally stimulated by QE, asset prices have been on a roll. The Dow hit new all-time highs, the FTSE not quite, but nevertheless surged, the Nikkei near enough doubled; hard assets as well have performed strongly (one exception of course being aluminium, but that’s a story all of its own), which is not only due to recovering economic growth. Politicians may talk about austerity, but it is in many ways just talk; I’ve yet to see figures from any of the major economies showing substantial sums of government spending cuts. Those of us who are in the fortunate position of being employed and/or being investors have been enjoying that increase in asset prices. A while ago I was speaking to a (pretty well-heeled) friend of mine and asked him if he had suffered from the economic crisis. Did he take less holidays, go to restaurants less? Had he had to sell one of his cars? No, was his answer, but he had had to cancel his NetJets subscription; austerity, twenty-first century style.

Price versus Value

But that’s just part of the story; the privileged part, if you like. Outside that, there is genuine difficulty. Those without access to those appreciating asset values have been suffering. The UK is fortunate in that employment has held up well, but that is not the case everywhere – look at France or Spain, for example. But that difference in outcomes is part of the pernicious effect of QE. It polarises the difference between prices and values. Those with access to the increasing asset prices – broadly speaking, that means people with investments or property, for example – have up to now been cushioned from the effects of the bubble prior to 2008. Values, actually, have not really changed; the increase in price has been a direct consequence of the way QE devalues money. If you don’t hold hard assets, all you experience is the pain of reducing purchasing power. QE has a lot to answer for here, because of where the newly-created money went.

Preparing to Bite

It potentially gets worse though; as QE is unwound, and let’s remember the Fed’s tapering has now begun, without new money to support them, the prices of assets – hard or financial – will almost inevitably drop. Look at the action on the major equity markets since tapering began. Some will say:  “Good, let the richer elements of society suffer as well.” Well, personally, I’d rather try and lift the bottom rather than force down the top, but that’s for another debate. The problem for policy makers is that after a good party, normally those who enjoyed it the most have the worst hangover. QE has always threatened to turn round and bite us; perhaps now it’s just sharpening its teeth in readiness.

 


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