Sunday, 16 September 2012

QE, LTRO, QEII, OMT, QEIII Spells Desperation - Part 1

In the aftermath of the Financial Meltdown of 2008, Capitalist States began a process of money printing. In fact, money printing is nothing new. States always have to print, or mint money, in order for it to circulate. Its actually the quantity of money minted or printed that is important. What is really being discussed is printing more money than is actually required by the needs of circulation, in order to try to encourage additional spending, and thereby stimulate the economy. Once again, Capitalist States have always tried to intervene in the economy via Monetary Policy, but they have usually done it through interest rates.

During most of the post-war period, states were able to increase money supply by changes in Bank Rate. By lowering the Bank Rate, the Bank of England (or other Central Bank) lowered the cost of borrowing for commercial banks. This increases the money supply because of the way fractional reserve banking works. It essentially means that the commercial banks themselves are able to create money – bank money. Banks know that of all the money deposited with them, the depositors will only ever require a fraction of it. That means the Bank only needs to keep that fraction available to pay out, as cash, to those depositors. In turn, that means the Bank can lend out the remainder of the deposit. Its on this lending, and the difference between the rate at which it lends, and the rate it pays to savers, that commercial banks make their profits – which is why its nonsense for the Government and others to complain that the Banks are refusing to lend, because that's like saying the banks are refusing to try to make profits!

When, the Bank lends to someone, they do so by creating a new deposit. So, if A deposits £100, and the bank knows it can lend £90 of it, it lends £90 to B, by depositing £90 into B's Account. However, the Bank now has B's Account with £90 in it. It can now lend £81 against that deposit, and so on. This “Credit Multiplier” means that an initial amount of Money of £100, when deposited in the Bank, can create £1,000 of Money in circulation.

So, if the Bank of England cuts Bank Rate, this allows commercial banks to cut their lending rates, which causes more people to want to borrow money, which then by the process described above creates more money. In the 1980's, when Capitalist States began to intervene in the economy using monetary policy as the main tool, (Monetarism), rather than fiscal policy, it was in this way that money was printed, or likewise withdrawn from circulation. After the 1987 stock market crash, Alan Greenspan, as Chairman of the US Federal Reserve, slashed US interest rates. The Stock Market recovered, and house prices bubbled up. When Greenspan began to raise rates again, the economy slowed down, especially with the recession of 1991, which coincided with the oil price spike of the time. House prices crashed in the US and UK, falling 40% in Britain.

Greenspan intervened again, cutting rates. Markets recovered, and house prices began to bubble up again. This process of raising and then lowering rates continued into the last decade. The market got used to the idea that, not only if the economy was slowing down, but even if just the stock market or property market was slowing down, the central bank would intervene to give it another push. On that basis both property markets and stock markets continued to bubble up. The backstop that the Federal Reserve provided, became known as the “Greenspan Put” - a Put is a Stock Market term referring to an option to buy shares at a particular price some time in the future.

In 2008, it became apparent that this means of intervening in the economy was no longer sufficient. Central Banks have always had other means of printing money besides simply cutting interest rates. They can, for example, reduce the proportion of assets that Banks are required to hold as a proportion of their lending. The Chinese State, which owns the main banks in China, uses this method frequently to control credit availability, as well as more direct measures to direct lending to those economic activities which are consistent with the Five Year Plan. However, the 2008 Financial Meltdown had been caused, in part, by reckless lending by commercial banks, which had given out loans of 125% of inflated property values, often without any kind of check as to whether the people it was lending to had any reasonable means of making the necessary repayments. Rather than loosening the requirements for lending by banks, it was obviously necessary to tighten them again, reversing the deregulation under taken by Thatcher and Reagan during the 1980's, which had made such reckless lending possible.

The other method for printing money besides simply literally printing more dollars, pounds etc. is for the Central Bank to buy assets from the banks, providing them with cash – in fact, an electronic deposit in the banks' accounts with the Central Bank – in return. This method – what used to be termed Open Market Operations – is what the Federal Reserve, Bank of England and other Central Banks did in 2008, and what they have continued to do since. It is what is called QE or Quantitative Easing. Although, it is portrayed as being a measure to stimulate economic activity, and thereby rescue the economy, its main purpose is to rescue the banks themselves, and Capital in general, which has large amounts of Money Capital invested in those Banks, as well as in other Financial Assets such as shares, bonds, and property.

The Bank of England, in its recent analysis of the effects of QE, admitted that the main beneficiaries had been the richest 5% of the population. That is because, it is they that own the bulk of shares, bonds and property, the bubbles in which have been kept inflated by the money printing. In the meantime, it is the other 95% of us, who have lost out. QE has not had any significant effect on stimulating economic activity, because, especially in an environment of austerity measures undertaken by the Government, no ordinary person is going to splash out on more borrowing, if they are struggling to pay their bills, face wage cuts, and might lose their job. Firms are not investing, and will not borrow to invest, for similar reasons i.e. they do not see any immediate prospect of economic activity improving significantly. In fact, many firms have lost out directly as a result of Government austerity measures – witness the 10% drop in Construction activity just announced.

Whilst QE has not increased economic activity, it has had other bad effects for ordinary people. It has reduced interest rates for savers to next to nothing, hitting older workers, and young workers trying to save to buy a house, particularly hard. The same effect has reduced Annuities for Pensions to next to nothing too. A Pension works by building up a pot of money, which is then used to buy an Annuity. The Annuity is a fixed amount of money (sometimes with an inflation linked increase) calculated as a percentage of the pot of money, paid out as pension each year. The lower the Annuity Rate, the less Pension you get. QE has also increased inflation, because the money printing means that suppliers can more easily raise prices, and because it has caused a devaluation of the Pound, which increases the cost of imports. Rising inflation, manifest in rising energy and food costs, is squeezing ordinary workers real wages, whilst it increases profits, which are paid out in higher dividends to Capitalists. QE, by keeping the bubbles in stock, bond and property Markets inflated is also detrimental to workers.

Higher share and bond prices, mean that workers monthly pension contributions, buy fewer of these assets, and the yields on them remain low. The continued bubble in the property market means that large numbers of workers are unable to afford to buy a home, and the cost of rent is artificially kept high. In his Press Conference a couple of days ago, Ben Bernanke, in justifying more money printing, argued that it would increase property prices in the US, and thereby stimulate economic activity by encouraging more people to buy homes, and the attendant furnishings etc. This is economic madness. The general principle of economic theory, of Supply and Demand, is that demand for a commodity increases as its price falls, not as it rises!!! There are exceptions to this rule, but in general, the only reason that people buy more of something when its price is rising, is because of speculation. The very thing that caused the crisis in the first place!

In the US, demand for houses has stabilised, and may even be rising slightly, but the cause of that is not that house prices are rising, but because they have collapsed by between 60-75%!!!! They have fallen to prices where they have once more become affordable, as things people want to buy to live in, rather than something they want to buy on a speculative whim. If another round of QE increases US house prices, it is likely to choke off that new demand, not increase it! What Capitalism really needs is a prolonged period of very low house prices, share prices, and bond prices, so that speculative froth is removed, and available Capital is invested in productive capacity, and hoarded money – of which there is literally trillions of dollars – becomes transformed into Money Capital, available for such investment. QE, and the alphabet soup of equivalent measures, is a reflection of the extent to which Money Capital continues to dominate in the realm of politics over Productive Capital, in the West. The longer that persists, the more the West will fall behind Asia, and other industrialising parts of the world.

After, the QE introduced by the Federal Reserve and Bank of England the governments in those countries also reverted to Keynesian fiscal intervention, ensuring that the additional money was directed into actual economic activity. China, Brazil, Japan and other countries did the same. The result was fairly immediate, and effective. Economic activity picked up sharply, giving the traditional “V” shape of the recovery. In the US, growth at one point was up to 5% p.a., UK growth rose to 2.5% p.a., unemployment was declining, and yields on UK 10 Year Gilts were declining, despite the size of the debt and deficit. In the Eurozone, the ECB, under the influence of Jean Claude Trichet, a supporter of the so called “Austrian School” of economics, however, decided to raise interest rates, soon after the immediate crisis appeared to be over, and to insist that Eurozone Governments had to be fiscally conservative. Strong Eurozone economies like Germany could cope with that, weaker economies like Greece, Spain, Ireland, and Portugal could not. Those like Spain and Ireland, which had blown up huge property bubbles, which now either burst, or at least stopped inflating, were particularly vulnerable. Greece, as a tiny economy, which had borrowed to excess, and used virtually none of the borrowing to invest in making its economy more competitive, was the most vulnerable of all.

In the US, the rise of the Tea Party, representing a virulent form of right-wing populism, mobilised to push the Republican Party towards the kind of fringe economic and political positions that previously had been the preserve of the lunatic fringe of the Libertarian Party, based around the Neo-Austrian economic theories of Von Mises, and Hayek. They began to remove and replace Republican candidates with Tea Party candidates, dedicated to a mindless commitment to oppose any tax rises, which nearly caused the US to default on its debts last year. All Republicans were pressed into adopting a similar stance for fear of losing their seats. Moreover, in the mid-term elections, it seemed to be a useful approach, because as Obama failed to tackle the real problems of the US economy, and failed to live up to the expectations many, misguidedly, had placed in him, the right-wing populism seemed to garner votes for Republicans.

That, together with the fact that many States have Constitutional requirements for Balanced Budgets, meant that Obama's attempts to use fiscal stimulus to rescue the US economy faltered, as Republicans scuppered any such attempts where they could. In the UK, the Tories saw this happen, and spied their chance. Having previously been committed to at least matching Labour's spending commitments, they did an about face, and committed themselves to Austerian economic policies, justified on the back of an incredible misrepresentation of the state of the UK economy as being on the verge of collapse like Greece. The Opportunists of the Liberal-Democrats, who had been opposing such policies even into the Coalition negotiations with the Tories, quickly ditched those policies and any principles they might have had, in return for a seat in Cabinet, and a ministerial limousine.

The consequence was inevitable. The recovery of the UK economy stopped in its tracks, as individuals and businesses took the Government at its word, about the likelihood of economic catastrophe, and certainly at its word that they intended to deliberately retrench the economy through their Austerian economic policies. Within months, of them taking office, the incompetence of the Government had caused the economy to essentially come to a standstill, and then to go into the current double-dip recession. During all that time, the Bank of England has continued its policy of near zero interest rates, and money printing without any noticeable effect on economic recovery, and with all the negative effects for ordinary workers referred to earlier. The beneficiaries have been the Banks and Financial Institutions, and the Money Capitalists behind them.

Similar policies in the Eurozone have cratered economic growth there too in the periphery, although the core of the Eurozone has largely not had Austerian economic policies imposed on it, (largely because the underlying problem, in the UK, Greece, Spain and Ireland, of huge amounts of debt, particularly private debt, did not exist, because of the different structure of its housing market and larger productive sector) and has largely avoided recession. Indeed, until the last few months, the economy in Germany, Sweden and other northern European states has been growing strongly. The main problem faced by the Eurozone is how to deal with that huge amount of private debt in the periphery, just as it is how to deal with the huge amount of private debt in the UK and US, without destroying the Banks who have issued all that debt, and who own in return huge amounts of assets, worth trillions of dollars on paper, but next to nothing in the market! That is a problem for Germany, in particular, for two reasons. Firstly, its banks and financial institutions provided a lot of the lending to the periphery. Secondly, the German economy depends on being able to export to other Eurozone economies. But, it is also a problem for the UK for the same two reasons, which is why the arguments of the Eurosceptics are so remote from reality.

In the US and UK, the problem has been partly resolved through QE. In the US, in particular, the Federal Reserve has not just bought Government Bonds, it has also bought commercial paper, such as Mortgage Backed Securities (MBS) from the Banks, effectively transferring worthless paper assets from the books of the banks on to the books of the State, in return for dollars. In the UK, the Bank of England has mostly confined itself to buying Government Bonds. The Bank of England now owns about a third of all the Government debt issued! That is why, UK Gilt Yields are at such low levels. But, it does not resolve the main issue, which is the amount of private debt outstanding. In the UK, Public Debt amounts to around £1 Trillion, but Private Debt stands at around £2 Trillion. In the US, many people have walked away from their houses, leaving Banks with worthless property, to sell at about a quarter of its price, prior to the Crash. However, there is still a huge amount of mortgage debt in the US, and added to it, is over $1 Trillion in student debt, and a similar amount of credit card debt. Unless the Federal Reserve printed money, and sent a cheque to everyone to pay off those debts, which it will not do, that debt is not going away. Or, at least, if it goes away, it will only be through massive defaults, much bigger than happened in 2008, which would in turn destroy the banks.

The same is true in the UK. A large part of that £2 Trillion of private debt is mortgage debt. But, record numbers of people are in arrears, despite the lowest interest rates in British history! The properties, against which those mortgages were given, have bubbled up in price to ridiculous levels. They are like zombie properties, walking dead, that have the appearance of value, but on the inside are hollowed out, with no real value other than what is being maintained by the fiction of asking prices in estate agents' windows, and official House Price Indices, but whose unreality is demonstrated by the fact that no one can sell houses at those prices. Yet, not only are the mortgages of millions of people dependent on the façade of these zombie properties, but the billions of pounds of additional debt, credit card debt, store card debt, and increasingly pay day loan debt, has also been accumulated on the back of it. At some point the elastic can stretch no further, and as happened with the sub-prime crisis in the US in 2008, so all of this debt will become odious too. A small rise in unemployment, the continued rise of inflation, squeezing real wages even more, a panic in financial markets, causing a sell off in Bonds, and spike in interest rates, a continued Credit Crunch, pushing rates higher, as is already happening with rising mortgage rates; any of these could be the straw that breaks the camel's back, and causes an avalanche of selling, and the bodies of the zombie properties crumble to dust, bringing down the zombie banks, that created them, in the process.

After 2007, when Northern Rock collapsed, interest rates were slashed, and millions of mortgage payers benefited by, on average, £7,000 a year, in lower monthly payments. Yet, although that had an immediate effect on bolstering consumer spending, in the next year or so, it has not countered the effects of the Government's austerity measures over the last two years, and those policies have hardly begun. So, far only about 6% of the Government's austerity measures have been introduced! Further job cuts, wage cuts, pension cuts, benefit cuts, and tax rises have yet to hit the economy. The job figures are a mirage, hiding the reality of millions in part-time work, forced into self-employment that pays little more, if anything, than benefits, and thousands on zero hours contracts. Appearance and reality, as with the property market can only remain separate for so long. Alongside zombie properties and zombie banks, we also have zombie jobs in an increasingly zombified economy.

In the Eurozone, politicians have played a game of hide and seek with markets for the last two years. They continually announce another set of new measures that are to be dramatic, and big enough to deal with the problems, which will be unveiled at an unending series of meetings of Finance Ministers, only for those measures always to be far less than spectacular, far less than is required to actually deal with the problems. Each time, the markets follow the usual practice of “buy on the rumour, sell on the fact”. So, stock markets and bond markets rally on the announcement of some new proposed initiative, and then after its been announced, they sell off again. The main reason that markets have risen by 30% in the last year, has been money printing.

Forward To Part 2

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