There is something rotten in the Bank of England. According to its pamphlet on quantitative easing (QE), the Bank is "committed to low and stable inflation" because it is "crucial to a thriving and prosperous economy". What a joke. Controlling inflation – and specifically keeping it as close as possible to the 2% target set by government – is supposedly the Bank’s raison d’etre. And yet the Monetary Policy Committee (MPC), led by Bank of England governor Mervyn King, has failed to achieve this for the past 21 months.
In fact, inflation has been running at or over 4% for the past eight months and at least 3% for the 12 months preceeding that. King has repeatedly trotted out the increasingly implausible line that the UK’s inflation problem is down to short-term effects and that there is no justification for attempting to bring it under control by raising interest rates. Quite the contrary in fact, for last week the MPC voted to pump an extra £75bn of QE funny money into the economy, on top of the £200bn added in QE1. Why should printers care about this? Because high inflation is bad for business.
The argument for QE is primarily centred on growth – or the lack thereof – and the need to get people lending, borrowing and spending again to drive the economy forward. The money created through QE is used by the Bank of England to buy up government debt held by private financial institutions, including banks. The argument goes that this will increase the banks’ capital reserves, prompting them to increase their lending to businesses and households, while at the same time driving down the cost of borrowing. So, given that the Bank of England already pumped £200bn into the economy in QE1, with no noticeable impact on lending, why should we expect another £75bn to help?
According to Gerry Hoare, founder of Deal Bureau, we shouldn’t. "The banks aren’t lending, so what has happened to all the money that was put into the economy to lend – has it just been used to improve banks’ balance sheets and capital?"
Quite probably. The banks – who will almost certainly fail to meet the lending targets agreed under the Project Merlin deal – argue that the shortfall in lending is down to a lack of demand. There is a sliver of truth in this, in that the uncertainty caused by low growth and high inflation means consumers and businesses are reluctant to take on new debt. However, any finance broker will tell you that the real problem is that nobody wants to lend on terms that are affordable for the bulk of businesses.
The major new problem that the West is facing in the current crisis is the rise in consumption in the East. In past recessions the price of commodities such as crude oil and metals has fallen in line with falling demand in the West. This has had a self-correcting effect, in that falling demand results in falling prices, which increases disposable income and gets people spending again, leading to economic growth. However, the rapid growth in the BRIC economies, which has run at around 8% throughout the meltdown in the western economies, has meant that commodity prices have remained persistently high. The effect is exaggerated by the devaluation of sterling that is the result of QE, which obviously raises the cost of imports, causing inflation.
This means that businesses have been left facing rising utility and transport costs and raw material increases, while demand has remained stifled. This makes it hard to justify passing on price increases – a familiar situation for UK printers. "Looking at print particularly, distribution costs are going to be higher, electricity higher, paper costs will probably go up and the margin will go down," says Hoare.
Addiction issues
QE has been likened to a drug in that once you start it’s very hard to stop. If it works – great, print more money. If it doesn’t – as QE1 evidently didn’t – then you obviously didn’t print enough. However, as the economist John Maynard Keynes said: "To think output and income can be raised by increasing the quantity of money is rather like trying to get fat by buying a larger belt." Keynes, who died in 1946, would probably have been concerned that his theories have been used as the basis for much of the justification for QE, given that he had similarly stong views on inflation: "By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."
