Tuesday, 29 January 2013

Kicking the habit of QE


The great and the good have been trying to resolve the riddle of rising employment with no GDP growth. This implied weakness in productivity is certainly a troubling and new phenomenon.  There are a myriad possibilities that might be contributing factors, I have picked four: high government spending, low productivity, poor tax receipts and poor private sector performance.  The common threads that harness these 'four horses of the apocalypse'  are quantitative easing (QE) and the associated low interest rates and high inflation.
Firstly, let's look at low interest rates. The Bank of England has held rates at 0.5% for the last four years, given inflation has been running at over 3% for most of this period we have had real negative rates of interest averaging -2.5%+.  Trying to grow the economy when savers (people and businesses) are losing 2.5% of their income and value every year, is going to be tough.  These negative rates have been helpful in some respects - propping up failing businesses and over extended families.  But there has been a huge down side in penalising pensioners, other savers and well run businesses.  This benefits equation is clearly out of balance with low interest rates helping distressed non-contributors while disadvantaging those who, ordinarily, would be the engine for growth.  These secure businesses and private individuals who are most likely to invest and spend must be the main components for GDP growth.
The negative interest rate has had another significant effect on the business world.  Well run and productive businesses looking to invest have had the distraction of having to make increasingly large pension provisions as investment return dwindle to nothing.   Another bi-product of negative interest rates has been an overvalued Pound, which has damaged our exports and sucked in cheap foreign goods.  The cumulative effect of negative interest rates  have had the unintended consequence of creating a vast number if Zombie companies - I have been banging on about this for a while. Zombie companies can't afford to make the redundancies required and are in a permanent loss making position, only able to pay the interest on outstanding loans.  I have estimate that these Zombie companies in the UK amount to over 3 million employees. These unproductive businesses and employees are soaking up financial and human capital resources that other better run businesses need. 
So while negative interest rates seem like a good idea, keeping mortgage payments low they also have put a massive break on the economic growth.
The other consequence of QE has been stubbornly high inflation, which has been running at 2-4% over the last three years.  The cumulative effect of negative interest rates and high inflation has been the killer blow that has forced savers to hoard cash and business to shelve investment plans.  The Government has been unlucky that the Pound has been perceived as a safe haven, sheltered from the storms buffeting the Euro and the Dollar. 
These mistakes in economic management were started by Gordon Brown in the aftermath of the credit crunch, desperate to keep the economy afloat with an election looming 'Gordo' was not planning ahead.  The Coalition have, under the guidance of The Bank of England, continued the process of QE, which exchanges future government debt for short term monetary relief.  In retrospect a more traditional approach to maintaining low inflation (with all the pain and insolvency that would have caused) would have made the 'dip' steeper but may have accelerated the recovering.  The path we have chosen looks likely to offer a stagnant economy for the foreseeable future, unless the government change tack.
To rectify the problem the focus needs to be on lowering inflation, rewarding savers (not the over borrowed),  whilst maintaining the value of our currency (which is starting to come under pressure).  Oddly these are complimentary medicines and we need to start now!

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