Why QE is not the answer to Britain’s economic problem

Once again Allister Heath hits the nail on the head when it comes to the latest MP decision.

Read the original article here.

IVAN PAVLOV, the psychologist who famously trained his dogs to respond to stimuli, would have been proud. Whenever the economy grinds to a halt, regardless of reason, well-conditioned policymakers from Beijing to Frankfurt always respond in the same way: they cut interest rates and wheel out the printing presses. It is the new orthodoxy: ever easier money is the answer to every economic problem. True to form, most people in the City backed yesterday’s news of £50bn in extra quantitative easing (QE).

There are some dissenters, of course. Only borrowers benefit from lower rates: Ros Altmann of Saga points out that annuity rates are down by 23 per cent since July 2008 and that QE has hit over 1m pensioners via annuity and drawdown income falls. Economists such as Simon Ward (see page 19), Andrew Sentance, the Institute of Economic Affairs’ shadow monetary policy committee, various Austrian-leaning analysts and some others all opposed this latest round of QE. But they were drowned out by the pro-QE voices.

The tragedy is that the supposed omnipotence of monetary policy is in fact a misunderstanding of the work of economists such as Milton Friedman. He rightly identified that the bursting of the bubble in 1929 only became a depression when the money supply was allowed to collapse by the Federal Reserve. Because there suddenly wasn’t enough money left in the economy, demand slumped and prices were forced down – but because the adjustment wasn’t immediate, especially with wages, it caused mass unemployment. Many firms and individuals went bust as the real value of debt shot up.

Central bankers have since pledged not to allow such deflationary episodes caused by monetary contraction to happen again, and quite rightly so. The point of QE is that it can create extra money. The Bank of England was therefore right to engage in its original round shortly after the banking implosion. But subsequent interventions have been increasingly desperate and useless. The money supply is already increasing, albeit slowly, in the UK, not collapsing. In real terms, the broad, adjusted measure rose by 1.3 per cent (not annualised) in the six months to May – the largest increases since April 2009. Given that the rate at which money is being passed around the economy is also going up, the case for more QE is non-existent.

Monetary policy errors can destroy the economy – but that doesn’t mean clever monetary policy can create a boom. Bad monetary policy is disastrous – but good monetary policy is neutral. It doesn’t mess things up. It allows the private sector to do its thing. QE is not like alchemy. It can’t cure an economy which is suffering from real ailments, such as excessive debt, bad skills, too much regulation, bad incentives and the like. These problems require real medicine, not a bit more money printing.

Friedman ended up advocating that the money supply should follow a very simple, unvarying rule to prevent governments from trying to manipulate the economy. Other economists of the Austrian persuasion believe in even more radical monetary policy rules. The crucial common ground is that manipulating money and interest rates can only work for short periods of time – and then only when it fools people into thinking that there is more real demand for their services than actually exists. Britain needs a real growth strategy – and that means incentivising companies to invest and hire and to produce more. That is a job for a reforming government, not an over-stretched Bank of England.

6 comments on “Why QE is not the answer to Britain’s economic problem

  1. Simon Roberts
    July 6, 2012 at 9:13 am #

    I keep reading criticism of QE and, while it is indeed a bad thing, not many people seem to focus on what it is actually is.

    While the BoE may argue that purchasing government bonds in the secondary market is being done to stimulate the economy, everyone seems to focus on the primary (visible) function – the buying of assets from banks and the additional liquidity that this produces.

    What I don’t see is anyone commenting the secondary (real) function of QE – the purchase of government bonds. This is money printing to fund government spending, plain and simple, but people seem to miss it and concentrate on the supposed economic stimulus that it provides.

    Printing money to give to banks is also a bad thing and is understandably politically unpopular, but the funding of government debt via the printing press is far, far more destructive. I would go as far as to say that it really is the beginning of the end for the fiat money system. At least, that’s what history would seem to suggest.

  2. West Tipp
    July 6, 2012 at 8:03 pm #

    What would actually happen if the fiat money sytem did totally collapse?
    How would the new “Economy” operate?
    I met someone recently in Dublin who said,
    the Irish Money Supply would dry up very soon.
    People are now regularly saying
    “where will this all end”.
    Many many people are very fearful here.

    • Simon Roberts
      July 7, 2012 at 9:00 am #

      When we talk about the collapse of the fiat money system, we aren’t talking about the supply of money drying up. Quite the reverse. The danger is that, because governments have the power to create currency out of thin air, they will do this to cover their deficits in public spending (including bailing out banks).

      When we say “collapse” we mean the governments create so much currency that prices rises run out of control and eventually people lose confidence in the fiat currency. This is the point after which you see photographs of people carrying armfuls of paper notes to buy groceries. There are recent examples: Yugoslavia, Argentina, Zimbabwe.

      In those countries, people were using commodities as money where they could. You can see videos on YouTube of people in Zimbabwe panning for gold dust to buy food etc. The other thing that often happens is that people start using foreign currencies eg US Dollars or Swiss Franks to conduct day-to-day business.

  3. West Tipp
    July 8, 2012 at 8:38 pm #

    Is there anything one can do to prepare for this eventuality,, literally on a very basic level, being able to feed a family etc..
    Do you think the Euro will collapse?

  4. Boz
    July 11, 2012 at 12:03 pm #

    For starters, turn all spare cash savings into safe, useful, commodities ; all which can be traded.

    If you are lucky enough to have loads of spare savings, all the better.

    If very long term savings exist which are just a store of long term wealth, then property as a long term commodity is unbeatable – even though house prices may go down a bit soon.

    Property produces that magic thing called income – rent or food (which is tradable and can be turned into money at any time). It always retains real value while money just evaporates while you simply look at it.

    • West Tipp
      July 11, 2012 at 7:57 pm #

      Many thanks for that, could you expand more on “safe, useful , commodities”?
      Do you think we are in the “Calm before the storm”?

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