ultranomics

The world’s economy is floating about in uncharted waters, friends. You knew that though, right?

The economic leaders, i.e. the governments have no clue how this is going to play out. Neither do the so-called experts - the economists, the analysts, the commentators.

Due to the unmapped landscape and the all-pervading fear of this unknown scenario, politicians have literally been given a free reign to try experimental cures at alarming doses.

Just imagine going to the hospital with cancer which has been caused by exposure to some strange kind of radiation called ‘borrowtoomuch’. When you get to the hospital the doctor says he’s never seen such a case before. Then he says that the best they could do was try an experimental cure - by giving you a massive dose of ‘borrowtoomuch’! “Wait,” you remark. “Isn’t that what caused the disease in the first place?” you ask the doctor. He replies, “Yes you are right. But your body has now come to be dependent on it, like a drug addiction. The reason you have got ill is that suddenly you stopped getting it. Perhaps if we pump you full of borrowtoomuch we can jumpstart your system once more. I can’t guarantee the cancer will be cured but maybe we can keep the symptoms at bay!”

The £75 billion quick-fix

That’s what all these enormous fiscal stimuli which are being bandied about like sweeties feel like. An attempt at treating a problem caused by too much credit, by creating further credit. However crazy this all sounds, even we have to admit it does sound intriguing and we wonder if it just might work, but that is only because the true cure seems so tough and unbearable, i.e. to let everything crash and burn, to suffer deflation and depression Japanese-style for a decade or so, let greed vanish and bad companies die, let politicians and public come to their senses and realise you must first save and then spend, let real businesses which provide real services and real products drive a gradual increase in the economy, rather than institutions and individuals borrowing credit and speculating on asset classes and derivatives. This would ultimately be the healthiest way forward, but who wants to go to the physician and take bitter medicine for many years when the surgeon can remove the tumour far quicker, even if he leaves some scars and the risk of recurrence. Even in an idealistic world, this would be a tough choice. However in the real world of politicians who must win the next election, its no choice at all - it’s the surgeon’s quick hand every time.

Right now, the dear old Bank of England is ripping open the chest of the UK money system, and pouring in several gallons of cash. Glug, glug, glug. Can you hear those £75bn filling up the Governments fiscal heart? That heart hopes to pump it out into the arms of the banking system, and hopefully on from there into the hands of industry and business, to shore up productivity and jobs, as well as into our hands, through more mortgage lending. Plus, if that doesn’t work, there’ll be another £75bn ready to be pumped in just for good measure.

Printing presses off to a flying start

This radical treatment, called ‘Quantitative Easing’ (Q.E.) is so experimental that no-one knows if it will work. We hope it does, because this kind of procedure isn’t without side-effects. The Bank of England has basically just created this money out of thin-air remember. You will read in many places the phrase “the printing presses have been turned on”. In reality its even simpler than that, no more than tapping a few keys on a computer somewhere! However, adding such big injections of new money into the economy means that the already-existing money, i.e. that in our bank accounts and pockets, gets devalued. After all, Q.E. is a type of debasement – diluting value by increasing supply. Every new pound printed dilutes the value of every pound in your pocket. That spells bad news for sterling. The effects are numerous and different depending on where your interests lie. A devaluing pound might be great for exporters. It would be awful for importers.

Bear in mind also, that with so many extra ‘quid’ floating about, and this increased money supply chasing the same goods/assets/services - you know what it spells don’t you friends? Inflation.

Now personally we don’t think that a bit of inflation is a bad thing, in fact we’d rather have a couple of points of inflation each year rather than deflation. That would be healthy. However that level of healthy inflation needs to come from increasing economic activity and increasing productivity leading to increasing wages etc. The kind of inflation we might get from this Q.E. would not be this type of ‘good’ inflation. Instead it would be coming at a time when the economy is doing badly, companies are going bust and unemployment high. This is a time of stagnation in the economy, and inflation due to artificial stimuli at this time of stagnation is known aptly as Stagflation. This is not good, especially if it were to turn into hyper-inflation Zimbabwe-style (give or take a few zeroes!!). In an already depressed job market and time of trouble, the value of the pound in our pocket would plummet even further, and our mortgages would rise again from these historic lows. Its something we will all need to keep watching out for over the coming months.

Liquidity is not the problem!

The core dilemma we foresee with this tinkering with Q.E. is that it is trying to rectify the credit supply. Banks are not lending. The Government hopes that once they are given fresh injections of capital, the credit will start to flow again to businesses and individuals. The trouble is that it is no longer just an issue of credit supply. The banks do now have money to lend, they just don’t want to lend! They are being uber-cautious because they are scared. They don’t know what anything is worth. That’s why you can’t get a buy-to-let mortgage for more than 70% loan-to-value these days. The banks would rather hold on to their capital until the murkiness has cleared and assets have bottomed out in value.

Furthermore, even if they did want to lend, who wants to borrow? The public at large are scared. Everyone is worried about the coming years and is paying-down debt. People have actually started saving and we have entered a thrift-conscious era. Not many people want a new house or a new car (4×4 is now a dirty word, even in Chelsea). Garden centres are doing roaring trade as everyone wants to ‘grow their own’ veg. State schools are finding that their admission applications are rising as more of the middle classes opt for free State education. So even with these billions being pumped in by the Bank of England its no automatic guarantee that the economy will get the boost it needs.

Ultimately, what started out as a credit crunch, that spawned a recession, has now become a Depression. Both ‘credit crunch’ and ‘recession’ are events led by a country’s macroeconomics. A ‘Depression’ on the other hand manifests in the hearts and minds of the citizens. We are now ‘economically Depressed’. Our spending has stopped. You can’t Q.E. us out of our fear at the touch of a button or whirr of the printing press. We won’t feel like spending again no matter how many speeches you give or assurances you give. Not until we get jobs. Not until our firms stop going bust. Not until we feel safe.

Recommended related articles:

http://www.bbc.co.uk/blogs/thereporters/stephanieflanders/2009/03/qe_day.html

http://www.fleetstreetinvest.co.uk/shares/market-outlook/quantitative-easing-devalue-pound-11246.html