What’s another £50bn being pumped into the British economy going to mean for you and me?
That’s how much fresh cash is about to be minted and spent by the Bank of England.
The Governor and his minions won’t be standing on the corner of Threadneedle Street handing out fivers. But the aim’s more or less the same, to stir us up into spending lots of money again.
And it might work a bit – for now. But it’s just storing up even bigger problems in the future. Gilts could suffer horribly…
The UK economy looked like it was getting back on track…
The Bank’s latest move to prop up the economy was a big shock to the markets. They didn’t know it needed the help.
Investors had reckoned the UK economy was getting back on track. The service sector – everything from hotels to hairdressers – seemed in better spirits, says the latest CIPS/Markit survey. And ‘Trouble at t’Mill’ seemed to be receding too, as manufacturing recovered 0.4% in June.
Throw in the Nationwide and the Halifax both telling us that UK home values picked up last month, and the Royal Institution of Chartered Surveyors now forecasting an overall house price rise this year, and the recovery cheerleaders have been in full voice.
On top of all this, the Bank had already pumped a huge £125bn into the system via its quantitative easing (QE) money-minting scheme. So the City thought the Bank would probably announce that it was now getting ready to shut down the printing presses.
But it didn’t. So what does it all mean?
So why weren’t the printing presses shut down?
QE is all about buying – mainly – UK government bonds (gilts) from investors such as pension funds. That gives the latter more cash in hand, which the Bank would like to see invested in other areas, such as bonds that back lending to businesses and private individuals. If that happens, the Bank hopes that more money will filter through to the banks, the cost of borrowing will drop, and extra cash should eventually end up in the pockets of shoppers and home loan borrowers.
In short, QE is what desperate central bankers do to get money moving and to make it cheaper when interest rates have fallen as far as they can.
So what does it do? Well, in the short-term, QE lowers yields on gilts because there’s a big buyer in the market – the Bank. So bond prices rise, and gilt traders get very happy. Further, money being showered around like confetti must have an impact somewhere. Matthew Lynn was spot on in MoneyWeek a couple of months ago (Central bankers are just blowing up another investment bubble) when he suggested that the stock market could get a big boost from QE cash. It has.
And it may keep interest rates down for a bit longer – until the next general election, if you want to get cynical. After all, if Gordon Brown has any say in the matter at all, he would much rather that voters went to the polls with the UK economy looking set for another boom. So he’ll be all in favour of pumping the system full of steroids, regardless of the long-term effects.
Why QE won’t do much for you and me
But that’s about the extent of the ‘good’ news. Because the fact that the Bank has decided that Britain needs more QE, can only mean that “everything is either far worse in the UK economy than most imagined, or will get worse soon. Possibly both”, as the FT’s Lex column put it.
Certainly, that QE wedge isn’t doing much for you and me. The cash the banks have raised from gilt sales is sitting in their vaults – or in their own accounts at the Bank. As the Telegraph’s Edmund Conway says, “for the first time in history there’s a lot more money parked at the Bank of England in high street banks’ reserve accounts than there is flowing around the country in the form of notes and cash”.
The other side of the coin is that some of Britain’s banks are making fat profits again, and paying some of their wheeler-dealers bumper boom-time bonuses. Yet, as we pointed out recently in Money Morning (Profit from the lending drought – buy these two stocks today) they’re not lending at anything like the pre-crunch days. That’s hardly surprising. The Bank has kept its base rate at a measly 0.5%. If the banks can borrow here for next to nothing, and lend the stuff out to us at roughly the same rates that they used to – scooping a huge margin in the process – why should they risk making more loans?
Gilt holdings
Meanwhile, the rest of the Bank’s QE cash has gone abroad, as overseas investors have dumped their own gilt holdings.
And here’s where much bigger problems could kick in. QE is just confetti money. It’s not backed up by real things. If the amount of money sloshing around the system is increased without creating any new things to buy, inflation could eventually be stoked up once again.
Worse, there’s our huge national debt. The government needs to sell at least £220bn-worth of gilts this year, the biggest fund-raising effort ever, just to keep the Treasury’s books balanced. By itself that’s enough to drive up gilt yields as the government has to compete for investors’ cash. It’s starting to look like the real reason for the latest QE dose is to pay off Britain’s soaring overdraft – the Bank already owns about one fifth of all gilts.
If investors both start to worry about inflation returning again, and also get more jitters about the growing hole in the state coffers, then they’ll demand ever-higher returns for lending the British government money. Long-term interest rates will be forced up much further, killing off any economic recovery almost before it’s begun.
The Bank’s made a big mistake
In a nutshell, it seems the Bank has just made a big mistake. And to see what the outside world really thinks of QE, just look at the exchange rate. Currency markets don’t like more pounds floating around. Sterling dropped sharply yesterday. We could see much more of that unless both QE stops and the government slashes public spending.
But there’s no sign of the latter either. “Britain’s buy now, pay later, culture lives on”, says Lex. Which means that current 10-yr gilt yields of 3.7% are set to go a lot higher, and so prices have a long way to fall. Gilts look like a strong sell, as we’ve been saying for a long time. And as for the inflationary threat, gold still looks like a good way for UK investors to hedge themselves against what could turn into financial carnage for Britain.
• Our regular columnist Tim Price had more on the epic scale of the government debt problem, both here and in the US, in his latest Price Report newsletter – as well as a quite unnerving account of why there’s likely to be another big crash before the end of next year. You can learn more about The Price Report here.
Category: Investing in Gold