Thursday, 22 September 2011

QE3 won't work, the cuts will.

The Bank of England has indicated that it is considering another bout of Quantitative easing. This presupposes that the problem in the world economy is insufficient demand, to which a solution is printing more money. If insufficient demand WAS the problem, the incredibly low interest rates would have encouraged investment and spending. The first two bouts of quantitative easing would have seen demand pick up.

They didn't. We barely scraped out of recession.

What quantitative easing did do was push up the prices of Gold - a hedge against inflation. Up too went the price of Oil, of Commodities such as copper, and therefore share-prices. Much of the money went into banks, so their balance sheets were artificially boosted. The FTSE100, being mostly miners and banks did very well, for a time. Other commodities, such as food also rose as more money chased a short-term fixed supply. House prices in the UK have been artificially maintained at their inflated level. Most of all, Quantitative easing, a policy of buying bonds has contributed to a bond bubble, where the sovereign debt of the USA, UK, Germany, Switzerland and (for a long, long time now) Japan are paying nothing in real terms.

The cost of this policy is borne mainly by the poor. Inflation has been explicitly blamed on Oil price rises and rises in the cost of , especially in food hurts the poor. While the main beneficiaries are people with assets - the rich. Labour's left however is clamouring for MORE intervention in the economy, but this isn't a Keynesian recession caused by aggregate demand. Therefore Keynesian solutions such as fiscal stimulus (spending money, or cutting tax) won't work any more than monetary ones, at least until the Government books are nearly balanced. So Labour's solution - to keep spending until we're Greece won't work.

So if it isn't demand, what is causing the problem? First there is a lack of investment opportunities. Whether this is a cause of or caused by the excess bond issuance crowding out other investments is moot. What's certain is the low interest rates and negative real yields are shielding governments from the effects of their two decades of profligacy. Germany, the USA, Italy and Japan all have enormous stocks of debt. Thanks to Labour's 10% deficit, the UK is still catching up fast. Most of the debt is internal, to pension funds and citizens of the states involved. The External debt, especially the USAs is mainly bought by China.

This has the effect of keeping the Chinese currency down and the Dollar artificially strong. What this does is boost exports from China at the expense of domestic demand. This is, in effect keeping Chinese poor to allow the Chinese Government to sit on an enormous pile of Dollars. At some point, this has to end. The Chinese will have to allow their people to buy French handbags & Wine, Italian Clothes, German Cars and English Shoes at the cost of devaluing their Dollar reserves. A fall off in demand for Western government securities will force (or allow) Governments to cut spending even as real interest rates rise. As bond prices fall, and the bubble bursts, money will flood out of treasuries and look for more productive investments.

So, can cutting Government spending faster, closing the deficit and restricting the issuance of Government debt help without the Chinese releasing their reserves? A restricted supply of Gilts would lead to the real interest rate falling, helping with deficit reduction. This doesn't really help prick the bond-bubble, but restricting the supply of Gilts will drive more money into the productive economy. Furthermore the means by which spending will be cut faster - firing and not hiring people in the public sector will re-weight the economy faster towards the private sector. In the Last Quarter, the public sector lost 111,000 jobs, but the private sector gained 41,000. Year to date, the figures are 149,000 fewer public sector workers and 159,000 more private. The cuts are beginning to do their work, and the private sector, against the stark warnings of the left, is taking on the task of picking up the slack. Since public sector employment started falling in the first quarter of 2010, the Private sector has increased employment in every quarter. That's 617,000 jobs created for 290,000 lost in the public sector. Each of those public sector jobs lost is one fewer wage bill. Each of those extra private sector jobs is one extra tax-payer. This helps reduce the deficit.

But it's more than the reduced deficit. Most public sector workers aren't the Nurses, teachers, firemen and doctors which represent the public sector in the fevered imagination of the Left. It's bureaucrats, so there's another benefit of having 290,000 fewer of them: They're not sticking their clip-boards in the way of business hiring and investing. These bureaucrats aren't unemployable either. For a decade, business has been crying out for literate, competent people who are capable of turning up to work in the morning. In many parts of the country, these people have been working for the state, which has effectively crowded out private sector employment. With that option no longer open, the Private sector is now able to find the people to provide the investment opportunities for capital which have been so lacking since 2005. The fact is this recession, like all recessions is down to malinvestment. In this one we've over invested in public sector prod-noses and under invested in the productive private sector.

This has been multiplied across the entire western world, and added to imprudently low interest rates as Governments have pumped money into the economy in a desperate and futile attempt to keep the party going. This monetary and fiscal "stimulus" has had the same effect as moving off beer and onto vodka. Quantitative easing is like offering round the cocaine in an attempt to keep inebriated guests dancing at 4am. The conversation's still nonsense, but the hangover will be much, much worse as a result.

If the Chinese government can do a bit for us and allow their domestic demand to rise with their currency too, we (and the Chinese people) will be thankful. Chris Dillow argues against the usual reason for stimulus not working (as per this paper, often cited by Tim Worstall & Others including me on discussiong about "stimulus") keeping suggesting that it raises the currency, harming exports. In this recession, that might not be the case, AUSTERITY in the west may weaken our currencies relative to China's by slowing the flow of treasuries & gilts which are being purchased by the Chinese in order to keep western currencies artificially high.

The "double-dip" is a misnomer. We're witnessing the last gasp of an asset and credit bubble which started to burst in 2000 and it ain't going to be pretty. In truth, we've barely left the recession which started in 2007. Unless we free up resources - people, capital from the public sector, we will not get growth. BRING ON THE CUTS. More & faster, please.


Antisthenes said...

QE III wont work. Yes but they will probably do it anyway and more bond purchases and bailouts. Keynes (putting aside whether his economic theories are right or wrong, wrong mostly I believe) never said you should stimulate with borrowed money but with money that had been hoarded in good times the left of course conveniently do not mention that. Whilst the same old tried and failed economic and social policies are pursed then the mess is going to get exponentially worse and the reckoning is going to be soon and catastrophic. Your blog articulates well the current economic situation, however the governing elite are blind, stupid, afraid of losing votes or are unable to admit their mistakes. So I see no hope as adopting policies that further cut the public sector and the welfare state with the severity that is required to secure growth will not happen .

Mitch said...

It seems that the Lefts answer to any problem is to throw money at it.

It hasn't worked before, It wont work now.

Single acts of tyranny said...

That was a very good analysis.

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