QE, or not QE, that is the question

There was a global economic meltdown in 2008. World governments have since spent their time running through plans A-Z to try and reboot economies, but so far any recovery has been wiped out by other problems such as the crisis in the Eurozone. The problem of what to do with the levels of debt has been puzzling politicians all over the world. Big players, including Ben Bernanke, Chairman of the Federal Reserve, and Sir Mervyn King, Governor of the Bank of England, seem to think Quantitative Easing (QE) is the solution.

In buying government bonds, the central bank raises the price of the assets bought and reduces their yield. The aim of QE is to increase the excess reserves of banks so if everything goes belly up and debt is defaulted, the bank has enough cash (or liquid assets) to cover their back. So although the process increases the rate of inflation, the normal citizen does not get any access to the new money; it’s used to save the same people who caused the mess in the first place. Prices go up but with pay packets frozen debts are no easier to deal with.

The problem is deciding when to stop. How much money can be printed before the situation spirals out of control? Because it’s not just inflation QE will affect, it will also lead the weakening of a nation’s currency, which is especially problematic in an export based economy (it becomes more expensive for you to buy goods from outside, and cheaper for others to buy yours). As soon as the “good times” return QE needs to be reversed and banks will need to buy back the assets otherwise the problems could very quickly get out of control.

The recent party conferences produced some interesting alternatives, such as that proposed by the current chancellor George Osborne. Although the now famous Plan-G (G for graphene) stole the headlines, a £50m investment into R&D is unlikely to save the economy. More interesting was the mention of Credit Easing. The real difference with this alternate kind of Easing is that the Average Joe may actually see some benefit of the process. Instead of a central bank, e.g. the BoE, buying bonds in banks, the aim is to buy corporate bonds. Whilst no one has quite yet decided what an English version of Credit Easing might be, it would seem that banks will be encouraged to bundle together the loans and overdrafts of small companies which would then be bought by the BoE. This should in theory ease cash flow for small companies and help them stay liquid through the recovery.

Another problem with QE that has recently been uncovered is the pension ‘black hole’. Pension fund liabilities stretch long into the future, usually linked to long-term bond yields. QE lowers bond yields and so this would seem a problem, and it is. In fact it’s a big problem. When the BoE’s first round of QE was finished, resulting in £200bn worth of bonds bought, it was estimated that the pension deficit of FTSE 350 companies increased by £70bn. Now the BoE has committed to yet more QE, it has estimated another increase of £25bn in the deficit will occur. And these are conservative estimates. To cover the deficit, employers will have to use more of their own money to pay off pensions resulting in lower capital expenditure being pumped into the economy. These new facts seem to make QE seem less and less attractive.

It’s hard to say if QE is working or not with so many problems going on at the same time in world economies. In light of the pensions issue it seems we areseeing the bad effects of £200 billion, but the benefits of just £130bn. Most of the central banks love the idea of QE, but it’s not completely apparent why. Instead perhaps George Osborne should be praised for having the guts to say he is going to try something else. Credit Easing seems fairer, and will inject money into the economy where it is hurting the most: on the High Streets, in shopping centres, and in people’s pockets, not just the bonus packets of bankers as QE does.

So, to QE or not QE? It would seem that perhaps QE should not be the way forward. It’s been tried for three years, and although it may have helped prevent a double-dip recession, it is no way to promote economic growth. If the question were reduced down to picking teams as in the school playground - sorry Ben, but let’s go with George.