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Hold still! This might sting a little...
"TREATING serious
medical conditions often has unwanted side effects," said Charles Bean,
deputy governor of the Bank of England and a doctor of economics, in a speech in
Glasgow on Tuesday.
"But,
unpleasant as those side effects sometimes are, treatment is invariably
better than the alternative. So it is with the economic medicine of low
interest rates and quantitative easing."
The
sometime economics professor was specifically addressing the impact of
sub-zero real interest rates on savers and pensioners. That's when retained
capital loses real purchasing power, because the interest or yield that it
earns lags the rate of inflation.
"[Savers]
have every right to feel aggrieved at losing out," said Dr.Bean. "After all, they did nothing to cause the
financial crisis. But neither did most of those in work, who
have also seen a substantial squeeze in their real incomes."
Right!
And since neither workers nor savers are to blame for this crisis, they can
both pay – and pay dearly – by being fed another dose of
kill-or-cure medicine which has yet to work in 3 years of treatment...
Attempting
to defend quantitative easing and near-zero rates, as Bean did in Glasgow on
Tuesday, is a thankless task. Not only because it's done nothing to lift the
depression to date. But because it's actually adding to the gloom – as
his boss, the Bank's governor, Mervyn King, . In
a very roundabout way.
"I
would certainly accept that what is happening in the economy now is a very
large squeeze on household incomes," Dr.King
told the UK's Treasury Select Committee. "Real take-home pay has fallen
by more in the past two years than any time in living memory."
You
can see the squeeze on real wages above. Gross pay has risen much less
quickly than inflation, which has raced ahead at almost twice the pace of the
Bank of England's official 2.0% annual target. By February 2012, and three
years after it started, the avowed aim of quantitative easing – of
boosting inflation, to insure against the fat chance of it ever falling below
target – had cost the average wage-earner £1410 in spending power.
That's
the cumulative gap between what wage-earners actually made, adjusted for
inflation, and what they would have made if the Bank had indeed hit its 2.0%
target. Call it the cost of quantitative easing: £1410 in real spending
power. Now add the real loss imposed on bank savings too, and that cost today
runs – on average – to £3,241 for every household where one
person works. Families with two or more workers are worse off again.
Feeling
any better? Didn't think so. But here's how Dr.King,
with his best bed-side manner, explained the treatment to Parliament:
"Now,
that [loss in real pay] is not the result of inflation being high. Inflation is
the symptom."
With
it so far? The doctor went on regardless:
"The
causes of that squeeze on living standards are real causes. They are a change
in world prices of energy, and the utility prices of gas and electricity.
They are the consequences of higher value-added tax, higher food prices, and
a consequence of a fall in the real exchange rate, which was necessary for us
to be able to rebalance our economy in the way that was vital after a
prolonged period of a relatively over-valued exchange rate."
To
put Dr.King's prognosis in layman's terms:
#1. The Pound's exchange rate fell,
pushing up prices;
#2. Food and energy prices were rising
anyway;
#3. The rise in VAT sales tax (from
17.5% to 20%) made things worse.
Number
3 was of course a fiscal decision, made by the Treasury, not the Bank. But
"real causes" 1 and 2...? How did those boils break out?
"Countries
with faster growth rates of money experience higher inflation," said a younger, less care-worn Dr.King back when he
was deputy, rather than running the clinic. And "it is clear...that the
correlation between money growth and inflation is greater the longer is the
time horizon over which both are measured."
Quantitative
easing appeals to just the same mechanism
today. More money means more inflation. Meaning that injections of money are
sure to raise the cost of living. They're also sure to depress the currency's
exchange rate, especially if the injection goes unsterilized – a
disaster in medicine, of course, but very necessary in monetary policy
apparently. Because "sterilization" would mean withdrawing the same
quantity of money as you inject, by selling bonds to the very same value,
thus negating its impact entirely.
Nurse!
Spit on this needle for me would you?
Reading
today's notes from the consultants' latest meeting, we
guess the Bank of England believe that inflation means recovery will follow.
Because inflation rarely exists without economic growth. Hyperinflationary
depressions aside of course (see Weimar Germany, post-war Austria and Hungary,
Argentina time and again, Zimbabwe a decade ago...). More money must mean
more spending, right? And if it doesn't, then just keep injecting the patient
until he starts spending on something...anything!
"Interest
rate less than the inflation rate boosts gambling
businesses, on gold and foreign exchange markets," said governor of the
Central Bank of Iran, Mahmoud Bahmani,
last week. His colleagues in London, Washington and Frankfurt have seen the
very same results come back from the lab. Because people buy gold when they
fear or lose out to inflation. Others trade currencies, and still more find themselves
basing all financial decisions – from buying a house, to taking a job
or lending to business – on a wild speculation about what the next wild
move from the central bank might be.
Unlike
Bahmani, the US, UK and Euro authorities refuse to
raise rates, but for now the Iranian doctor's got much further to go.
Tehran's base rate now stands at 6%. Inflation is running above 21% per year
– making for the kind of negative real rate not suffered by Western
workers and savers outside mid-1970s Britain. Gold has again helped ease the
pain of zero-rate money printing since 2009. Every fresh dose of unsterilized
money is likely to indicate a greater dose of gold buying, too.
Back
in the doctor's surgery, meantime, and let's not forget that the Bank of
England's collective PhD brains are savers and workers as well. We are all in
this together, remember.
Yet
in medicine, "Doctors administer so much care that they wouldn't want
for themselves," admits one physician,
now widely quoted and
breaking a taboo within the profession. "They know enough about modern
medicine to know its limits. And they know enough about death to...want to be
sure, when the time comes, that no heroic measures will happen – that
they will never experience, during their last moments on earth, someone
breaking their ribs in an attempt to resuscitate them with CPR (that’s
what happens if CPR is done right)."
No
one's ribs get broken if quantitative easing is done, right or wrong. But
better to be safe than sorry perhaps. Dr.King's own
pension pot got a £1.4 million boost
($2.1m) just as his team began prescribing ever-lower rates of interest on
savers and retirees. The trustees of the Bank's staff pension scheme then
switched the entire fund out of government gilts and
into inflation-linked government bonds – the
best-peforming income-bearing asset under the UK's
stagflation – in the 12 months immediately preceding the start of QE in
March 2009.
Now
hold still – this might sting a little.
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