Grinding Down The Value

Leo Schulz writes: 

There were two big responses to the great financial crisis:

Governments borrowed heavily to pay to bail out financial institutions engorged with toxic debt, fearing that the alternative would be an economic depression of vast proportions.

 And central banks attempted to re-stimulate economic activity by pushing interest rates down to the lowest levels in modern history and then kept them down through a policy known as quantitative easing.

Between 2007 and 2014, national government debt rose in the US by 98.5 per cent and in the UK by 151 per cent. 

Over the past six or so years, just short of £4 trillion has been spent on QE by its leading proponents, the US, the UK and Japan.

The result has been hugely to enrich multinational companies and the owners of financial and real assets, while grinding down the value of earned income, pensions and benefits.

In the UK, we have spent £375 billion on QE, the equivalent of running the NHS for three and a half years. 

The US has spent £2.8 trillion, (US$4.5 trillion), a sum equal to one and a third times the entire Federal budget for 2014 and possibly the largest sum ever spent on any single project since Cheops’ pyramid. Japan, having already spent £623 billion, at the end of October upped the ante and now plans to spend an eye-boggling £450 billion every year until kingdom come.

QE consists of the Bank of England buying up government debt, or gilts. Since the Bank of England kicked off its QE programme in January 2009, the return on long-term gilts has been 45 per cent. 

As investors sold gilts to the Bank, an eager, price-insensitive buyer, and reinvested in equities, the value of the FTSE All-Share rose 100 per cent. 

The value of equity in mid-sized UK companies, which are more responsive to domestic conditions, rose 200 per cent.

Home ownership is a core characteristic of the Anglo-American economies and house values are closely watched by politicians, regulators and the media. Stable or rising values are taken as a sign of economic health. 

But in the past five years (since the beginning of QE), the strangest thing has happened. 

Disposable income has declined and access to mortgages has tightened, while the average value of a residential property has risen, 25 per cent nationally, 65 per cent in London.

Far from reflecting economic activity, house values have responded to asset-price inflation as a result of QE. As barriers to ownership went up, so did rental values. 

And because housing stock is the least liquid asset, yields on rental properties were soon far higher than the yield on financial assets. 

For those who owned financial assets and had access to capital at rock bottom, state-suppressed interest rates, it was a choice between a 2 per cent – 4 per cent yield on a gilt or an equity or a juicy 7 per cent – 8 per cent yield on a London buy-to-let flat.

As the value of assets ballooned and the cost of capital sank, big, globalised companies became cash-rich. 

This money, amounting to trillions of dollars, has never been reinvested in the economies where it was earned, or indeed in any other economy. 

For the most part, it has been diverted into offshore tax-havens.

While central banks spent and spent and spent, governments responded to their burgeoning debt through policies which crystallised under the label of austerity, pushing up taxes and cutting benefits and services.

In the UK, according the Office for National Statistics, direct taxes went up 3.5 per cent for the average household between 2008/09 and 2012/13, but by 8 per cent 13 per cent for the ‘squeezed middle’. 

The average amount paid by each household in VAT in the same period went up 24 per cent.

A key aim of QE is to maintain a degree of price inflation in goods and services. 

As a result, as taxes rose, so did the price of core goods, food, clothes, fuel and housing. Earned incomes, though, stayed flat due to globalisation and the over-capacity endemic to recession.

The outcome was that those on earned incomes, pensions or benefits have become poorer. 

According to the Institute of Fiscal Studies, household incomes in the UK fell by 3.2 per cent between 2009 and 2013. 

In a study commissioned by the Labour Party, the House of Commons Library predicted a  2.3 per cent fall in real earnings through the life of the current Parliament.

The UK economy has returned to growth at an annualised rate of around 3 per cent, the best in the G7. But nothing is trickling down. 

The benefits continue to accrue to asset-owners rather than to wage and salary earners or to those on pensions or benefits. 

A recent report by the Financial Times claimed 85 per cent of the British electorate feel no economic improvement since the crisis, with the most pessimistic the most likely to vote UKIP.

Among under-25s, one in four are unemployed and a good many more keep off the statistics by moving aimlessly from one to another unpaid internship, saddled with unwieldy student debts and forced to live at home long into adulthood. 

The Guy Fawkes Night demonstrations in London gave a glance at their discontent.

According to current economic theory, fiscal austerity is essential to make QE work, as government spending pushes up the cost of capital (as measured in bond yields or interest rates) that QE is designed to push down. 

This is true, if you’re satisfied with a policy set that enriches the rich and slowly crushes everyone else.

It is surely impossible not to think that the gargantuan sums spent on QE would not have had significantly more and better effect if they had been applied, through direct state spending, to rejuvenating our health service, expanding the stock of social and middle-income housing, rebuilding our railways, remodelling our security services, abolishing university fees and replacing our ageing, polluting energy infrastructure.

The parliament elected in 2015 is likely to be among the most fractious and bitter we have seen in several generations. 

And, quite frankly, it is what we deserve.