Saturday, October 08, 2011

More QE madness ...

In the last five years, GBP has dropped in value by between 23-47% against the USD, EUR and CNY when Gold is used as the standard. GBP has taken a pasting. Our UK inflation during that time has been around 18% (based on CPI) but that's a basket of goods approach, as we've all seen basic commodity inflation has been much higher. You can pretty much put the entire inflation down to GBP devaluation.

One might argue that devaluing GBP is good for exports, however the UK has a huge balance of trade deficit managing to clock up a record breaking £9.2 bn in Dec'10. Whilst exporters have raised some recent cheer, what has to be remembered is that the UK imports almost all its copper, ferrous metals, lead, zinc, rubber, and raw cotton and about one-third of its food, along with a whole range of finished goods. With the GBP down the toilet, the cost of these goods has risen dramatically and certain items just aren't luxuries.

So, who has made good with the collapse of the GBP and where did it come from? Well, the reason why GBP has been hit hard is basically because of monetarist policies such as quantitative easing and keeping interest rates low. Quantitative easing (QE) is the best wheeze of the two and consists basically of buying back debt we're constantly selling, at an obvious premium, and hence simply amounts to printing money and handing it over to banks. The monetarist delusion is that those banks will lend it out, increasing money supply, and hence magically all our problems will be solved. In reality it takes no consideration of capitalisation requirements, debt exposure, weakness of infrastructure, business cycle etc. The net effect is always bad for GBP.

Through financial engineering we've created a situation of increasing inflation (due to GBP devaluation through money supply manipulation) combined with a weakness in the economy as a whole since we're not bothering to directly investing in it and trying to combat the economic cycle. This combination gives us stagflation = stagnation of industry + inflation.

So who benefits? Well, a depressed GBP makes the stock market and housing more attractive to foreign investors. Hence the FTSE, though fluctuating, remains artificially high and London housing is undergoing a mini-boom. Hence some people in the city think we're doing well, when in reality they might be doing ok but the rest of country is sinking fast.

Of course, viable solutions to this problem which include increasing interest rates, direct investment in industry (rather than QE) etc will cause lots of short term pain for those with debts and exposure combined with haircuts for banks and investors. Rather than face this, we continue on a path of devaluing our future in the belief that somehow this can correct problems caused by borrowing too much from the future. It's like a drunk reasoning that the way to deal with their drinking debts and find the path to happiness is through selling a kidney and only buying methylated spirits.

So, does our current policy help us? Not a jot. The increasing focus on money supply will probably mean more QE. At the same time, the overall economy will continue to weaken, unemployment rise, tax receipts reduce creating a need for more cost cutting, cost of basic goods will continue to increase, export led business (without direct investment) will continue to flounder but at least the FTSE will look somewhat rosy until reality catches up with it and graphically demonstrates the error of its ways.

Eventually, if we keep on this route we will finally reach a tipping point and enter the world of hyper inflation combined with extensive contraction of industry. I can't think of a nifty combination of these terms, so I'll resort to, Hyper inflation + Contraction = "Zimbabwe" Economics. Of course, I use the phrase loosely here because to actually achieve the stunning results of Zimbabwe requires a very rare kind of recklessness (or more appropriately "wrecklessness") which is unlikely to be repeated.

I'm writing this so as we enter these more troubled times, can we please, please, please remember to round up all the monetarists and either lock them up in the Tower of London or ask them to provide the data which demonstrates why what they're doing makes sense.

Post a Comment