Protect your wealth from the Bank's money printing madness
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Associate Editor
David Stevenson Nov 06, 2009
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Yesterday there was a bit of a turn up at the Bank of England's latest Monetary Policy Committee meeting.
Interest rates are being held at 0.5% - no surprise there. But the Bank isn't planning to print as much extra money as markets had hoped. 'Just' £25bn fresh cash will be pumped into the system, rather than the widely expected £50bn.
But what has quantitative easing (QE) really achieved so far? And what does the latest move mean for the economy – and your investments?
The Bank of England began printing more money - officially called quantitative easing (QE) - in March this year. So far it's pumped a staggering £175bn into the economy, and it's going to spend another £25bn over the next three months. Bear in mind, British GDP is about £1,400bn, so we're talking about nearly 15% of GDP in total here.
What QE should do (in theory)
We'll come to what that's achieved in a moment. But first, let's have a quick reminder of how QE takes place. The Bank creates money electronically, in effect out of thin air. It then uses this to buy assets – mainly British government debt (gilts), although a smattering of corporate bonds have been bought too - from big institutional investors such as pension funds.
This results in the Bank's money ending up in the accounts of investors who had previously tied up their funds in long-term securities.
The theory is that two things will happen. One, these new funds will be lent into the wider economy, lowering borrowing costs for consumers and increasing demand for goods. Or two, these investors will buy other, riskier assets such as corporate bonds or shares, driving up their prices. This makes it less expensive for companies to raise money in the capital markets (because there's more demand for their bonds or shares), and should in turn eventually trickle down and decrease the cost of borrowing across the economy.
QE certainly seems to have succeeded in driving up asset prices. The timing of the Bank's QE programme neatly coincided with the start of this year's major rallies in both stock and corporate bond markets. And large quoted companies have managed to tap into this wave of euphoria by selling more shares and bonds to investors.
And it has probably been behind the recent bounce in UK house prices too, which has been strongest at the top end of the market. That's hardly a shock, because a new boom in financial products is great news for the wage packets of those investment bankers who sell them. Inevitably, a large slice of bankers' bonuses ends up in bricks and mortar.
But all QE has really done is blow up new bubbles
But QE hasn't been such a success for the wider economy. The money hasn't made the banks any keener to lend. In fact, Britain's banks are in such a mess that they've really been forced to batten down the hatches - here's my recent blog on how large a loan slowdown there's been recently: What the money numbers are saying. So they've been hoarding what cash they can.
And that means that QE hasn't been much help to many cash-strapped small firms, families, and first-time buyers, who simply haven't been able to access any extra funds.
Looking at it that way, all QE has done is pump up fresh asset bubbles. And that's the last thing we wanted, given that bursting bubbles are what landed us in this situation in the first place.
And the biggest bubble of all could be in the gilt market. The other problem with QE is that it's enabled our profligate politicians to fund their overspending habits. We have a government that's borrowing like crazy to attract voters, with the Bank on hand to pick up the tab (via third-party investors, of course). The Bank has so far bought up more than a third of all outstanding gilts.
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But that can't go on forever. And it looks as though investors are catching on. Yields on ten-year gilts dropped to 3% when QE kicked off, as the Bank's buying drove up prices, but yields have now climbed back up to almost 3.9%. That's because gilt buyers are getting worried about being swamped by the sheer scale of future borrowing the government will need to do, so they're demanding higher compensation for taking that risk.
Sterling's sliding steadily
Meanwhile, sterling has been steadily sliding. Again, that's to be expected – more pounds around = a lower price – but it hasn't helped out much either. In theory, lower sterling makes British goods cheaper to overseas buyers, but our national trade deficit hasn't shrunk much. And the other side of the coin is that our imports now cost more, which is stopping inflation falling. Factory input prices rose 2.6% last month alone. As John Stepek pointed out last week in Money Morning (The biggest threat to the recovery – the soaring oil price), the rising price of petrol, which is pushed even higher by a weak pound, is becoming a real pain in the wallet again.
So like it or not, the printing presses will have to be turned off at some stage – which may be soon, given that the latest £25bn was less than the markets expected. That'll be painful, because economic growth expectations are bound to suffer. House prices will drop back again. And among the worst hit assets will be the share prices of cyclical companies that have soared on the back of all that freshly created cash in the hope of a sharp economic recovery. As for gilts, the disappearance of the Bank as a big, guaranteed buyer, can only be bad news for that particular asset class
So again, we'd repeat our recent advice to investors: if you're going to be invested in the stock market, defensive stocks are the place to be – and keep steering clear of gilts.
Our recommended article for today
Stocks have been bid up far too far recently. But they will be good value again at some point. Here, Theo Casey tips nine stocks to buy once the markets have corrected - and what you should buy until then.
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