The problem may be that we're not printing enough money
By
Matthew Partridge Feb 10, 2012
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Yesterday the Bank of England decided to pump another £50bn into the British economy via quantitative easing. It wasn’t a surprise – most analysts had expected the move.
Dr Ros Altmann, the head of Saga, warned that this will make pensioners “poorer for the rest of their lives.” Savers are right to feel victimised. They are being thrown to the wolves in the effort to bail out our hugely over-indebted economy. And the Bank also risks driving inflation higher by reducing confidence in the pound.
But that’s the path the Bank has chosen. And with the British economy looking very fragile indeed, there’s another problem. The real worry is that the £50bn alone may not do anything to boost activity.
Here’s why – and how to protect your wealth.
Watch the money supply
Economists agree that the money supply has had a strong effect on growth in the short and medium term. In the past, the money supply has generally grown by about 2% more than nominal GDP growth.
The average rate of ‘real’ (ie, adjusting for inflation) growth for the UK economy between 1948 and 2010 was 2.5%. That’s what’s known as Britain’s ‘trend growth’ rate. So if the Bank is targetting a rate of 2% inflation on top of this, then the money supply needs to grow by around 6.5% each year.
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Too much monetary growth will make the economy overheat, producing inflation. However, too little will lead to deflation and recession. Economist Tim Congdon of International Monetary Research believes that it should not be lower than 5%.
The measure that the Bank of England uses is M4ex. This is all the cash and money in bank accounts held by households and the private sector, excluding banks and other financial companies.
From the spring of 2000 to the summer of 2008, M4ex grew year-on-year by at least 5% a quarter. However, from September 2008 onwards, it fell to 2.7% - and has since fallen even further. Indeed, the latest figures from December show that the money supply is falling on both a quarterly and monthly basis.
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Forcing investors to take more risk
So what are the Bank of England’s options? With interest rates at 0.5% there’s no more scope for cuts. The government has tried getting banks to lend more money to firms – but increased capital requirements mean that they couldn’t even if they wanted to.
So the Bank has opted for QE. It buys gilts (and very occasionally other assets) from investment managers, who then put the money into something else. It’s the ‘hot potato’ effect, as Merryn Somerset Webb points out in the latest issue of MoneyWeek magazine.
By driving gilt yields down, the Bank basically forces more risk-taking in the economy. Gilt purchases will also reduce long-term interest rates and make it easier to deal with the deficit.
So far, the Bank has bought £275bn worth of assets since March 2009. This is going to be expanded to £325bn over the next few months. But is it enough?
Some economists think not. Given that the total amount of M4ex in the economy is £1.55 trillion, the extra purchases represent only 3.7% of the money supply. In other words, it won’t boost the money supply sufficiently to help the economy. Indeed, Trevor Williams of the Shadow Monetary Policy Committee believes that QE needs to be extended to £500bn.
How to protect yourself as the Bank stumbles along
It’s an interesting argument. And our own regular contributor James Ferguson has argued on several occasions that QE is the only thing that stopped Britain from suffering a fate like Ireland’s following the financial crash. (For more on this, see James's article: Ignore inflation – deflation is the real threat to your wealth.)
The trouble is, none of this is much consolation to those suffering as their savings and pensions fail to keep up with inflation. And if there’s one thing that we know QE does, it’s that it weakens the currency. That in turn will raise the price of imported goods and energy.
Yes, the fact that the VAT hike is dropping out of the year-on-year comparisons gives the Bank a bit of breathing space. But it seems likely that with more money-printing a distinct possibility, inflation may not fall as far as the Bank likes to imagine it will this year.
So on the one hand, consumers will continue to feel the inflationary squeeze. On the other, the Bank’s efforts may do little more than keep the economy stumbling along.
What does this mean for your money? Well, one benefit of the weak pound is that it should help firms sell more overseas. And there have been signs of a revival in Western manufacturing as the advantages of setting up in China become less and less compelling. My colleague James McKeigue looks at how to profit from this in the latest issue of MoneyWeek: China's had its day and manufacturing is coming home.
Another way to protect yourself is to focus on high-yielding stocks in sectors that will not be hit by a weak economy. The ‘defensives’ story has become more popular in recent months, and yields have slipped back. But there are still some decent options out there. My colleague Phil Oakley looked at one such stock, GlaxoSmithKline, earlier this week.
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