Debasing Britain

                                                    The shape of things to come?

The EU’s open theft from Cyprus accounts is immoral and dangerous. Clearly, in the words of ECB head “super” Mario Draghi, the EU leaders are ready to do “whatever it takes” to save the euro.

But ruthless and amoral though they are, set against Britain’s current government they are the merest babes in arms. Next to Cameron and his crew Merkel and her gang are honest thieves.

As several commentators have pointed out the Bank of England’s quantitative easing (QE) has stolen much more than Merkel’s one-off Cyprus “freeze and filch” raid and much less honestly. Dishonest because the government has never admitted to the certain results of this policy.

QE is simply the creation of money from thin air. Back when gold and silver were used in coinage the equivalent of QE was to mint currency with a lower and lower percentage of precious metal in it.

The effect of QE, or debasing the currency as it used to be known, is no mystery and has always and everywhere been the same. Modern money has no intrinsic value; it’s simply a medium of exchange. If you increase the supply of money you reduce its value. Or in other words QE causes inflation.

And since QE began prices are up 17% in Britain.

This is annoying, but the ever dissolving value of the money in your pocket is hardly news to anybody. Governments have been causing inflation ever since we came off the gold standard. And with this in mind most people keep as little cash as possible lying around and instead put their money to work to maintain its value.

But the effect of QE is much more toxic than the regular deficit driven inflation we’ve all got used to.

First, it’s much more difficult to avoid. The government has nailed down interest rates so leaving your money in the bank means that inflation taxes it a couple of percent a year. And after a few years through the magic of compound interest that really starts to mount up.

Second, they’re using all the money they’ve magicked up with QE to buy government debt. This has swamped the bond market and so the interest rates bonds pay have slumped. So if you figured on buying gilts to protect your hard-earned, once again you’ll find it shrinking in real terms just as if it was in the bank.

Then there’s the cost of QE to private pensioners. When those in real jobs retire they use their accumulated pension pot to purchase an annuity (a yearly payment for as long as the retiree lives). Sadly, if you’re in the market to buy an annuity today, you’ll get 27% less pension from the same sized pot than back in 2007 before QE. Once again it’s because the price of annuities is based on yield of gilts. And as described above these are at historic lows due to QE.

On the bright side, though, the government gets to pay less interest on its ever mounting debt, but every penny saved comes out of pensioners’ pockets.

Then there’s the ironic outcome of this brave new government policy. QE was designed to fix the banking system gutted by the collapse of a property price bubble. This is ironic because all that incredibly cheap new money now washing around bank coffers has inflated some all new share and commodity price bubbles. These will likely burst as soon as the cheap money that supports them dries up.

So, next to the enormous costs to savers and pensioners and the very real danger from the new asset price bubbles, the initial EU proposal on Cyprus to openly take between just 6 and 10% from Cypriot bank accounts seems almost up front and reasonable.

But underhand and unfair though it is, many experts argue that QE is still justified. Many economists say that QE saved the UK economy from meltdown in the wake of the banking crisis. “OK so a few million pensioners and savers are being ripped off,” they argue. “But the banking system faced collapse in 2008 and QE saved it. And unemployment which was expected to shoot up has stabilized at below 8%.”

The ruthless truth is though that, far from saving the British economy, QE and the massive government borrowing it enables, will cause a slump that will make the 1930s slump look like boom time.

Under Labour real government spending increased by more than 60%. And even at the height of the boom Gordon Brown still needed to borrow to finance it. In fact, it was this unsustainable spending binge itself together easy credit that caused the boom in the first place. The real productive heart of the economy didn’t grow by anything like as fast as the headline one.

So when the crash came much of the tax revenue that evaporated was gone for good. The only remedy to the problem of our much reduced tax base was to cut and cut deep into Labour’s profligate legacy. But with real spending up so much in the previous decade that should have been pretty straight forward.

A successful template for such a policy exists. In 1931 the National government with Neville Chamberlain as Chancellor faced with a recession every bit as deep as ours in 2008 cut spending across the board by 10%. Just three years later the economy grew by nearly 7% in 1934.  

But the policy of QE gave the government another option. It offered the possibility of appeasing the BBC, the lefty elite opinion formers and anybody with their lips clamped firmly on the state spending teat. Creating vast amounts of new money would keep borrowing costs down whilst also providing an imaginary buyer for government debt at the same time. This has allowed the government to continue for years to borrow at a vast and needless to say unsustainable rate.

QE has disastrously enabled the cowardly coalition to not do the right thing.

The best scenario is that a strong recovery in the world economy drags Britain along and raises tax revenues enough to keep the whole show on the road. But it won’t exactly be a return to prosperity. The rising interest rates that will accompany any recovery will take a bigger and bigger chunk of revenue resulting in an endless series of austerity budgets and ever higher tax rates . Thatcher's fizzing entrepreneurial Britain cannot revive under a vast debt burden and the endless expansion of government regulation.

That's the best possible outcome of Osborne's idiocy.
                                                                                                                                                      

But if the world economy continues to falter at some point the government will have to choose between ending QE and watching the UK bankrupted by rocketing interest rates on our mountain of debt, or continuing QE with the inevitable hyper-inflation that will result.

Either way, in the straitened times to come we’ll look back in anger at the waste and folly of the Blair, Brown and Cameron governments.