Firms still don’t have much spare cash
MUCH nonsense will be written on quantitative easing (QE) over the next few days, regardless of what the Bank of England decides to do today. So it is worth taking a look at what Mervyn King’s massive purchases of gilts have actually achieved, apart from merely bailing out Gordon Brown.
By the end of last year, QE had probably become necessary as a result of previous blunders by the Bank of England and the government. The policy’s two main dangers were that it could work too well and hence trigger inflation, Zimbabwe-style; and that it would allow Brown to engage in unlimited borrowed spending, as all his fresh gilts would be snapped up by the Bank.
The former danger hasn’t materialised; my second fear, however, has turned out to be all too real. But first things first. Contrary to what many commentators have argued, QE has been working in the intended way: it ensured that the amount of money in the economy didn’t start to collapse at the height of the recession; and in recent months it has helped it actually increase again. The annualised rate of growth of the M4-X measure hit 5 per cent in the three months to July.
With these sorts of increases, and even with an rise in the velocity of money – the rate at which notes and coins are passed around individuals – there is no chance of hyper-inflation, especially as there is still plenty of spare capacity in the economy. A good chunk of the extra liquidity may have spilt over into house prices and the stock market, helping to explain why it breached the key 5,000 level last night. If so, this would be tantamount to a mini-bubble being inflated; but I’m reasonably relaxed about this. As I wrote yesterday, house prices now look fairly valued and the stock market is certainly not suffering from extreme exuberance.
The real problem with QE is that it has almost eliminated Brown’s budget constraint, storing up problems for the future. A fifth of the total stock of gilts has already been snapped up, allowing the government to remain in a fantasy land of ever-greater budget deficits (probably now worth around 13 per cent of GDP).
Tim Congdon – who has thankfully returned to regular economic commentary with International Monetary Research, his new firm – explains why money is not growing any faster than it is. Banks have barely grown their net lending to the non-bank private sector; they have reduced their overseas loans (partly by cutting their exposure to international wholesale markets); and they have incurred liabilities in non-monetary form (capital and bonds) rather than in monetary form (in the shape of deposits to consumers or firms). Part of this is due to firms and individuals paying back loans; a lot of it is due to government decisions to up capital requirements.
A key consequence of all of this is that private firms still don’t have much cash in their bank accounts. The ratio of their sterling deposits to bank borrowings, the best measure of corporate liquidity, has only increased from 45.7 per cent at the height of the crisis to 47.6 per cent today. Usually, the ratio would have to reach 55-60 per cent to ensure a strong recovery in corporate spending.
The Bank is bound to come in for lots of flack today. It fuelled the bubble throughout the noughties; but its policies have been much more sensible during the past year.