McDonnell should not forget People’s Quantitative Easing

John McDonnell proposed People’s Quantitative Easing shortly after Jeremy Corbyn was made leader of the Labour Party. It might have been wiser at the time to promise nothing controversial because the party establishment were in a state of shock at Corbyn’s win and were hostile to radical economic policies.

McDonnell has since gone quiet on the idea. However, the concept appears to be gaining traction as Adair Turner and Martin Wolf have each recently advocated “helicopter drops” for monetary policy, as an aide to the sluggish world economy. The helicopter drop is an idea of Milton Friedman whereby the central bank would print off cash and give it directly to the general population.

McDonnell’s idea is to use money created through Quantitative Easing to invest in infrastructure rather than buying government bonds. The latter has had the effect of boosting the stock market without boosting capital investment by the listed companies. In fact, the low interest environment has often resulted in companies borrowing money to buy back their own shares rather than investing in expansion. In America, Apple has issued bonds to pay dividends to share holders, in order to avoid bringing home their foreign earnings. As long as it stays abroad they don’t have to pay tax. This wasn’t the intention of the policy.

Both QE and FLS are in a mess

George Osborne’s nanny state policy responses are failing our banks and perverting our markets. In the midst of the political rhetoric on welfare and debt, there is one economic policy that the chancellor has implemented which has a genuinely significant impact: Quantitative Easing (QE).

This has had a profound impact on the economy.

The normal way for the money to be supplied into the economy is for banks to provide loans. If ten £1k loans are made for every deposit of £1k, then £9k of new money has been put into circulation. The banks are liable for it if it isn’t paid back, so they have become expert at judging risk. The supply of money makes a good demonstration of the private sector achieving a public good, normally.

The problem is that lending is too slow. As a result there is a lack of new money going into the economy but people are continuing to repay the loans they previously took out. The net effect is less and less money in the economy. If money is the oil on the cogs, then without it, the machinery will grind to a halt.

As a policy response, we’ve had QE. The Bank of England is creating money on a grand scale. Under Quantitative Easing they have so far produced an extra £375billion. In this respect it is the largest nationalisation of private sector service since the 1945 Labour government. I wonder if George Osborne realises that.

For a long time the banks have been receiving contradictory instructions from government. They must lend more, but they must increase their capital reserves. It’s like telling a schoolboy to spend his pocket money then scolding him for not saving it.

As a result, innovative policies are not only proving expensive but also potentially counter-productive. The government driven Funding for Lending Scheme (FLS) aims to subsidise bank lending for small businesses.

It is bad economics. It has lowered the interest paid to savers, but achieved little increase to the loans given to small businesses. With the state competing with savers, the banks no longer need to attract deposits as they have cheaper source with government cash.

A Gift from Alistair to George

The funniest line of George Osborne’s letter to Mervyn King begins with the words, “As you are aware, my predecessor agreed…”

The predecessor is Alistair Darling and the letter concerns the £35billion of interest payments, or coupons, that would have been paid on the gilts bought up by the Bank of England, under the policy of Quantitative Easing.

The agreement struck by the Labour Chancellor, is that the Treasury would not make coupon payments on the gilts, since it would be pointless for the Treasury to pay interest to the Bank of England (the state to pay the state).

The reason the letter is amusing is that Osborne won an election on the promise to reduce the deficit at spectacular speed, but has spectacularly failed to do so. However, he has done a good job of blaming his predecessor for his own failure. In this letter he has been forced to admit that his predecessor has delivered a £35billion gift to the public purse.

All this means that George Osborne must be tremendously happy. You can picture him getting out the bunting in Number 11 Downing Street. He’s probably kissing a photo of Alistair Darling at this very moment. There must be a proper spring in his step.

Danger! George Osborne’s “Credit Easing!”

There is something very strange about George Osborne’s “credit easing” policy. He proposes to use a complex financial instrument in order to bring the UK economy out of a recession which was caused by a complex financial instrument.

When you look closely at the proposal, it sounds awfully familiar. The UK government will sell loans to small businesses, then package them together, and sell them onto the bond market in tranches.

In other words, his proposal to get us out of this mess is to use the same financial instrument as that was used to package the securitized mortgages, which then became toxic, and got us into this mess in the first place.

I’m not saying it wouldn’t work, but I am saying it’s ridiculous to blame the bankers for their complex financial instruments, when the Tory Chancellor of the Exchequer is proposing exactly the same instrument as a cure.
The other proposal is to use Quantitative Easing to buy the bonds of British banks. He hopes this will boost their capital which will cause them to lend to small businesses.

He hopes. How he must hope. There is no guarantee that the banks won’t hoard the money. And besides, why would they lend to small businesses in this country, when they could do safer lending to bigger businesses abroad? I mean, they’re not exactly civic minded.

The new QE idea is that if we pay over the odds for bank bonds, this will raise their market price, causing the yields on those bonds to fall. With a lower interest rate to pay, this makes it attractive for the banks to issue more bonds. In other words, a second bank bail-out, but done on the sly. Further to that, with no equity in return, it’s a free gift from us to them.

The Bank of England governor, who has been very quiet of late, has refused to issue the QE to private businesses, saying that he doesn’t want the BofE to be politicised. Can someone explain what he means by that? However, he has today agreed to print £75billion and pass it onto the Treasury, for them to purchase of the banking bonds.

So the proposal is to supply the banks with debt, in the hope that they supply more debt to small businesses. At the same time as this, the government will directly supply loans to small businesses, through the “credit easing” policy. These proposals are in direct contrast to the Prime Minister’s insistence that it was debt that got us into this mess, and that the only way get us out of this mess is to pay off the debt.

According to the Bank of England’s own analysis, the last bout of QE boosted the consumer prices index (CPI) by between 0.75 and 1.5 percentage points. In other words, it caused 1.25% inflation. The difference between then and now is that then it was necessary to create liquidity in the economy. Everyone agrees that the problem now is one of demand, not liquidity. This bout of QE will certainly be much more inflationary than the mere 1.25% last time. And as people get used to inflation, they get used to demanding higher wages, which causes inflation. This is how governments lose control.

It’s the elderly and the poor who pay for inflation. Women are especially sensitive to prices. So by bailing out the banks with free money, it will be these groups that pay for the bail-out, not the wealthy supporters of the Conservative Party.

However, this is the biggest hypocrisy of Osborne’s policy: Inflation would affect holders of government debt. By stoking inflation, Osborne would be inflating government debt away. The international markets know this and, in normal times, would flee to preserve their capital. But the market doesn’t have anywhere else to go and Osborne knows this. The Euro is in a mess, and so are the Dollar and the Yen. Emerging markets are hardly risk-free, even if they were accessible. The safe haven of gold has far further to fall than it has to rise. There is no obvious place of refuge. So Osborne can stoke inflation without much fear of the markets turning against us.

This blows a hole in his entire raison-d’etre. His continued opposition to Labour’s economic strategy has been, and still is, that the markets will turn against us if we spend to create growth. So why does he not fear the markets now?