Economic Crisis

Let’s print more money!

Last night, as I uncomfortably jetted southwards across the Atlantic ocean, a reminder of our strange times was hitting the news wires. Once upon a time, proposing the idea that interest rates and bond yields should be held well below price inflation was unthinkable. But nine years after the global financial crisis got started these policies are run of the mill. Future financial historians will conclude that current policy makers collectively lost their minds. And ask why we didn’t all buy gold.

I’ve just landed back in Buenos Aires. The overnight flight from London was more than 13 hours long, and the plane was packed to the gills. Unfortunately I was surrounded by people who seemed to be travel rookies. Sleep came even less easily than usual in the cramped seat.

The 21 year old Scottish guy in the window seat beside me had to answer the call of nature an unnatural number of times. That’s when his left foot wasn’t kicking my right one throughout the night.

Behind me was a middle aged couple who felt the urge to turn their reading lights on at regular intervals during the night. That’s when they weren’t talking loudly to each other, or pulling and pushing the back of my seat.

At one point an older Scottish man decided to hold a conversation with his weak bladdered friend by the window. They were both on their way to crew a liquified natural gas tanker off the Argentine coast. The de-gassing had begun early. (Argentina is a country rich in natural gas resources, but many years of inept government policy has left the country with a massive energy deficit.)

After 10 minutes of this…and following many low altitude and screen-blocking hand gestures in front of myself and the woman next to me…I suggested he might like to take his “nice chat” somewhere else. I received a withering Scottish glower for my troubles, but at least my intervention seemed to do the trick. Scot the elder returned to his seat further up the plane, and the Argentine woman next to me gave an approving look.

So I hope you’ll forgive me if today’s missive is a little shorter than usual. And I don’t mean to sound grumpy. In fact it’s good to be back in Argentina, my chosen home.

…the governor of the Bank of England (BoE), Mark Carney, has got out his big bazooka. Fearful of an impending “Brexit” recession, the bank rate has been cut to 0.25%, having been unchanged at 0.5% since 2009, the previous record low.

But what’s this? While I’ve been in the air the governor of the Bank of England (BoE), Mark Carney, has got out his big bazooka. Fearful of an impending “Brexit” recession, the bank rate has been cut to 0.25%, having been unchanged at 0.5% since 2009, the previous record low.

But wait. There’s more!

The BoE will also restart quantitative easing (QE) and print money to buy another £60 billion (US$79 billion) of UK government bonds, known as gilts, over six months. That’s on top of the £375 billion total that they reached in late 2012, before taking a break.

AND they’ll buy £10 billion of corporate bonds.

AND they’ll loosen up rules on commercial lending banks, potentially injecting £100 billion more credit into the economy.

All this, just to avert a recession risk? There was a time when this sledgehammer stuff only happened in the teeth of a massive banking crisis. Like eight years ago and any time before that.

Let’s have a quick reminder of what QE is. It’s when central banks print money to prop up financial asset markets, meaning bonds and stocks. In the short term that’s good for people that own those assets – like investment banks and fund managers – but not much good for anyone else.

Normally most new money is created by commercial banks. Those are the places where we all go to get a mortgage loan or make deposits (loans to the bank).

Every time a loan (bank asset) is made the money is electronically conjured out of thin air and a matching deposit (bank liability) is created at the same time – either at the same bank or elsewhere. (Unless the loan is paid in physical cash, but that’s rare.)

The amount of credit money created and in circulation is mainly limited by complex regulations around how much capital cushion (mostly equity) banks have to hold in relation to their assets. In other words, put simply, banks’ leverage is limited by regulations.

QE bypasses all of that. In this case the central bank…Bank of England, Federal Reserve, European Central Bank, Bank of Japan, etc…directly creates the electronic money itself. It uses it to buy up bonds or (in the case of Japan and perhaps others in future) stocks as well.

The new money flows into fund managers’ bank accounts, and then has to find a new home. The fund managers buy more bonds (or stocks, or anything else investable). Prices are bid up, yields falls, and also much of the money flows to the government, which is issuing new bonds to satisfy new demand.

And the “best” parts? With lower bond yields the government can borrow more cheaply than before. Even better than that, all the interest due on the bonds now owned by the central bank is paid back to the government. Free money for the government!

Argentina knows a thing or two about money printing. It’s been in the “helicopter money” game for decades, on and off. The government prints and spends, the peso plummets, and consumer prices rocket. That’s why the consumer price inflation rate in these parts is kicking around 45% a year at the moment.

QE is more or less the same thing, except it inflates asset prices (bonds and stocks) instead of consumer ones (goods and services). It’s supposed to stimulate the economy, but the evidence is mixed. Many people think it actually drags the economy down, because people have to save more – and spend less – to make up for the terrible rates of return that result.

Whatever the rights and wrongs of QE, the question is whether Britain really needs a massive stimulus. The BoE itself now says it expects inflation to reach 2.4% by 2018, from 0.5% in the year to June. A two year gilt now yields just 0.1%. In other words, if the BoE’s prediction is right then gilt owners will lose several percent in the next few years (a negative real yield).

What about the economy? Britain has had the second best performing developed economy in the world in recent years, after the USA. Still expected, by the BoE, to grow 2% this year. Revised down to 0.8% next year. BUT STILL NOT A RECESSION.

That means more money stimulus and/or less austerity. Is Carney basically funding the new deficit plan? Implicitly, if not explicitly, yes…at least partially.

Also the new government has said it’s not worried about eliminating the budget deficit any more, a key plank of the previous government’s policy. That means more money stimulus and/or less austerity. Is Carney basically funding the new deficit plan? Implicitly, if not explicitly, yes…at least partially.

What’s more the UK’s employment rate is at a record high. Including those that choose not to work, over 74% of people of working age are employed. That’s the highest it’s ever been, since they started tracking it in 1971. Where’s the crisis?

Really, Mr. Carney? Is this necessary? Money printing and yet more cheap credit? You used to need a proper crisis before you considered that. Now all it takes is a bit of unease. What a bizarre and depressing state of affairs.

Japan and the eurozone are still playing the QE game. The UK now wants another go. How long until the USA gets back at it?

This is more evidence – as if it was needed – that debt-sodden developed countries are approaching their economic and financial endgame.

Keep hold of your gold. At US$1,382 an ounce it’s now up almost 31% since its December lows. I’ve been recommending that everyone has a substantial gold holding for a long time now. Do you?

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.