QE is policy vandalism - so why are we doing it?

The UK is in the midst of the most dangerous economic experiment for generations. Yet it’s the subject of no debate.

Since March, the authorities have been using “quantitative easing”, or QE. This involves the Bank of England expanding its balance sheet ex nihilo (from nothing) in order to purchase debt instruments from the market – mostly commercial banks.

The idea is that the proceeds of such sales boost the money supply and kick-start lending. By decreasing the supply of gilts in the market, QE is also meant to push up gilt prices, driving down the yields that determine borrowing costs right across the economy – not least for commercial loans and mortgages.

At this point, people in my position are supposed to explain that QE isn’t “printing money”. I’m not going to do that. For the only difference between the UK’s current policy and Zimbabwe-style economics is that QE involves the creation of electronic balances rather than actual notes.

That last paragraph will have caused a sharp intake of breath among my friends in the higher-echelons of the UK’s economics profession. Unable to dismiss me as a “non-economist”, they’ll say I’m being alarmist – perhaps due to some kind of personality trait.

I would suggest they sit down, turn-off their mobile phones, take a cold look at the evidence and then ask themselves if they’ve got the guts to help expose the madness of the current policy consensus – the debt-funded fiscal boosts, the non-conditional bank bail-outs and, above all, QE.

Over the last three months, the Bank has now spent £106bn of QE funny money. By the end of July, it will have purchased the £125bn of assets it has so far been authorised to buy. At this week’s meeting of the Monetary Policy Committee, interest rates will be held at 0.5pc. But, with the original QE “pot” almost gone, the Treasury and Bank could well signal there’s more to come.

I accept the start of QE caused share prices to rally and business sentiment to improve. But that sugar rush has gone. The harsh reality is that despite the huge inflationary dangers posed by QE, the credit crunch is getting worse.

The Bank of England has more than doubled the monetary base since March, yet mortgage approvals remained at 43,000 in May – consistent with house prices falling at double-digit annual rates. Lending to non-financial companies contracted 3pc last month.

Banks are keeping the QE cash on reserve or lending it to their own off-balance sheet vehicles (the ones stuffed with sub-prime toxic waste). So rather than helping solvent firms and households access credit, QE is re-capitalizing, by the back door, banks that are otherwise insolvent and should be going bust. Gilt yields haven’t come down either. The 10-year yield remains roughly where it was before QE began, having been much higher in the interim.

Around a third of the Bank’s QE purchases are, anyway, from overseas investors – doing nothing to ease credit in the UK. Such sales by foreigners reflect mounting concerns about the UK’s wildly expansionary policy stance and sterling’s related medium-term fragility.

As someone who spends a lot of time talking to overseas asset-managers, I can’t tell you how often I’m asked: “Liam, why this money-printing? Have your politicians gone mad?” I can only reply that I ask myself the same thing.

There is, in extremis, an argument for QE – but only to buy commercial paper, not sovereign debt. When used to re-purchase gilts, QE allows governments to carry on borrowing like crazy, rather than facing up to the reality the country must balance its books.

When QE was announced, the emphasis was on the commercial debt purchases the authorities would make. In the event, gilts have accounted for a staggering 99pc of the total. That’s why QE will inevitably lead to dangerously high inflation – whatever nonsense is spouted about “withdrawing the monetary stimulus”.

History shows you can’t get the inflationary toothpaste back in the tube. That’s why price pressures are rising – and gilts yields refuse to fall.

At the outset of QE, the Tories called it “a leap in the dark” – failing to reveal if they backed it or not. Since then, HM Opposition has been silent on a policy that’s destroying the last vestiges of this country’s policy-making credibility.

Such credibility is what keeps inflation benign and borrowing costs low. By providing a solid macro economic platform, such credibility is vital if this country is to create the jobs and wealth that will be so important to our citizens in the years to come.

Such credibility, tough to win, is extremely easy to lose. Because of QE, the UK is now losing it – at breakneck speed. Yet those who will form our next government are silent – not yet in power but complicit, anyway, in this grotesque policy vandalism.

TURNER CHANGES HIS TUNE - BUT WILL THE TORIES TAKE THEIR CUE?

Lord Turner’s Pensions Commission - which reported in November 2005, after three years of pondering - promised a “system of retirement provision fit for the 21st century”.

But with another three years to go until Turner’s recommendations are finally implemented, the man himself has just admitted his pension blueprint lacks ambition.

“My gut feel,” Turner said last week, “is that were I to do it again, having seen what I’ve seen, I’d probably say we should have been more radical”.

For years, this column has warned Turner’s “National Pension Saving Scheme” won't work – not least due to the rampant expansion of means-testing engineered by Gordon Brown

From 2012, workers can choose to pay-in to a “personal pension account”. If they do so, their employer must chip-in too. But the proposed contribution rates are so low and means-testing so widespread that many millions would still be better off on benefits. So they'll opt out, condemning the NPSS to the scrap heap.

Turner has a razor-sharp political mind. Why is he saying this now? Like me, he privately views means-testing as the major road-block to his reforms. Until recently, Brown’s statist instincts and refusal to admit mistakes has made reining-in means-testing impossible.

But now Brown is politically weak, Turner is pressing his case. The question is whether or not the Tories have the guts to grasp the nettle.

IDS SHOWS THAT, BEYOND SPIN, POLITICS CAN BE USEFUL

“Never underestimate the determination of a quiet man”. So said Iain Duncan Smith, amid much media guffawing, at the 2002 Conservative conference.

Since losing the Tory leadership, IDS has toiled away at the Centre for Social Justice, a think-tank he established, which works with small charities finding innovative ways to tackle poverty.

Most of the famously catty Westminster village initially saw the CSJ as a joke - expecting it to disappear into obscurity, along with the Chingford MP. Having attended its fourth annual awards ceremony last week, I’d say the joke is on those who, indeed, underestimated IDS.

We heard speech after speech from charity leaders and beneficiaries engaged in genuinely useful work – and full of praise for the CSJ. The Nelson Trust runs drug and alcohol abstinence programmes. WorkingRite pairs directionless youngsters with local tradesmen, giving them paid work, a skill and an adult role model. The not-for-profit Blue Sky group is a recruitment agency where you need a criminal record to get a job.

The CSJ has won the active support of a cross-party group of highly-respected MPs – including former Labour ministers Charles Clarke and Frank Field and Lib Dem Simon Hughes.

Politics is at a low ebb. Slowly but surely, the CSJ is showing what can be done when MPs stop spinning, roll up their sleeves and actually engage with those they’re elected to serve.

Liam Halligan is Chief Economist at Prosperity Capital Management