Austerity and Quantitative Easing, the two signature economic policies of the second decade of the 21st century, possess an uncanny symmetry. The former was a brutal snatching away of funding from the poorest in society such that life expectancy was diminished, while the latter, despite the free market rhetoric, was – and is – a massive unconditional subsidy to the richest.
Both are profoundly ideological. Austerity was presented as a penance for the sin of previous overspending, a rooting out of waste and inefficiency and a long overdue imposition of “tough love” on the unemployed and disabled. Quantitative Easing (QE) was framed as a vital injection of liquidity into a flagging economy, technocratic medicine that, according to the BBC, encourages “people to save less and spend a bit more”.
Both conceptions are utterly misleading. The UK was never on the verge of becoming financially like Greece after the Eurozone debt crisis, and years of austerity failed to even make a dent on government debt. The huge rise in government borrowing precipitated by the Covid pandemic – more than £300 billion – and last year’s £16 billion hike in defence spending have both materialised without the gods of the market punishing us with financial ruin.
QE, meanwhile, was never about encouraging banks to make loans, companies to invest or consumers to spend money. Interest rates – the cost of borrowing money – are already so low as to provide adequate incentive for the taking out of loans or consumer spending in preference to saving. If people aren’t doing so, there must be other reasons for their reticence. “Think about it:” write the authors of Do Central Banks Serve the People? “if investors are reluctant to invest in the real economy with interest rates already at the zero lower bound, under what circumstances, if any, would extra liquidity be sufficient to change their mind?”
Thus the “extra liquidity” of QE, one must conclude, has remained within the financial system. The creation of $834 million dollars an hour by the world’s central banks has fuelled asset bubbles – in company shares, property and, after at first freezing in the wake of the pandemic, in corporate mergers and acquisitions. “Dealmakers”, it is comforting to know, “are having a record year”.
The classic explanation for inflation is too much money chasing too few goods. If the staggering amount of money created by central banks had really been “pumped into” the economy, as the bedtime story tells us, it would show up as inflation. Undeniably inflation is rising but not by anything like the level implied in the standard narrative of QE.
This indicates a crucial difference between austerity and QE. Both are ideological constructs but austerity has a placebo quality – its purpose lay entirely in the perception that it was necessary. QE – actual, real-world QE – by contrast really was, and is, necessary.
The Long 2010s
Government cannot go bankrupt, the gurus of modern monetary theory assure us. But the private sector definitely can and ever since the demise of Lehman Brothers in 2008, governments around the world have strained every sinew to ensure the contagion of insolvency doesn’t spread. The initial bank bail-out was followed by successive batches of QE around the world. The US Federal Reserve increased its balance sheet in the first tranche of QE by $4.5 trillion. The Bank of England has resorted to QE every time the economy has hit turbulence – after the credit crunch, after the Brexit vote and now during the pandemic.
It is commonly accepted that QE works to ensure, artificially, a low effective interest rate (whilst increasing the price and reducing the yield on government bonds, incentivising investors to shift into other assets). So-called zombie companies – firms that do nothing more than survive by meeting the interest payments on their debt and paying wages – are permitted to live on thanks to rock bottom interest rates. It is estimated that a fifth of US and European companies are zombies.
The silent assassin
Interest rates are a potentially devastating tool of government policy. When she first gained office in Britain, Margaret Thatcher hiked interest rates. They peaked at 17% in late 1979 and didn’t drop below 10% until 1983. The ostensible aim was to bring down inflation but the side effect, many think consciously pursued side effect, was to send countless companies to the wall – the UK’s manufacturing sector, which contained many unionised firms, shrunk by a quarter in the first wave of Thatcherism and unemployment rose to more than four million.
This mirrored what was happening in the US where a doubling of the interest rate – dubbed the “Volker shock” after the head of the Federal Reserve, Paul Volker – also precipitated a wave of bankruptcies and send unemployment soaring. The Volker shock also caused international interest rates to spike, triggering many developing countries to default on their loans and sparking the so-called Third World Debt Crisis. Mexico was the first to default in 1982 and others followed. Countries were forced to go cap in hand to the IMF which imposed free market structural adjustment programmes as a condition of support. Thus the worldwide market fundamentalism of today can plausibly be traced back to a massive rise in interest rates four decades ago.
So, for a seemingly arcane financial instrument, interest rates can have shattering consequences. And as a general rule, high interest rates cause bankruptcies while low interest rates preserve companies that would, under free market conditions, go under.
The Janus Face of Interest Rates
It might seem therefore that today’s ultra-low interest rates are a good thing – the government’s bank rate is currently 0.1%, the lowest for hundreds of years – because they stave off suffering both personally and for the economy as a whole. But it’s not that simple. Low interest rates, because they make the cost of borrowing so low, encourage speculation which is exactly the flaw in the economy exposed by the financial crisis and which has only got worse since. They also make it easier to be indebted. In late 2020 non-financial corporate debt hit $11 trillion and for the first time exceeded global GDP.
Near zero interest rates thus have to remain incredibly low in order to make the debt they encourage manageable. But if, for example, inflation takes hold, higher interest rates may become necessary to combat it by damping down demand the economy. And inflation, it should be stressed, doesn’t just affect creditors and the wealthy. By making basic goods and outlays like rent more expensive, inflation makes life harder for most people. Thus policymakers are in a quandary.
Low interest rates also seem to require endless QE, a perpetual subsidy to the wealthiest, to remain low. Obviously there is more than one kind of interest rate. The official bank rate, set by the Bank of England, is augmented by countless other interest rates –for example, the rates given or charged by commercial banks or mortgage interest rates. They will usually roughly follow the bank rate.
According to economist Harry Shutt, if markets were “undistorted” (i.e. didn’t have QE), banks and others would refuse to hold the huge debt of corporations without demanding a much higher interest rate. “Rates would have rapidly risen to unaffordable levels, probably 10 per cent or more,” he writes, “thus precipitating mass bankruptcy in both public and private sectors.”
Destined to Repeat it?
Clearly markets, notwithstanding the propaganda, aren’t suddenly going to become undistorted. Authorities will use every weapon in the arsenal – no matter how much they contradict free market doctrine – to ward off systemic market collapse. They have also, one would assume, learned the lessons of the recent past. The 2008 Financial Crisis had its proximate cause in the steady raising of interest rates by the Federal Reserve (mirrored by other central banks). They rose from 1 per cent in 2003 to 5.25% in 2007. As a result US mortgage interest rates increased and holders of sub-prime mortgages began to default, leading to a nationwide collapse of the housing market.
So central banks will not willingly hike interest rates or end QE unless compelled to do so. They can, it might be assumed, continue to follow the example of Japan, which pioneered QE and has taken it further than anyone else. This is a world of low growth, low interests rates and low inflation – unequal, rigged and immensely unfair – which nonetheless persists for fear of the alternative. Or the pain of the real economy, probably exacerbated by inflation, could compel the authorities to change tack.
At present, the financial system and the economy most people actually inhabit seem to exist in near total isolation from each other. The former prospers while the latter suffers. If their fates realign, things could get very interesting.
You can read part one of this article here
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