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QE has worked it's time to wind it down

Allister Heath

IT is nonsense to believe that quantitative easing has had no effect on the economy. It has prevented a collapse in the money supply, which would have triggered a collapse in output. It has also led to a surge in asset prices and started to fuel new bubbles in Britain and abroad, which is why I believe the Bank of England was wrong to extend the policy by another £25bn yesterday.

As ever, the best guide to what is going on comes from Simon Ward, of Henderson New Star. The money supply is not doing as badly as the Bank of England’s preferred broad money measure – M4 excluding “intermediate other financial corporations” – suggests. This fell in September, resulting in a third-quarter contraction of 1.7 per cent at an annualised rate. It is this figure that all the supporters of ever-greater QE are using to welcome yesterday’s announcement.

But the quarterly decline was entirely due to “non-intermediate” financial corporations – such as insurance companies, pension funds, trusts and other fund managers – cutting their holdings of money by £10bn last quarter to buy other, riskier assets such as equities (and hence fuelling the market rally). The money holdings of households and non-financial companies was up 0.3 per cent in September and 3.8 per cent annualised in the third quarter – the fastest since the second quarter of 2008.

Gilt-buying is trickling down to households and regular businesses, who now have much more liquidity than previously. And as well as building their bank deposits, non-financial firms also repaid a lot of loans. Another sign that QE has worked and is no longer required: the corporate liquidity ratio – money holdings divided by bank borrowing – rose further to a two-year high of around 52 per cent, up by around seven points since the trough. Far from being a failure, QE has worked pretty well – and, I would argue, ought now to be wound down before it triggers too many bubbles in asset markets such as property.

Money supply figures are tricky to interpret; just looking at top lines without trying to understand what is really going on can be misleading. The same is true of lending data. The figures that constantly get cited by those who want more (or different types of QE) supposedly demonstrate that banks are failing to offer much credit. But the oft-cited figures are for “net lending”, not gross lending. There is plenty of credit being offered and taken up – it is just that many individuals and firms are paying back more than they are borrowing. The demand for debt has gone down.

I’m not saying that the system is working smoothly: many lenders have quit the market and it is tough for certain kinds of projects to find finance. In the main, however, the situation is nothing like as bad as mainstream analysts keep claiming. It is good that it is reasonably tricky to get credit; we cannot go back to the bad old days of covenant-free corporate lending and 125 per cent liar mortgages available at the drop of a hat.

The biggest problem now facing us is the prospect of more bubbles all around the world; for example, British gilts are now massively overvalued (and yields too low) as a result of the false market created by QE (a development which has also let Gordon Brown off the hook and allowed him to get away with his out of control budget deficit). It is a shame the Bank didn’t bite the bullet and terminate QE yesterday. Let us hope at least that these are the last £25bn.
allister.heath@cityam.com