Masking the Symptoms

Ewen Stewart, a leading bond and equity analyst, investigates whether current UK monetary and fiscal policies are sustainable in Masking the Symptoms: why QE and huge deficits are not the cure.

He finds that:

  • The quantity of UK sovereign bonds issued has increased by two and a half times in just five years, by £832 billion – the equivalent of £33,000 for every UK household.
  • At the same time, monetary policy has been extremely loose: UK base rates at 0.5% are at their lowest in 300 years. QE has also been larger, relative to GDP, in the UK (at 22% of GDP) than in either the US (13%) or the Eurozone (4%).
  • These policies, while extreme, have had unimpressive results. Since 2008, UK growth has been the weakest of any G20 nation (with the exception of Italy).
  • The Bank of England and the Treasury promised that QE would be temporary, stimulatory, and non-inflationary. These promises have been broken.
  • QE has punished the innocent parties of this recession to the benefit of the indebted. QE has imposed a stealth tax on savers, who are losing an estimated £65 billion a year in interest foregone. Pensioners and the young have also lost out.
  • The sovereign bond market is no longer a free market in the normal sense of the phrase. Low gilt yields should not be taken as a ‘vote of confidence in the UK economy’ (as the Chancellor has previously claimed).
  • If public spending had grown in line with nominal GDP since 2001/02, it would have been £150bn lower than it was in 2011/12. There would be no deficit. Despite claims of austerity, total spending is rising, not falling.
  • The Coalition’s initial deficit reduction plan was predicated on a return to robust growth. This was wrong then; and is wrong today. Without radical reform, the deficit is likely to remain between £100bn and £150bn a year.
  • Loose monetary policy, coupled with huge deficits, distorts asset decisions, delays economic rebalancing and harms long-term productivity. It also masks the underlying problem of too much debt, a bloated public sector and a crowded out private sector.
  • There is a real danger that markets could now lose confidence in the UK economy, with devastating consequences for bond yields, house prices and prosperity.
  • But the right policy prescriptions would raise the productive potential of the economy. The precondition to recovery must be for politicians to tell the truth about the UK’s economic predicament. His ten steps to economic health for rebuilding the productive capacity of the economy through radical supply-side reforms and a normalisation of the public expenditure to more sustainable levels would then include:

–        the Bank of England should rule out any further QE on the grounds it is distorting asset prices, diverts capital from productive areas and damages savers.

–        the Bank of England should announce a medium-term plan to start the process of interest rate normalisation with a very modest target of a 2% base rate by mid-2014.

–        the Government should set a target to reduce public spending relative to GDP to 2000/01 levels (i.e. midway through Blair’s first term) to 36% of GDP, from the current 49%, within 10 years. This needs to be achieved by real spending cuts, significant supply-side measures to raise the underlying growth rate of the economy and gradual, fair and clearly articulated tax reductions.

–        the Government needs to seriously control spending, with a particular focus on sustained and meaningful welfare cuts and a control of health budgets.

–        the Government should bring simplification and consistency to the tax system.

–        the Government should develop energy policies based on their cost effectiveness not on the basis of climate targets. High energy costs remain regressive in their impacts both in terms of cost and employment and, from an economic perspective, remain a substantial source of capital misallocation.

–        the Government should exempt micro-businesses from significant amounts of regulation.

–        The Government should encourage business growth through introducing a more equitable and flatter (lower) corporate tax structure, reducing regulation and putting in place the long-term drivers for productivity growth. Under such circumstances, the relatively healthy UK corporate sector will once again invest and we will be back to the virtuous cycle that we enjoyed in the past.

Ewen Stewart concludes that:

“The choice is hard. Put off the tough decision-making, with more and more desperate measures which attempt to promote growth at the price of strangling long-term asset allocation and productivity? Or take the hard choice and create the right long-term environment for investment and sustained growth?”

Media Impact:

“The Centre for Policy Studies provides useful context. QE has already been larger, relative to GDP, in the UK (22 per cent) than in either the US (13 per cent) or the Eurozone (4 per cent). It has helped mop up 46 per cent of the massive issuance of UK sovereign bonds over the past five years – the volume of outstanding gilts has increased by two and a half times in just five years, by £832bn, the equivalent of £33,000 for every UK household, much of which has been monetised.”

“Wonders never cease. I awoke this morning to hear that the Deputy Governor, Paul Tucker, had announced that consideration should be given to the Bank of England setting negative interest rates. Whatever next?

Anyone who had seen our current fiscal and monetary predicament, outlined in detail in my Centre for Policy Studies report today, is certainly likely to feel bemused.”


Ewen Stewart - Wednesday, 27th February, 2013