Tuesday 8 November 2011

Quantitative Easing - why now?

Previously we discussed what Quantitative Easing is, and I promised that I would go on to explain why you've never heard of it until the last few years and suddenly now it's everywhere. I'm also probably going to scare the living daylights out of you when you understand the eventual results. So, strap yourself in for another brief ride on the money rollercoaster ...

First you must understand there are two different types of 'money' in today's world.

  • There is 'base money': money that has been created by the Central Bank - in the UK the Bank of England, in Europe the European Central Bank, in the USA the Federal Reserve, etc. This is money that already physically exists as bank notes or coins, or money that's in the system which the Central Bank has committed to print or mint into coins if it is necessary to do so. This is money that will not go away.

  • There is 'credit money': created by high street banks whenever you or I take out a loan and promise to pay it back. This money doesn't physically exist and never will, because it is simply a record in the bank's database, stating that base money was passed to borrower X, who has promised to repay it at date Y, paying along the way a rate of interest Z. This is money that exists only for as long as the borrower keeps up the repayments until, hopefully, they make all payments and the full amount promised has been paid to the bank.
Once you understand the difference in the qualities of credit money and base money, you can move on to understanding that when you as a saver look to earn interest from your bank by leaving your money in a savings account, you are effectively giving your money to the banker. He (or she) can do with it as they see fit.

What they do is give it to someone else in return for a promise to repay it later, paying him a higher rate of interest than he has committed to pay you, the saver. You as the saver no longer have that money even though, if you're like most people, you still consider it to be your money. You expect to be able to take it out of the bank and spend it when you want to. But the money you gave to the bank has already been given to someone else, and they've already spent it. It is no longer accessible to the bank, so how can they pay it back? The answer is they cannot possibly pay it back to everyone at the same time. Or in fact to even 10% of  savers at once.

The rationale is that the money to pay you back will exist in the future when the borrower has earned more money over time and repaid the loan to the banker, who then can repay you the saver. A great system, as long as everything goes to plan. But you do need to understand that your savings are at risk if you leave them in a savings account with the bank. Because the banks no longer have all the money everyone has paid in. Even the most conservatively-run bank doesn't keep as much as 10% of depositor monies available.

There is not a big problem if one or two borrowers are unable to repay their loans. In fact the bank expects a few people to stop paying and they factor this into their interest rates on the loans. But in a serious recession, like the one we are in today, there are many more than one or two people failing to keep up the repayments on their loans, credit cards and mortgages. There are a LOT. This is why many of the banks are in a lot of trouble and governments have been frantically working with them to try to hide it from everybody. In the meantime Quantitative Easing (the process of issuing more base money) takes the heat off temporarily, giving the banks the money they need to ensure all savers can get their money back if they ask for it.

Once you understand that your savings are actually not just stuffed in a shoebox in the safe for you by the banks, but are being put at risk, you need to consider what will happen if a lot of borrowers find themselves unable to repay their loans after all, as has happened in recent years and is still happening today. The simple answer is that savers will find that their money is no longer available to them from the bank.

Think back to Northern Rock and the images on the TV and in the papers showing the queues along the street outside their branches, it was the first British bank run in centuries. Before the doors were closed and they had to be nationalised. Bailed out by the government (in other words by YOU, the taxpayer), via the magic expedient of Quantitative Easing. But it wasn't only Northern Rock that was in trouble, because Halifax Bank of Scotland, Lloyds TSB, and Royal Bank of Scotland also were in just about as much trouble. They were swiftly part-nationalised before a run on them took hold, setting off a chain reaction through the global banking system as confidence in all banks the world over came into question. The government stepped in to guarantee the deposits of all savers at all British banks. Without this assurance, there would have been a run on almost every bank in the UK. The lights would have been turned out on the British economy. Not only that, but the same story of bank panic, as the world wondered who these questionable banks had borrowed from, was playing out at the same time all across the Western world. It was unthinkable to see the global banking system crumble. This bailing out of the failed banks is what Quantitative Easing is really all about. It's not about you, the saver - although, ultimately, banks that don't fail are something of a benefit to anyone keeping their money there.

The sheer scale of failing loans in this recession has put many banks at the brink of collapse just like Northern Rock. It cannot be tolerated, while the money system of today presents no barrier to prevent the authorities simply issuing more base money out of thin air, for savers to lose their money that they think is in the banks. All the money the government needs to ensure all the savers get "their money" back from the bank, will be created to replace the credit money that went to money heaven when the borrowers stopped repaying their loans.

So that is why you've heard so much about Quantitative Easing in recent years. Unfortunately, since we are still stuck in a recession, you're going to hear a lot more too.

I also want to ensure you appreciate another difference between 'credit money' and 'base money'. You can spend 'base money' right now, today, but you have to wait to spend credit money that is locked up in a savings bond or a savings account with a notice period (which we agree to because these are the only ways to get a decent rate of interest). This is why you will notice the pitiful interest paid on your current account — it's a bid to tempt you into a savings account instead, so the banker can loan out your money and make a bit himself for the trouble.

The 'velocity of money' (the number of times the same money changes hands between different people over a given period of time) will increase as a result of Quantitative Easing. This is because so much of the locked-up credit money has been converted into easy-spending base money. Not only does the banker find he has access to the money he should really have had to write off as a loss, but he even has access to the money earlier than scheduled — like now! He can either keep hold of it in his reserves to ensure that he has enough on hand to satisfy savers who might decide to take out their money, which is what is happening now. Or, if (when!) he is no longer afraid of this eventuality, he can reinvest the cash, which is burning a hole in his pocket, in new loans that will earn him more money again. If there is one thing you and I know about banks, it's that they won't wait longer than they feel they really have to, before they return to making as much money as possible.

Once enough of us realise that under today's money system there will never be a shortage of money after all — because more base money will simply be created in the system to replace the savings lost through bad loans — then the recession will be over. People will stop worrying where they will get money to pay their bills. They'll stop taking money out of the banks to put it somewhere they think is safer for them. The banks will start making loans easily available again. People will quickly spend the money they have borrowed. And other people will therefore have a job to make the goods and services the borrowers wanted to buy.

But you can probably already see through this I'm sure. More money in the system, chasing after the same amount of goods and services, will result in higher prices for those goods and services. Well, an increase or decrease in the velocity of money has the exact same effect as an increase/decrease in the amount of money in the system. If the same £10 note is spent twice as many times, it's the same as if there were two notes.

VELOCITY IS WHAT WILL SEND PRICES THROUGH THE ROOF, once people are no longer scared of recession. The current fear won't have a hold on everyone forever. When it subsides, are you ready to hold on tight as all this tucked-away money comes out to play and you get to watch the price of real things take off? Or, more accurately are you ready to watch your cash become increasingly worthless?

So it's still not clear to you why QE is inevitable? OK, how about this...

Let's assume, for the sake of simplification, that all of China's foreign exchange reserves are held in US bonds, plus also that the entire rest of the world doesn't hold any US bonds in their reserves.

This is of course totally bogus — because while China doesn't hold only US bond securities, they for sure comprise the lion's share of what they do hold. Similarly, it is ridiculous to say that the rest of the world outside of China hold no US bond securities. Not forgetting, for a start, "rest of the world excluding China" would of course include the US itself! :-)

Anyway, let's suspend our shared disbelief in this idea for a moment, because it is really only a device intended to massively simplify something we're about to look at together.

First: here is a List of countries by foreign-exchange reserves from Wikipedia, which is composed of data made available by the CIA. Remember, for the purposes of our simplistic illustration, China have only US securities in reserve; nobody else has any at all. China have $3.3 trillion owed to them by the US today. Pretty easy to get your head around this, right? The US owes China $3.3 trillion.

Second: here is a recent set of data from the US Federal Reserve, showing how many US dollars exist ("the monetary base"). As we can see here, according to the US Federal Reserve themselves (the controllers of this currency — so they ought to know if anyone does!), there are currently a little under $2.8 trillion US dollars that actually exist in the world.

The question: How does China get paid $3.3 trillion US dollars, when there are only $2.8 trillion of them in existence today? Even if every single currently existing US dollar were paid over to China to settle the debts to them, there would still not be enough.

And what about all the people inside the US, who need US dollars in order to go about their daily lives? Wouldn't there be a bit of a "shortage of money" (have you heard that anywhere before?), if China started demanding all of their dollars that are owed to them? Again, let's forget for now that US dollar-denominated bonds are today's primary world reserve asset, so in fact the whole world holds predominantly US bonds as their reserves — things are considerably worse for the dollar than our mega-simplification here.

Do you see it now? Do you see why QE is inevitable? Do you understand that massively more dollars in this world (as promised to bond holders) are going to chase after roughly the same amount of goods and services in this world, which can only lead to much higher prices for those goods and services?

If you're like most people, observing this reality leads you to the only rational course of action: to attempt to dump this currency (and bonds that will pay out the same) while you can still buy quite a lot with them. This, unfortunately, has a habit of becoming a self-fulfilling prophesy — the more people realise what is going to happen, the more rapidly it unfolds. The end of this story is a currency collapse, or 'hyperinflation'. This always unfolds at first slowly, then all of a sudden.

So, unless you like to be last in line and to pay the bills for everyone else who came along before you, I would humbly suggest you get to work finding a way out of this predicament. As in so many aspects of life: if you don't know who is the Patsy, it's probably you.

Has anyone ever told you, It's not coming true?

What's that you say? It's STILL not clear to you why QE is inevitable?!?!

OK, here is yet another, killer, reason for you then.

The rest of the world is no longer buying sufficient US/UK Treasury bonds (recycling their trade surpluses back into US/UK debt) to cover the entire budget deficit of the US/UK government. If we take a look today at the size of the US/UK trade deficit, take it away from the size of the US/UK budget deficit... we arrive at a number that approximates the size of Quantitative Easing. But that's just a coincidence, right? ;)

When the rest of the world is no longer willing or even able to mop up all the sewage we have spilling out of our toxic national balance sheets (or should I say, unbalance sheets), we just have to let it all soak in on the front laws of our own houses. Every single person holding Dollars/Pounds today, or even any assets denominated in them, is taking a bath in this shit. And most of them are begging their government not to cut the budgets — presumably because they just love the smell of bullshit in the morning?

Strap yourselves in, because this ends badly.

You do it to yourself, you do
And that's what really hurts

Tuesday 20 September 2011

Enough stuff! What to do with this spare money?

At some point in time, I hope that you look around you at all the stuff in your life and you think to yourself "seriously, I've got enough stuff! I don't need anything more". Maybe you don't even have enough room in your house for more stuff! Not only do you no longer need anything, but you physically can't take any more.

What a great situation!

Perhaps you should blow it all on a holiday instead of buying more stuff! Holidays don't take up a lot of space, and I'm sure you could use a rest after all this hard work you've been doing if you've got spare money that you're wondering what to do with it. But wait. Hmmm, if you spend all your money on a holiday or something like that, it's gone. That's not storing your purchasing power for when you'll need it some day in the future. That's using it up already. Better think again I guess...

So then you're thinking "OK, but I still have money that I want to save somehow or another for later use, but you're telling me that keeping it in the bank isn't without risk of loss". Well, yes and no.

As we previously discussed, because of the nature of today's money system, you are never at serious risk of losing all your savings in the bank. You may not get them all out of the bank instantly if you want to get it out during a panic, but you will eventually get all of your cash back from the bank. The Central Bank will ensure that the banks eventually have whatever amount of money is required to pay back all their depositors. Politics and the possibility for Quantitative Easing will see to it for you.

The problem is that, as we also previously discussed, the cash you get back after it has been Quantitatively Eased into existence for you will likely no longer buy what it used to. You have the same "nominal" number of Pounds, Euros, Dollars, etc — but you won't find you can buy as many things as you could before. In "real" terms (in terms of the world of real things you might wish to buy) there is a strong risk that your purchasing power will have been reduced by the time you wish to buy your stuff in the future.

So, we can see that, nominally, you are not at risk by keeping your money in the bank. But in real terms, you are at risk of lost purchasing power. The whole point of the exercise in saving was that you would put off buying stuff until later, the goal of your saving is to store purchasing power into the future, when you will wish to spend it. So, it doesn't seem very likely that you'll find a reduction in your purchasing power to be an acceptable risk, given what you know about the future of money in a world of widespread loan failures and Quantitative Easing to repair the damage.

Your question then is likely "how can I store my purchasing power, without buying masses more stuff, most of it useless to me or I would already know I want it now, and I can't possibly keep much more in my house because it's already rammed full?" You're pretty good at asking good questions aren't you? It's nice working with you.

Given that 'money' is something of ever-expanding quantity and ever-diminishing value, you are looking to avoid keeping all your savings in money. You are looking for something else that you can buy with part of your money that (1) won't go rotten, (2) there is always a willing buyer for, and (3) doesn't go down in value, depreciate, the older it gets — like, say, a car or a fridge or any other "consumer item" like that.You want something that you can rely on to retain its real purchasing power, in the face of a world where money is gradually becoming worth less and less over time. To offset the loss of purchasing power in your money savings.

Many people thought that buying houses was the best plan, and that's what pushed up house prices to unaffordable levels. Well, we can all see with hindsight that houses weren't, after all, the perfect item to purchase if you are looking to protect your purchasing power. For one thing, you can't always guarantee there will be somebody willing to buy your house from you at what you consider to be a fair price. I bet you've noticed at least one house in your area that has had a For Sale sign outside for months on end, right? For another thing, houses deteriorate and need money spent on maintaining them all the time. For another you are probably going to have to fork over a fortune in Council Tax while you own it, or if not you then your tenant will — a tenant that won't look after the house like an owner would by the way, so again you can expect some maintenance bills. Then you're going to get a nice tax bill for almost half of whatever amount of nominal money you "make" when you sell the house (unless you bought it to live in it yourself). Next we have to consider that houses are big and expensive things, and you can't just break off a chunk to sell when you need to buy something; you're going to have to sell the whole house. It may also not have escaped your attention, that lots of people don't like it when the houses they wanted to buy are too expensive for them. They need houses! By this point in time, most people have come to appreciate that houses are not the perfect investment after all. So I won't waste any more of your time here dissing houses-as-investments.

So you are looking for something from the real world, that doesn't go rotten over a long period of time, that isn't something large that you can't sell off little by little as and when you need to. This is how, in a global tradition built naturally across thousands of years of human experience, precious metals have come to fill the role of first choice stores of value. Specifically, gold. But also, to a somewhat lesser extent, silver.

If you have gold, you can chip off a little bit as and when you need to, and you will always find there is a world-wide market where there is always someone looking to buy whatever you have got. These metals never rot. One piece is interchangeable for any other of the same weight (it is 'fungible'). You can take any gold you have into a high street jewellers, or Cash Converters, or a pawnbrokers, and walk out with cash minutes later. That is why gold is the prime thing you can buy and hold with confidence, and you have been able to do so for thousands of years.

Gold is quite unlike, say, a diamond — you can't chip off a bit of diamond to sell, at least not without ruining it and making the whole lot worthless. And you can't take a diamond into any high street jewellers and walk out with cash either, because there is not a large and reliable market for diamonds. They cost you a fortune, and will last forever. But you'll discover they're not worth so much when you want to sell them and nobody's buying.

Another great thing about gold, is that it is relatively expensive by weight — so it takes up very little space in your house! In fact, the more expensive it becomes, the better it is for everybody. People who already have it, great they love it when it becomes worth more. People who are looking to store value in the future but have an already-full house, great they don't have to make a lot of space for their extra gold. People who don't have any already and aren't looking to buy any, well great whatever as far as they're concerned — it makes no difference to them either way.

I don't care who you are. I can say with confidence: gold is just the thing for you if you are looking to entrust some part of your long term savings to something other than your bank.

Monday 19 September 2011

What does Quantitative Easing actually mean?

You've by now most likely heard the term "Quantitative Easing" about, oooooh I dunno... maybe a million times? On the tele and in the papers, it's everywhere these days!

The first few times you heard it maybe you thought to yourself "OK, but what the hell does it actually mean?", and then after a while, since nobody in a position of authority that you feel like you ought to take them seriously seems to want to tell you what it really means ... you probably just started thinking "what-ev-er!" and switching off. I don't blame you, and you likely don't need me to tell you you're very much not alone!

To cut to the chase, it really is as simple as the name might suggest. It means they are creating new 'money'. They are "easing" the "quantity" of money in the financial system. Making money easier to get hold of, so that the economy isn't thrust into a depression like the 1930's, or perhaps more accurately in today's world, a prolonged recession like the last twenty years plus (and still counting) in Japan.

Back in the day, when money meant bank notes and coins in people's wallets, shoeboxes under the bed, and those massive whiskey bottles full of coins that your grandad used to have beside the sofa in the lounge, it would have been literally translated as "printing money". The Central Bankers would have been up all night and through the weekend just trying to print as much money as they thought they could get away with. But today most money isn't cash, it's electronic information within the banking system. Electronic digits on a computer hard disk somewhere. They no longer have to employ people into the dark hours and through the weekend, and especially on bank holidays, feeding paper and ink into the printing presses. No, printing actual, physical bank notes is so last century! Nowadays they simply type the number of new Pounds (or Dollars, Euros, etc) that they want to create, into the Central Bank's computer, and presto! There is more money to go around. It's done before you've even got the kettle boiled for your tea break. In the immortal words of Tommy Cooper: Just like that!

Wonderful isn't it, this modern world of ours? So civilised. At the stroke of a keyboard, the Bank of England (and other Central Banks around the world) can create more of that lovely stuff you need to buy things every day and spend most of your time working to earn, or more importantly to pay back the loan of the money you previously borrowed to, say, buy your house perhaps. Or your car. Or that nice holiday you had last year. Or that natty pair of jeans and designer shoes that you put on the credit card and will, y'know, get around to paying off sometime soon. Yeah, soon... OK, maybe never then eh?

You have to work for money, but the people who create the money you must work for, type numbers into their computer. It's a tough job, but someone's got to do it, right? The really hard part is stopping themselves from going mad at it and creating so much of this money that people start to realise ... Hey! This money is no good! What am I doing with all this money in my bank account and my personal pension? Why haven't I got a lot of stuff, real-world and tangible things, instead of this mirage? Why am I working so hard to pay back these loans and mortgages and whatnot that I've accumulated over the years, when someone else can just make it up out of nowhere!? I reckon you'd have a pretty good point.

Rich people don't have money in the bank. They have debts, and they have stuff. They understand that money is no good. So they borrow it expecting that it will be easier to pay back later. Stuff will have become more expensive, just because there is a lot more money chasing after it by then, so if necessary they'll just sell their stuff to payback the debts. Simples. But they'll have the stuff at today's prices in the meantime... and they'll probably wind up keeping it.

This was how houses became so unaffordable! Many people took on money debts to bet on house prices rising forever and making the debts easier and easier to repay, which did kinda look almost like it might the case... until it clearly wasn't any more and people started not just losing money, but finding they couldn't even pay off the mortgage loans after selling the houses. Oh dear! But that's a whole different story and, thankfully, I'm not about to take you there in this post, because I like to keep focused. Call me old fashioned.

Anyway, moving swiftly on. You're probably about now thinking something like "OK, so QE = printing money, I get it and you can stop labouring the point now... but why are we only recently hearing this term bandied about?". That's a great question! I'm glad you asked. But you'll need to read yet another article to find out the other half of the Quantitative Easing story. Sorry about that! Why not stop and relax with a song before you click that link and continue with this voyage of discovery?

A thing for me

In the real world around you, there are only so many things available. In the pretend world of money, there are an unlimited number of claims to those real things.

If we could somehow scrape together a comprehensive list of all the things in the world that anyone could possibly buy, add up the total value of them all, we'd establish that a very large amount of money would be required for all those things to be bought.

But not as big a number as the total of all the claims (money) already in the world. (And there's still plenty more money coming from where that all came from!)

How can all these claims for stuff spread out across the account holdings of people around the world (not even considering the additional claims that are coming into the system all the time) provide all of those claim-holders with the stuff they will wish to purchase at some point in the future (why else would they hold the claims, rather than spend them on something right now?), given there are already so many more claims than goods available?

What if you suddenly came to realise that your current savings are not really worth what they say they are? Because, clearly, we can't all buy what we think we can today. There is too much money and not enough stuff.

You understand this at some level as of today, if you didn't consciously know before. But what if everyone else realises too? Will you beat them to spend your money on stuff, before all the stuff runs out and your money no longer buys you anything? Not at today's kind of prices anyway.

No more claims for me, a thing for me please!