The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (41 page)

David Bone lives in the Hampshire countryside. His healthy £1100 monthly pension reset in February 2012 to take account of the record low interest rates on UK government borrowing. His pension was cut by £500 per month. This extreme case was as a result of a combination of factors, but there were many millions with some version of this story. ‘It’s dropped off the face of a cliff, it’s halved. It’s driven by low interest rates, QE and government policy,’ he told me in his kitchen on the day another £50 billion of QE was announced. I put to him the Bank of England argument that he had benefited from the fact that QE had kept the economy out of depression. ‘I don’t need low interest rates, because I don’t borrow any money. They’re good for some people, but they’re absolutely no good to me,’ said Mr Bone. His predicament was making this once staunch Conservative question his support for the government.

As the pensions expert and director general of Saga, Ros Altmann, says, ‘QE is the worst thing that could happen to pensions, it’s devaluing and destroying pensioners’ income, and all for a short-term sugar rush for the economy.’

This is the dilemma for central bankers. Their monetary interventions have created large bands of winners and losers. In the late 1990s, the governor of the Bank of Japan gave speeches saying he would refrain from cutting interest rates too far, in order to protect the interests of Japan’s army of elderly savers. I had the opportunity to put such points directly to the Bank of England’s deputy governor, Charlie Bean, in 2010. He admitted that if you’d taken out an annuity recently it would have been ‘impacted by our QE’, because QE drives down longer-term rates. ‘On the other hand,’ he said, ‘if you were somebody who already held some government or corporate bonds, then actually you would have benefited from QE because the underlying price of those has been driven up by our actions.’

The Bank’s view was that the long period in which the base rate had remained at 0.5 per cent had had a bigger impact on savers than QE. Between March 2009, when the base rate was cut from 1 to 0.5 per cent, and 2012, borrowers, particularly mortgage holders, had gained £104 billion (and £89 billion of that has gone just to the holders of variable-rate mortgages). Savers had lost £70 billion in interest payments since the attempt to boost the economy in 2008. Many people save and borrow at the same time, so some of these numbers cancel out. But it’s not difficult to see why many believed that the feckless were being bailed out at the expense of the prudent. It seems to be a massive transfer of wealth. But there was a context. Almost the reverse had occurred, generationally, during the property bubble (see
here
).

‘It’s like the opening scene out of
Harry Potter
,’ said one Bank policymaker of the deluge of letters received when the Bank used to cut interest rates. (They haven’t been cut since 2009, when they were cut to rock-bottom.) Savers complain more in writing to the Bank of England governor when it puts interest rates down than do borrowers when rates go up, so the Bank claims to be ‘very aware of the different interests of different sectors of the economy’. But the deputy governor, Charlie Bean, explained to me rather directly in that 2010 interview that despite sympathy for savers, there had been ‘swings and roundabouts’, and that it was wrong to condemn borrowers as feckless. ‘Most borrowing is carried out by younger households. The bulk of it has been to buy houses, which of course have risen in price, and very often the older households have actually benefited from the fact that they’ve seen capital gains on their houses,’ he told me in his office. It was not a popular argument in a Britain that had come to view house price appreciation as a type of human right.

‘I think also it needs to be said,’ Mr Bean continued, ‘that savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit. Conversely of course when interest rates are high they might want to build their capital back up again. Now, there’s no doubt that at the current juncture we’re in a situation which is not particularly good for those savers, but it’s not good for people who’ve lost their jobs.’ Neither was it good for those people in work who had only received minimal pay increases, in the private sector at least. ‘Because prices have been rising,’ Mr Bean went on, ‘that means they’ve been suffering real income losses, so a lot of people have been suffering pain in this recession, not just savers.’

Although Charlie Bean is one of Britain’s most respected economists, his delicately balanced argument was met with derision in the mid-market pensioner-friendly press. The Bank was in difficult territory trying to explain that its policies were favouring some groups and costing others. Detractors such as Ros Altmann believe even the core thinking here is wrong, given Britain is suffering something of an economic hangover. ‘As borrowers are already heavily in debt,’ she told me, ‘they are not spending more if borrowing costs fall. They accelerate debt repayments, rather than boosting growth. As interest rates fall, academic models say QE should lead households to bring forward spending at the expense of saving, which should boost growth. But in an ageing population, older households are not substituting spending for saving, they are actually cutting their spending as they fear for their financial future when their current income and prospective pension incomes have fallen.’

Ultra-low interest rates and, in particular, QE were leading Britain’s central bank into the uncomfortable realm of politics. A central bank likes to project itself as a trusted high temple of dispassionate wisdom and prudent beneficence. No more. The Bank of England’s decisions have been impacting the living standards of some groups more than any cabinet minister would care to imagine. But Charlie Bean’s delicately balanced argument was also a statement of the obvious. The UK press, politicians and public were not ready for such a flash of lucidity, but it represents what they think at Threadneedle Street. At a dinner in spring 2007, just as the boom was fading, a very senior Bank of England figure told economic journalists that issues of tax/spend and Bank of England independence were overshadowed by a far larger economic shift. ‘By far the most profound change in Britain’s economy in the past decade,’ he told the assembled company, ‘has been intergenerational redistribution caused by rampant house price growth.’ He went on to mention his ‘surprise’ that younger people hadn’t kicked up more of a fuss (see
here
).

The Bank’s concern was the paradox of thrift, also known as the paradox of policy. In the longer term, Britain needed more savings and investment. Right now, to get savers to spend, what was needed was a near-zero interest rate (negative in real terms), plus quantitative easing. Mr Bean was again amazingly clear: ‘What we’re trying to do by our policy is encourage more spending. Ideally we’d like to see that in the form of more business spending, but part of the mechanism that might encourage that is having more household spending. So in the short term we want to see households not saving more, but spending more,’ he told me. ‘I would fully recognise that in the longer term we would expect to see a higher savings rate than we saw in the decade or so before the crisis.’ It was one of those truths that normally goes unsaid.

Two years on, after prodding from the Treasury Select Committee, the Bank did produce a fuller analysis of the distributional consequences of its actions. The results completely contradicted the popular wisdom, but fleshed out the thinking outlined to me by Charlie Bean. Firstly, it was not pensioners who suffer the most from QE, but in fact the young, or indeed anyone without assets who needs to build them up. And secondly, QE makes the wealthy even wealthier. Astonishingly, the Bank calculated that the increase in household wealth from the bank’s £325 billion QE programme was £600 billion. That includes pension wealth. If you exclude pension wealth, then I calculated that of the £300 billion remaining in non-pension wealth, 40 per cent of assets are held by the wealthiest 5 per cent of the population. That is a remarkable £120 billion, or £96,000 for every one of the 1.25 million of Britain’s wealthiest. Including pensions and making different assumptions, the wealth increase for the top 5 per cent could be anywhere from £50,000 per wealthy household to over £200,000 (statistics on wealth are derived from data on estates, and are notoriously uncertain).

For comparison, the half of the British population that is most asset-poor (excluding pensions) did not benefit at all from this principal channel of the impact of QE on the economy. However, it should also be pointed out that the wealthiest households have not definitely become wealthier. The asset-rich took a big hit from falls in share and house prices at the start of the crisis. The big picture, though, is pretty stark. QE is monetary policy for the wealthy. QE disproportionately benefits the already wealthy, even if people like Mr Bone, the pensioner in Hampshire, are unlikely ever to notice the fact that their house price, for example, did not collapse. One Bank of England official told me privately that QE works through increasing the prices of assets, significantly property. ‘If you don’t hold assets you don’t directly benefit, he said. ‘The most affected are those short of assets but who need to acquire them.’

The Bank argues that others will also benefit from QE, for example, by not losing their job. The clearest message from the Bank, though, is that many of us are not taking into consideration an estimated 28 per cent boost to the price of all assets from its programme of quantitative easing. That includes the pension pots of those who have suffered the most from being locked into scandalously low annuity rates. Yes, the flow of income is small. But the size of the pot is greater than it would otherwise be. And these two factors cancel each other out.

But even that was far from the end of the story. The Bank does admit that pension funds that were in deficit by (for example) 30 per cent, would be a further 10 per cent in deficit as a direct result of QE. A critic might argue that this has hastened the end of some defined benefit schemes. It might also have cost the exchequer tens of billions of pounds in taxes as profits were squeezed to fill pension accounting holes. Still worse, one institutional quirk of the UK could mean, argued Toby Nangle, a clever City analyst, that QE was largely counterproductive. The lower long-term borrowing rates in the economy depressed the value of company pension pots, so the companies were obliged to pour billions into those pots to cover annual accounting deficits. So rather than increase the tendency of a company to invest and create jobs, QE in combination with accounting rules was acting like a mega-tax on Britain’s largest corporates. As Mr Nangle put it, ‘Bank of England purchases of long-dated bonds that depress their yields might serve to tighten rather than loosen monetary conditions.’ It took nearly four years of QE for anyone to spot this. The Treasury announced plans to change the accounting rules. The risk on the other side is that pension funds will blow up, at huge expense to the taxpayer in the years to come.

There were other winners and losers. QE had its fans on the City trading desks, as they saw the value of their bond portfolios soar. Other beneficiaries include the sovereign bond dealers who passed bonds from the DMO to the Bank at zero risk, making margins and fees on both sides of the deal. The commercial banks also benefited, gaining a supportive source of basically free funding.

The Treasury under Labour was convinced that much of the City was making riskless windfall profits from QE. In the mid-2009 private talks between leading City bankers and senior Treasury aides, the issue of QE profiteering cropped up. The Treasury told the banks that these unearned windfalls were part of the justification for their planned multibillion-pound tax on bank bonus pools.

Another injustice of QE has been the differential access to credit for small companies and large companies. For those large corporates that can tap capital markets directly, QE has opened up cheaper finance, seen a return to merger-and-acquisitions activity, and helped to bypass the banking system in favour of direct funding from pensions and insurance companies. QE is changing the nature of corporate finance. For the small- and medium-sized enterprises dependent on the banking system for credit, there is no such luck. Unfortunately, such firms happen to employ 60 per cent of the private-sector workforce.

It is for these and other reasons that Britain’s former chancellor, Alistair Darling, told me he thought that Britain should ‘take stock,’ and that he has concerns about QE profiteering. So much so that he would not have automatically granted the Bank an extension to the QE programme, had he remained chancellor instead of George Osborne.‘Were I still chancellor and the Bank came to see me again, then I would want to see some assessment of what has happened,’ says Darling. ‘In the current climate I can’t see any problem with it being a public report. Where is this money? We need a Treasury/Bank of England evaluation as to where it is. Is it in circulation, or is it sitting in bank vaults?’ he asks. But if Darling had blocked another round of QE, it could have created a huge stink, and raised those institutional questions about the extent of Bank independence.

And what would such a report actually reveal? The impetus towards QE2 and QE3 had been pretty strong. The Conservative establishment, including the Institute of Directors and the think tank Policy Exchange, repeatedly called for more QE. Since the election, George Osborne has been rather candidly describing his budget austerity policy as a way in which the Bank can keep interest rates lower for longer. Monetary and fiscal policy are no longer clearly separable. From 2010 David Cameron’s view was that the failure in Japan related to its three-year delay in moving from zero interest rates to QE. This view has shaped the coalition’s macroeconomic strategy. The Treasury’s job is to get the public finances in order. Economic fine-tuning can then be left to the Bank of England. Both George Osborne and David Cameron have repeatedly made very supportive suggestions about new rounds of QE. The prime minister describes himself as ‘a fiscal conservative but a monetary activist’.