James Ashton: Printing yet more money can only end in economic tears

Last week’s dip in the bull stock market is a reminder that quantitative easing is a painkiller, not a cure 
28 May 2013
WEST END FINAL

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Like the bubbles that fizzed all over the Chelsea Flower Show last week, stock markets had flattened by Friday. While the bankers and chief executives will carry on sipping champagne as the season continues with summer parties, tennis and cricket lunches, the direction of global equities is less clear.

Fears of irrational exuberance were tempered by the heaviest one-day drop in the blue-chip index in a year last Thursday, and Friday saw another retreat. The question now is whether this unlikely stock market bubble is running out of air or we are merely seeing a pause for breath before shares carry on inflating in value.

Before that smallest of corrections, markets had opened up a gap with reality. Global economies remain fragile, uncertain — yet equities were roaring away. The bulls have trampled over the bears this year, driving the FTSE 100 up 13 per cent so far, smashing most analysts’ predictions for the whole of 2013. Equity experts think there is still more to come.

How can this have happened? The economy, after all, takes two steps forwards and one step back. For every sign that inflation is cooling, there is a countersign of disappointing retail sales or weak construction figures. If you are being generous, the economy is firing on two cylinders, with the other pair still out of commission.

Yet the blue-chip index was trading like it was 1999, at little more than 100 points off its all-time high touched 14 years ago when investors were entranced by specious dotcom promises.

Then, entrepreneurs could march around London and raise easy cash to rent office space and buy bean bags even if their business plan was sketched on the back of an envelope. Credit is anything but easy now, even though the brightest stars of Tech City exude great confidence for the future — this time with more reason.

Of course, the FTSE is no longer a proxy for the health of the British economy. It says much more about global confidence levels because of its mix of miners and multinationals. But even the second-tier FTSE 250, whose members have a bigger domestic agenda, has been fired up. Meanwhile, some blue-chip stocks, from outsourcer Capita to Smirnoff drinks giant Diageo, have scaled record highs in recent times. Bosses love it too. The reason so many chief executives are enjoying bumper payouts this year is because of the maturation of three-year incentive schemes, which were priced when shares were plumbing the depths.

The markets were oversold in late 2008 and 2009, when the brave could scoop up bargains. And it’s true that a lot of our biggest companies are in good shape: debt is at low levels across many sectors because cash has been carefully husbanded. Real value is probably somewhere between that trough and the recent peak. It was definitely time to take some profits.

Markets have been fired by a cheap supply of new money. Quantitative easing has generated a glut of liquidity with no home to go to, so buying shares has been back in vogue. It’s a fake prosperity when held up alongside the economic fundamentals. Back in the so-called “real” economy, plenty of firms are hurting: the Midlands metal bashers, or manufacturers whose prospects are lashed to the domestic economy. So fragile is today’s boom that equities took fright when Ben Bernanke, the Federal Reserve chairman, suggested that the time for weaning the economy off its stimulus might not be so far off.

QE, at a cost of £375 billion in Britain alone, has been an extra fillip that was arrived at when it became clear that rock-bottom interest rates weren’t in themselves enough to get growth going again. Sir Mervyn King, the outgoing Bank of England Governor, is still voting for the money printing to carry on.

In his new book, When the Money Runs Out, HSBC economist Stephen King likens this type of economic stimulus to Vicodin, a painkiller popular in America. King asserts that these policy drugs are dangerously addictive and dodge the discovery of a cure. QE is designed to encourage tomorrow’s spending today, but at the same time it puts off paying down the debts from yesterday’s misadventure.

As the drugs continue to be administered, the path ahead is not clearly defined. The International Monetary Fund, which talked tough about Britain ditching its austerity drive, is doing its best to sit on the fence now. Last week’s health check on the domestic economy still stressed how far we are from a proper recovery, with capital investment down, companies hoarding cash and high youth unemployment. The IMF warned that continued economic weakness could result in long-term fallout and suggested Fed-style guidance on long-term interest rates, something Mark Carney could well introduce when he arrives at the Bank of England in July.

Meanwhile, the threat of an imminent eurozone collapse has abated, cheering investors. The economic data from France in particular might be cause for concern, but investment banks have been busy downgrading the chances of a Greek exit from the currency bloc any time soon. Traders are deaf to the fact that Greek public debt is still on an unsustainable path and its people are suffering in harsh recession. These last months, when a kind of stable instability has existed, have represented a buying opportunity.

We don’t learn. It is easier to prevent bubbles from inflating than put them together again after they have popped. Yet we keep blowing. The drugs that are powering markets have made us delusional. We will have to be weaned off them in the end. And when the money tap is eventually turned off, or politicians turn finally to address Europe’s structural failings, stand by for a hard landing for which last week’s wobble was merely a harbinger.

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