Bill Jamieson: Zig and Zag and the junkie’s jag

FIRST Zig, now Zag: just as Bank of England Governor Sir Mervyn King warned us, we were destined for a Zig-Zag year. So it is proving, with signs of a pick-up a couple of months ago faltering in recent weeks.

But why should the Zigs give way so quickly to the Zags? Given the phenomenal amount of monetary easing here and across the major Western economies, it should be all Zigs and no Zags. But recovery is by no means linear or uniform.

In financial markets there was a notable stumbling last week. Hints by Ben Bernanke, head of the US Federal Reserve, that he was less inclined to provide additional monetary stimulus beyond the end of June sent Wall Street and European stock markets into a tailspin. The reason for Bernanke’s hesitancy is the apparent improvement in the US economy. That should be good news. How ironic that an upturn in the world’s biggest economy should be greeted by a global investor sell-off.

This is worrying on two counts. First, the sell-off could be seen as evidence of investor doubts as to how strong and sustainable that recovery really is. And there are many in corporate America who seriously doubt its extent and durability.

The second – as salient here in the UK and the Eurozone as in the US – is that the markets have become so hooked on cheap money that the prospect of withdrawal of it brings on a bad case of the shakes.

Last week, economists at Barclays Capital confidently expressed the view that the Federal Reserve, European Central Bank and the Bank of England will not launch further monetary easing. But there are real doubts, not only about this confidence but also whether monetary easing provides any lasting boost beyond the immediate period of its implementation. Hence the concern, here and internationally, of the onset of “junkie economics”. The problem, of course, is that “recovery” by such means is not just unsustainable but liable to end in inflation and a severe monetary breakdown.

The scale of monetary easing through the Fed’s “Operation Twist” and the ECB’s Long Term Refinancing Operation (LTRO) making three-year money available at very low interest rates, has been colossal and without historic precedent. In the Eurozone the supply of cheap finance to the banking system has crossed ¤1 trillion (£820 billion). In the UK the total of bond purchases by the BoE since 2009 stands at £325bn, or almost 30 per cent of all UK gilts in issue. With the purchase of government debt on this scale, one has to ask whether this is really an exercise in monetary policy or a wheeze to enable the government to finance its huge debt pile at ultra-low interest rates – fiscal stimulus by another name.

Monetary easing is widely hailed as having pulled back the Eurozone from a financial catastrophe. The Centre for Economics and Business Research boldly claims in an analysis out this weekend that the mass printing of money “has saved the world economy from potential meltdown”. It has also revised up its forecast for global GDP growth from 2.5 per cent to 2.8 per cent. Fractional though that seems, that would be good news for UK exporters and for business confidence generally.

Others are less sure of the benefits. After each major official intervention – the 2009 banking intervention and QE, the 2010 QE and the 2011 ECB re-financing operation – there has been a brief burst of euphoria and a stock market bounce followed by relapse – and the bounces are each time are getting smaller.

One notable consequence of money easing has been a recovery in commodity prices and a higher price for oil. This works both to create inflationary pressures and to slow the very recovery that QE was designed to stimulate.

Others see monetary easing as a means of currency devaluation – “an assisted suicide kit for national currencies” is the acrid summation of Edinburgh fund manager Robin Angus.

Others see it as a 21st century version of the beggar-thy-neighbour policies reminiscent of the 1930s. It has already provoked a complaint from Brazil’s finance minister Guido Mantega that everyone’s at it: “While advanced countries and those of Asia are continuing to manipulate their exchange rates [lower], we will also intervene to keep the Real at a level that will permit the survival of Brazilian industry. Brazil is not taking protectionist measures. It is taking defensive measures.”

And does America really need more cheap money stimulus? Jobs are being created and consumer confidence is improving, as borne out by car sales. Liquid assets are at a near-record high. The sum of total savings deposits (including money market deposit accounts), small time deposits, and total money market mutual funds held by individuals and institutions rose to $9.3 trillion (£5.9 trillion) on 19 March, nearly matching the record high on 1 June, 2009.

Corporate liquid assets are at a record high. Liquid assets held by non-financial companies rose to a record $2.2 trillion at the end of last year. Companies have also raised record amounts in the bond market. Worldwide, companies have rushed to lock in historically low interest rates and issued $1.14 trillion in debt during the first quarter. Bond funds have also attracted record inflows, and banks are flush with cash.

The central bank has pumped in lots of liquidity but it seems to be trapped there. “Pouring more liquidity into the system,” says veteran Wall Street watcher Ed Yardeni, “isn’t likely to make much difference”. Historic low interest rates have enabled companies to borrow lots of money in the capital markets rather than at the banks.

The Eurozone, however, is a different matter, with a failed Portuguese bond auction last week reminding everyone of the fragility of the current “solution”. More QE is likely to be needed, just as in the UK further monetary easing is likely to be needed to help counter the impact of heavy government spending reductions scheduled over the next two to three years. So: more QE likely – but don’t expect much change in Britain’s Zig-Zag fortunes. Junkie economics will be a difficult addiction to break.