Sean O?Grady: Is quantitative easing working? The Bank’s latest projections won’t tell us

Definitive, though not necessarily right. For on Wednesday we will see the
latest quarterly Inflation Report. This is as close to holy writ as a
secular organisation such as the Bank can get. The first, back in 1993, was
personally written by the Bank’s then chief economist, now Governor, Mervyn
King. Working on it is regarded as one of the more fun-time activities by
those toiling in Threadneedle Street’s vineyards.

The Bank tries to cope with the inevitable vagaries of this sort of activity
by producing something it calls a fan chart; a range of possible economic
outcomes rather than a bald figure for growth or inflation.

These fan charts have become wider and wider during the credit crunch, so
balanced have been the risks of either rampant inflation or 1930s-style
deflation, and they have started to get a bit meaningless. I wouldn’t hold
out much hope of anything too precise when the Bank makes its
pronouncements. Besides, we know from the £50bn extension of quantitative
easing last week that it is worried about the economy: by their deeds shall
ye know them, not their fan charts.

So economic predictions, even from those clever souls at the Bank, can be no
more reliable than those from the (equally brainy) Met Office. As far as the
economy is concerned, we are not enjoying “barbecue weather”.

But, to be fair to the Bank, through its extension of quantitative easing by
£50bn to £175bn, it is concentrating on the one big problem that we do know
about. In doing so, the Bank is behaving like a hedgehog, in the sense that
Isaiah Berlin meant when he divided thinkers into two categories ? foxes and
hedgehogs: “The fox knows many things, but the hedgehog knows one big

In this case, the Bank, along with the rest of us, knows one big thing: the
banks are still broke. Hence the Bank’s efforts to boost bank lending though
quantitative easing. How it does that ? the “transmission
mechanism” as economists call it ? is summarised in its own admirable
graphic included in the Bank’s helpful little leaflet on the subject,
available via its website. For some reason the leaflet has missed out the
bit about some overseas owners of UK gilts selling them to buy foreign
currency assets instead, which reduces the value of the pound and boosts
exports. There’s been some doubt about whether this channel works, so maybe
that’s the reason for the omission.

Anyway, the big fact of contemporary economic life was made perfectly apparent
in the big banks’ results last week. The picture was pretty simple. Behind
all those mindboggling numbers on writedowns, capital adequacy, and wrangles
over bonuses, was a clear pattern. The various groups’ investment banking
arms have done very well out of the revival in markets since the spring. The
rest of the domestic banking scene is fairly sick, weighed down by
write-offs, bad debts and arrears. Those groups that have big investment
banking arms did better, for example Barclays. Those with none, such as
Northern Rock, exposed the weaknesses. Something approaching £40bn was
written off last week, a sobering figure that explains why the banks are so
wary of lending to any but the most rock-solid credit risks ? they don’t
want to lose any more money by lending to people and firms where there is
the remotest risk that the money won’t be coming back.

The banks, whatever they say, are not lending enough to secure the recovery.
It may be because there aren’t better lending opportunities out there;
lending may be more or less than some notional government target; it may be
more or less than it was a year ago; it may be that companies and households
are more interested in paying off debts than taking new ones on. But the
picture is the same. Credit is not running sufficiently smoothly to propel
us decisively out of recession.

So does that mean that the Bank’s policy has been a failure? No. First, it
needs time to take effect. Second, look at what has been happening in the
corporate bond and equity markets lately. Researchers at Dealogic tell me
that some £88bn of new capital has been raised via equity and convertible
bond issues this year alone, against £117bn for the whole of last year and
£110bn for 2007. That is quite a turnaround and may well help some of the
more heavily indebted big companies survive. Think back six or 12 months;
who would have thought such sums could be raised via rights issues,
including those offered by banks?

This resurgence of animal spirits, or “risk appetite”, can’t be
solely down to the credit and quantitative easing efforts of the G20’s
governments and central banks, but it must be a material factor. Which helps
answer the Bank’s own question, posed in its QE-for-beginners leaflet as a
test of success: “Is it cheaper and easier for companies and households
to borrow than it would otherwise have been?”

Handily for the Bank, no one can prove the counterfactual either way, but the
circumstantial evidence is there. Bond yields have been driven down, sharply
so last Thursday when the £50bn extension was announced, and that makes them
less attractive compared to equities and corporate bonds, just as the Bank
intended. The fact that, as the critics maintain, the money supply and
lending haven’t risen by as much as they ought in an ideal world ? also
undoubtedly true ? is surely just another reason for going even further,
which is now what the Bank has done.

The danger of a double dip, or W- shaped recession therefore remains, and
will, frankly, for as long as we have to deal with our overhang of debt. And
getting rid of our debt is what the authorities wish us to do to rebalance
the economy, but ? in true Augustinian style ? not yet. So we now have the
perverse situation of the Bank encouraging us to take on more debt at the
time we’ve decided to be sensible and start paying off the credit cards, the
overdraft and the career development loan.

The unsettling thought arises that the Bank may well be doing all the right
things now, but it has started doing them just a little late. There was a
crucial “lost” period for policy. The six months between the
collapse of Lehman Brothers and the launch of quantitative easing witnessed
many radical moves, including the £37bn recapitalisation of our banks and
the slashing of the Bank Rate to 0.5 per cent, the lowest since the Bank was
founded in 1694. It may well be, as the Bank argues, that things would be
much worse now without quantitative easing, but one can’t help wondering if
they could have gotten away with doing less, but earlier. Then again, I
admit, predicting the past is an awful lot easier than predicting the future.

Even the scrappage subsidy can’t take the shine off used cars

The car is usually said to be the second most expensive asset purchased by
most individuals, after their home. It might more accurately said that a
second-hand car is the second most important item most of us buy, given that
sales of used vehicles far outstrip those of new cars. The news on the
scrappage scheme last week was good ? that is, for those who buy new or
almost-new cars, though it has to be said that Korean makers such as Hyundai
are enjoying the most benefit, though they don’t make cars here.

The news is not so good for those of us who wouldn’t dream of buying new.
British Car Auctions says that the average value of used cars is up for the
ninth successive month. Second-hand car prices went up again in July, by 3
per cent, and the price of the average used car has breached the £6,000
barrier for the first time. The annual increase in older car prices stands
at a remarkable £1,079, or 21.8 per cent, way ahead of new-car price
inflation. Used-car prices have been bucking the market.

Of course, that covers a multitude of motors, from barely used Ferraris and
Rolls-Royces with price tags well into six figures, to those old Nissan
Micras that just refuse to lie down and die (still worth a few hundred
pounds, if they’ve got an MOT). But it is interesting that the average
used-car price has now crept up to overtake the list prices of many budget
hatches, and even more once the £2,000 benefit of the scrappage scheme is
factored in.

One can only assume that the impact of the credit crunch has made more of us
switch from new to used. Maybe we now realise what those in the trade have
long known; that the biggest single cost in running a car is invariably
depreciation, and most new cars lose 20 per cent of their value the moment
they leave the showroom. More and more of us, strapped for cash, are turning
to used cars as a way of avoiding that depreciation trap. Modern cars are
built so much better than their predecessors that it is a slight mystery to
me as to why anyone buys new, even with the scrappage subsidy.

Happy motoring!

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