The only way to preserve living standards is to prioritise creating, rather than consuming, wealth
The face value of coins in 16th- and 17th-century England was equal to the value of the silver they contained. Shaving or clipping the edges of the coinage and melting this down to sell as bullion was high treason. The penalties were severe, as the practice was widespread and undermined confidence in the value of the currency. As master of the Royal Mint in 1699, Sir Isaac Newton made it his mission to bring the clippers to justice and ensure coins were of the correct weight and standard.
Governments since Roman times have financed additional expenditure by increasing the number of coins in circulation and reducing their intrinsic value by adding a base metal to the composition. Yet the result in every case was the same: rising prices.
Since the financial crisis of 2008, central banks and governments around the world have been creating money out of thin air and using it to buy government bonds and reduce interest rates. Quantitative easing (QE) has some very unpleasant side effects. It exacerbates wealth inequality and generational inequality by inflating asset prices. Rich people become richer. Young people cannot afford to buy houses. By depressing interest rates, QE encourages a search for yield and investment in riskier assets. The Bank of England having to buy gilts last month to rescue pension funds that had purchased complex leveraged derivative products is an example of this. It increases the costs of servicing government debt and threatens the independence of central banks.
QE is often described as printing money, and when Covid crippled the world economy, central banks and their governments were doing it on an industrial scale. The Bank of England engaged in three rounds of QE in 2020, resulting in the total government debt owned by the Bank nearly doubling from £425 billion to £875 billion – that’s about 40 per cent of our entire GDP. This enabled the then chancellor, Rishi Sunak, to inject money directly into people’s pockets and businesses through the furlough scheme, bounce-back loans, Universal Credit increases, tax cuts and other measures such as “eat out to help out”. The Governor of the Bank came close to admitting in June 2020 that without intervention, “I think we would have [had] a situation where, in the worst element, the Government would have struggled to fund itself in the short run.”
As late as November 2020, despite supply shortages and high levels of savings and demand in the economy, the monetary policy committee voted to purchase £150 billion of gilts. Two months later, a survey by the Financial Times found that the overwhelming majority of the 18 largest investors in government debt believed that the Bank of England had bought gilts to keep government borrowing costs down. The House of Lords Economic Affairs Committee in its report Quantitative easing: A dangerous addiction?, published in July 2021, concluded that, “if negative perceptions continue to spread, the Bank of England’s ability to control inflation and maintain financial stability could be undermined significantly”.
The committee thought the Bank needed to have a better justification for its belief that the rise in inflation was transitory and for continuing with QE. Andy Haldane, who had resigned as the Bank’s chief economist, warned against complacency and of the need to prevent the inflation genie getting out of the bottle. Economic forecasters such as Peter Warburton and informed commentators like the economist Liam Halligan all predicted rising inflation at this time and rejected the Bank of England’s view that increasing inflation was a “transitory phenomenon”. Warburton described the Bank’s expansion of QE as a huge hostage to fortune flying in the face of monetary history.
Inflation was taking off on both sides of the Atlantic months before the war in Ukraine and the energy crisis as a result of QE. By August of last year, Jerome Powell, the chairman of the US Federal Reserve, declared that “transitory inflation” was a term that should now be retired. At his confirmation hearing this year, he described inflation as being a severe threat to the US economic recovery, due to higher costs of essentials such as food, housing and transportation. He has embarked on a two-year programme of quantitative tightening, which will crush inflation and result in much pain, market disruption, aggressive increases in interest rates and a strong dollar.
Quantitative tightening will be painful here, too. The Bank of England had started the process but was forced to reverse it temporarily last week, as selling gilts was putting too much pressure on yields. The Bank’s failure to match the Fed’s latest interest increase of 75 basis points also helped precipitate sterling’s fall against the dollar.
The truth is that the era of free money is over and more borrowing will be increasingly expensive. A resolve to tackle waste and control public expenditure is essential if we are to preserve our living standards and public services. We must, as the Prime Minister has emphasised this week, increase our competitiveness and concentrate on creating – rather than consuming – wealth. The wind has changed and we need to set a new course over tempestuous waters.
Lord Forsyth is a former cabinet minister, House of Lords’ Economic Affairs Committee chairman and is currently chairman of the Association of Conservative Peers
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