Out of Thin Air

Quantitative Easing is a funny old thing. It's effectively creating money out of thin air and it is currently seen as the method to rescue the global economies. It's such a great idea, it's a wonder that we don't do it ourselves - individuals that is.

But we have. More of that later.

The US Announcement

The theory goes that money, like matter, cannot be created or destroyed.

That's not entirely true. Today, the US Federal Reserve announced a package of $1.2trillion of Quantitative Easing in proposing to buy Government debt (Gilts or Treasuries) and mortgage backed securities over the coming months. It is effectively printing more money or creating more dollars in the economy out of nothing.

You see, the Fed does not have these dollars.

What it has is a Reserve of money or deposits and at any time it can use something known as Fractional Reserve Banking to say that at any one time not everyone will want access to that Reserve. In fact, so confident of this fact are banks, that they then create multiples of this Reserve as an amount of dollars or pounds to lend out to people. As long as they don't breach a certain ratio of circulated dollars to the Reserve then they can issue as many as they want. And this is what the Fed has done, as has the Bank of England.

Like my pyramid of champagne glasses analogy, the new money created cascades from the banks that hold the debts the Fed is buying, down to businesses and then onto consumers - and the one thing they then bet on is that like idiots we will spend this new money. We will receive it via greater lines of credit and lending from businesses and banks in the form of loans, mortgages and credit cards in the main.

Problem solved.

Not Quite

Of course, if you create more money, effectively you are reducing the value of money already in circulation and that is why the dollar took a sharp pasting from a range of foreign currencies in response to this. But it also has the effect of decreasing the yields on gilts (National Debt if you like) and again the US markets saw the sharpest ever drop on gilts yields in response. This has a big knock on effect for all people who are saving and wanting to retire as pension funds and annuities are very dependent on gilts - their value and their yields. As the Gilts market decreases, there is a large shortfall in pension funds created and in end salary pensions, the deficits sharply increase.

Quantitative Easing, just like increased long term Government borrowing, has a profound effect on the future earnings of individuals - and this time not just in tax payments but in actual retirement income. It is a short term fix which has a profound effect on the future of each and everyone of us and it is why it is a method of tackling the economy which smacks of deep desperation.

Quantitative Easing For Us

It is not quite the same but effectively in the last 10 years we, as individuals, have behaved like banks. We have leveraged our own 'reserves' which could be our property asset values, and raised more money to go and spend on other assets, lifestyle changes, holidays or consumables. As the yield on our own 'sovereign debt' was low in terms of interest, borrowing against our assets was relatively cheap and despite our own household disposal income actually shrinking over the same period, we actually made ourselves a good deal richer by releasing far more money to spend. In the wider economy this created a fantastic boost to GDP and corporate profitability and as long as our asset values remained high then there was no end to the cycle of getting more money.

The problem, of course, is that unlike the Fed our reserves were not deposits but variable value assets and their value had been artificially inflated due to the very process of releasing the locked up equity in them. The more we released, the greater their value became and the more we could release. It could not possibly be sustained - and there is a simple reason for it. The complex reasons which everyone had used to suggest it could never change was that even if there was a recession or downturn and the ability of people to repay the debt was changed, this could be accommodated for as things like unemployment could be less impactful while lots of incentives and creative lending practices could be used to keep first time buyers get in the game as someone had to be at the end of every chain.

But the simple reason was that the whole system was built on greed and that made sure that it got riddled with bad practice.

Criteria for loans went out of the window, which Gordon Brown points out was the cause or sub-prime, but it was not the primary cause as it was merely a symptom. The cause was the fact that banks were trading in debts many times over to create more profit and provide an endless supply of cash to lend for the next debt. It was the very system used to create the lending that was the problem, sub-prime became just a peripherary result that showed why the system was unsustainable. Banks had used the system of debt trading to access cash way above their own reserves which fuelled their profits and more lending and this became the principle method for growth and funding their business.

Sub-prime highlighted the folly and the availability of cash dried up immediately (The Credit Crunch) as no one had any idea who owned what asset and how much it was worth. In the UK some banks had lent 125% of asset value, some had increased earnings multiple criteria to 5 or 6 times earnings and included variable bonuses in it, some had taken external guarantees from parents or relatives, some had taken shares as security, then some had lent stupidly on the corporate market, on property - the fact was that each new loan they made had a fantastic, almost unbelievable return and this is waht produced a 162% rise in property value ove rthe 10 years.

And sure enough the whole thing collapsed.

For us, as mortgage holders who had leveraged the excess equity in our homes, the bottom quite literally fell out our world. Our money making machines - our homes - started to plummet in value and in conjunction with a lack of available credit to renegotiate the loans and a recession to threaten our abilities to repay, we saw the equity we had released turn into a massive loan with no security.

Our own version of Quantitative Easing had backfired on us spectacularly.

The Future

Real Quantitative Easing is different to how individuals raise their money but the principle of creating extra cash from thin air has real parallels. There are risks associated with Quantitative Easing as it can trigger higher inflation or even hyperinflation as Argentina has seen in its not too distant past. The Bank of Japan has used it in recent times in conjunction with zero percent interest rates to try to stimulate its economy - it has had no real tangible effect as Japan remains in a relative trough which has lasted for some years. The theory says that if this is done by Central Banks as opposed to Governments just printing money then the risks are less.

Tell that to the people who save and who are wanting to retire. They are shouldering all the burden right now to compensate for the greed of a few who could not help themselves and a set of Governments and Regulators who did not have the intelligence, gumption, fortitide and appetite to stop it.

Paying The Price

If you have steadily put money aside for your future in something like a pension, ISA or savings account, have had a relatively secure job over the last 10 years and are due to retire in the next 5 to 10 years, then you are probably bearing the brunt of the financial mess the country is in.

With interest rates at 0.5% and the stock market behaving like a lead-weighted yo yo, prudent savers have been amongst the worst hit by the financial fiasco. It is also likely that the same people will be the major port of call for solving the long term borrowing problems that the Government has bought for the future.

The Pension Pain

If, like me, you have seen your potential earnings in retirement trashed inside of 18 months, it is pretty disheartening to watch the massive monies being spent which we will have to pay back in the future. It can only mean one thing - higher taxes which will probably mean that we will have to work longer in order to save enough money to retire while the burden in retirement will be higher.

The reward for sensible financial controls and diligence by individuals is to have a shorter and less comfortable retirement.

The problem is very serious and there is no longer any real solution to it. The stock market may recover over the next 5 to 10 years but that will for many just get their pension pots back to some kind of parity to the value just ahead of the Crunch. How galling then to see Fred Goodwin lose billions and walk away with a highly lucrative and secure pension from the age of 50 for the rest of his life. But then again, how galling to see rafts of Civil Servants and Politicians get the same benefit but paid for entirely out of your pocket in current tax payments.

Making Pensions Pay

The serious outcome to all of this is that there is a greater potential for people to retire and move abroad to where tax regimes are kinder. Cyprus is currently a country that offer a superb climate, is very anglophile, and has a tax rate of just 20% on pensions. Properties are still reasonable value, the infrastructure and law mimic the UK, English is widely spoken and you are never far from a beach. For the homesick, there are branches of Debenhams to get the essentials like HP Sauce.

I am sure there are many other places, hopefully, that will keep such status despite the onslaught of the EU and 'harmonisation' which is not the process in which Harriet becomes first PM and then President of the United States of Europe - what a terrible nightmare that would be.

But certainly, this is a very real problem for the future and threatens to be another blow to the Government's plan on paying back its borrowing. If less people in retirement stay in the UK, then again tax revenues will fall - particularly if they take their estates beyond the borders of the UK and out of range of Inheritance Tax.

This Government has systematically ignored the growing problems of providing an income in retirement unless you are a Civil Servant or Politician where the fabulous pensions are paid for in current taxes - a nice 'Ponzi Scheme' for those in it. With better than 1 in 4 jobs now in the Public Service, more of our tax will be paying for these pensions as time goes on while we get nothing in return from the Government.

Personally, I think guaranteed, end salary schemes for Civil Servants and Politicians should be stopped immediately and make them carry the same burden as the rest of us and stop us paying for lazy bureaucrats' retirements funds.

Next up - Public Servant Expenses Accounts.

The Green Shoots Are All Over The Place

Hot news from the CBI Dinner on manufacturing in Birmingham tonight - Lord Mandelson confirms that 'Snow under New Labour is richer, heavier and more widespread than ever and when it thaws the green shoots of economic revival will be there for all to see. Just keep looking, damn you'

Interesting Times

Lord Mandelson was addressing the CBI Dinner on Manufacturing in Birmingham. On the menu was smoked salmon with a 'zest of low interest rates' followed by an 'amuse bouche' of a cup of bovril, an imported pasta dish simply described as an 'Italian Job', an entree of 'codswallop and chips', washed down with a Castrol GTX 1997 and finished off with 'Economy Brulee' as dessert. Coffee was served with 'Petit Intelligences'.

Firstly, Lord Mandelson congratulated himself for appointing Gordon Brown as his second in command, describing him as a 'Formidable also-ran and an aspiring poodle for Barack Obama'. He also pointed out that they had something in common on top of the fact they were both unelected leaders but he couldn't remember what. He then went on to outline why he very secretly tortured (no questions asked and 007 status) Mervyn King into lowering interest rates to 1.0%, describing it as 'Helpful to Russian Oligarchs who have very, very, very high loans'.

Britain Invented The Wheel

Lord Mandelson was quick to point out that 'Neanderthal Briton Man had invented the wheel, fire and permanent black eyebrow dye' and that these prehistoric achievements set the scene for Britain to lead the Industrial Revolution. He confidently predicted that 'Britain will lead the new industrial revolution with such innovations as Cillit Bang II (starring Barry Scott), the paperless clip, the wind assisted nasal hair strimmer and de-snotter, the solar powered nuclear power station, the nuclear powered solar steam engine, the self-perpetuating carbon-free house price rise, the new set of low carbon emmission large numbers to describe the magnititude of bank foul-ups and bank executive bonuses, the non-greenhouse gas anti-gravitron gravitron carbon-free collider thingee and the aroma-less non-carbon fart.'

'Britain is a hot-bed of writhing bodies of intelligence, not unlike the back streets Brazil,' continued Mandelson. 'With firm, muscular tone Britain will strong-arm its way gladiatorially, yet tenderly to become one of the world's leading manufacturing nations. Or in my mind at least.'

EC Commission Experience - Vital For The Economy

Lord Mandelson called upon his own experiences as an EC Commissioner. 'When I was a highly paid EC Commissioner as I still am now without being there and doing the commissioning bit, and was sitting in Brussels wondering where my next holiday would come from,' he said somberly, 'People would say to me that Britain was just a limp appendage at a spit roast - BBQ that is. And I would say, hey, we manufacture all sorts of things, I just can't think of which ones right now but, by golly, there's lots of them. Of course, I didn't say 'By Golly' as you know that would be a Thatcherite-ist racism comment but it was similar but not offensive. Anyway, is that the time?'

Lord Mandelson is a fictional character and doesn't resemble anyone living. Lord Peter Vader is a character from 'Ya Boo Wars, mine's a White Russian Oligarch, baby' and all copyrights are acknowledged.

The Credit Crunch Gets Personal

We all know mortgages are harder to come by since it dawned on the financial industry that their natty way to finance their business was suicidal, but that £1 trillion of personal unsecured debt is now the perfect way for finance companies to make money. Credit is crunching.

Would You Credit It?

I am talking about yesterday's report in the Telegraph business section which highlighted what frankly what we ought to know but it's still pretty shocking. While the Bank of England's base interest rate has fallen to the lowest level in its 300+ year history of just 1.5%, the Annual Percentage Rate (APR) on one credit card is up to 46%.

That particular beast of a card is the perhaps not a surprise one - it's the British Airways American Express Card, no doubt a prize possession of much travelled Bankers, Partners and Lawyers. To add to the cache of the card, its Annual Fee on the Premium Card has just risen from £120 to £150 just in case you should clear the balance regularly. Altogether, it is the most expensive card on the market (no I didn't mean say it altogether, I meant - oh, please yourself).

For the mathematicians amongst us, that APR rate is over 30 times the base lending rate - a nice profit in tough times for sure (must send a note to the LinkedIn Discussion at IOD on businesses booming in a Recession).

But BA Amex is not alone - the Northern Bank NI Platinum MasterCard charges a whopping 42% APR and a £200 annual fee, Citi's Ultima MasterCard is 41% APR and £300 annual fee, the Vanquis Bank (who are they?) Visa is 39% APR and no fee and (Oh no, not after yesterday's article on Virgin Trains) Virgin Money's Atlantic Black Amex is 37% APR and £115 annual fee.

There's Lots of Money in Plastic

The BA Amex Card has been singled out by Which? as leading the nasty stakes when it comes to credit cards and even dwarfs the kinds of APR charged by cards like Vanquis which aims its high interest rates at those with the worst record of payment performance (there is a perverse logic in banking which says make those who can't pay, pay more because no on else will lend to them). The nasty BA Amex card is generally used by frequent flyer types and the benefit is 1.5 air miles for each £1 spent on the card, a free companion flight when air miles are redeemed and a limit of £10,000 per year (why limit it with that kind of interest rate?).

Naturally BA say Amex set the rates and it isn't their fault that their chosen partner charges the highest rate on the market and is therefore not their concern. As an aside, comparing recent flight costs to Italy, compared to Alitalia in every instance BA were more than double the cost and this concurs with an 'insider' I spoke with at BA who tells me that it is BA's deliberate strategy in a downturn to charge significantly more for their flights while nearly all other airlines have adopted the strategy of lowering prices, usually temporarily. The perverse logic here is that BA own a significant proportion of the routes available and so travellers HAVE to use them in a large proportion of instances and especially businesses where BA have been mandated as preferred airline or of course those Frequent Business Fliers who ask their Travel Company for BA only as they get the Air Miles and Executive Club status as perks.

But BA Amex are not the only culprits - a study of 240 credit cards by Defaqto shows that the average APR on cards climbed from 17.2% to 17.6% in the six months to November 2008 - a period when underlying interest rates were falling at unprecedented levels.

To Point Out

The nasty cards pointed out by Which?, with the exception of Virgin Money which frankly has no excuse (and I have a card with them I paid off last year when it got very expensive), are almost all at the high end or aimed at bad credit risks. The logic says that snooty banking types can't have a flash car and job without a cache credit card that looks gold, platinum or jet black when they brandish it to buy their round at the Champagne Bar. Meanwhile, those who cannot afford to buy anything are charged extortionate fees as they are assumed to be so desperate they would pay anything. Loan sharks, we are told, are rolling up so much fees, penalties and interest rates that some poor people in real debt trouble are being charged 10,000% on their debts - and these credit cards only add to the agony and hopelessness of a situation.

While the snooty types can fend for themselves, why on earth do we allow companies to operate that can charge such high APR rates, particularly to people they already know cannot afford it?

Of course, credit cards make money at both ends of the spectrum. They charge the retailers a percentage of the sale value for effectively offering finance to the customer and depending on the card type it can be 2% or more but generally around 1.5% of the purchase price (including VAT of course). So these companies are raking it in.

It is also fair to say that the proliferation of cards is curious as many firms, like BA, offer cards which just bear their name. Beneath lurks the co-conspirators like Amex or in Virgin's general case the MBNA Bank who have a great reputation for high charges and poor service - or at least in my house they do.

Conclusions

Unsecured credit card debt is a licence to print money.

The providers are raking it in. In the case of BA and Amex, it is a cosy relationship where Amex can target specific high end net worth individuals who use credit cards very regularly on travel to buy travel and expensive goods and so can afford high costs of credit and are willing to pay for cache. While BA 'sells' this customer list to Amex for a nice return on the transactions and I dare say a share in the interest payments. Each can divorce themselves from the other at the consumer end as per the article when reporters go snooping.

Credit cards again appear to have a lack of regulation and control. While general interest rates fall, credit card average APRs go up. Part of this is that there is increased risk as this is unsecured debt and there is no longer the equity flying around to cover it if it can't be repaid and part of it is that it's easy to charge more because no one will stop them. Also, with increased protection being offered by the Government for people with smaller debts to get them written off, individual credit cards are coming into the firing line as they rarely offer greater than £5,000 to £10,000 credit limit per card - this means the new protection system for debts of £15,000 or less may force credit card companies to have to start writing off more bad debt in the future. Hence higher credit costs again.

The long and the short of it is that it comes back to spending our way out of a recession. There is a big risk that unsecured credit will rise if we follow the Brown/Darling/Keynes approach as we spend beyond our means and have no equity in our homes to cover it. The best advice surely is to consolidate and try and bring this debt down as servicing it is eating into our monthly disposable income at an increasing rate despite interest rates coming down.

I'm no financial expert but surely that makes sense?