The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (38 page)

Bye Bye Brick
, the book by the real-estate expert Señor Bartolomé, is dedicated to ‘the tens of thousands of families who bought a house at the top of the market’. But, Bartolomé tells me, ‘finally, the victims are the whole country. I am a victim. My children are victims. Governments (especially the Zapatero one, but the current as well) have mistaken priorities, leading the country to a Japanisation of the economy in the best scenario, or to the default if Germans get fed up of us.’

Yet beneath it all, Spain has pulled off something that Britain, for one, has not. The houses, airports, theme parks, high-speed trains and villas may lie empty and unused. But they are still there. Spain has been left with an amazing infrastructure, and lots of cheap housing. Exports are beginning to recover, and indeed the export boost has already exceeded that enjoyed after Spain’s last economic crisis, in 1992–3 when the peseta was devalued.

At Sareb they are attempting to fend off international sharks looking to buy up large tracts of Spanish property for a pittance. Massive rental programmes and some demolitions will occur in the ghost estates that litter the plains and the coast. But there are some innovative plans for Spain’s boomtime unused property assets. One idea is to turn Spain into ‘The Florida of Europe’. The surplus housing, sun, excellent medical facilities and availability of young workers might be the raw materials for a health tourism and retirement industry. Through it’s probably not the future the educated
milleuristas
had in mind.

I missed something when I first saw the flapping banner at Seseña, offering flats for sale at the knock-down price of €65,000. Behind this sale was the bank Santander, who were trying to liquidise their stock. It turned out that in 2009 Paco el Pocero had sold half his development – 2,000 flats – back to his bankers, including Santander, to pay off his construction debts before trying his luck in Equatorial Guinea. The banks had paid a high price, thought to be around €150,000 each. But by 2012 the hitherto empty flats that had become a symbol of the failure of Spanish economics were beginning to shift. ‘They sold more than 300 houses in two weekends,’ Señor Bartolomé tells me. ‘Now many people are living there, and you can see children, guys walking with dogs, and shops opening. When the price adjusts, everything fits.’

That banner at Seseña, offering homes at knock-down prices, was a rare sight across the world in the years after the bubble burst. It was the policy of ‘extend and pretend’ coming to an end, a sign that losses were being taken on the chin, as a healthy bank dusted itself down. And the end result is that – a decade of pain after Zapatero promised that mass house-building would keep prices under control – a family finally gets a home it can afford to buy.

Dramatis personae

Sir Mervyn King, governor of the Bank of England (2003
–13)

Alistair Darling, UK chancellor of the exchequer (2007
–10)

David Cameron, UK prime minister (2010
–)

Robert Stheeman, head of the Debt Management Office (DMO)

Simon Ward, chief economist at Henderson

Danny Gabay, Fathom Consulting; former Bank of England economist

Christian Noyer, governor of the Banque de France (2003
–); sits on the governing council of the European Central Bank

Markus Kerber, German economist who has led the constitutional charge against the ECB’s existing Italian and Spanish bond purchases

Richard Werner, now of Southampton University, an expert on Japan, and the man who coined the term ‘quantitative easing’ in 1994

David Bone, a pensioner who lives in the Hampshire countryside

Ros Altmann, pensions expert and director-general of Saga Group

Charlie Bean, the Bank of England’s deputy governor (2000
–)

Toby Nangle, a clever City analyst

Robert Lucas, University of Chicago, Nobel prize-winning economist

Richard Koo, the foremost expert on the post-bubble economic policy failures in Japan

Doormen with black top hats and pink tailcoats – like eunuchs in a Turkish sultan’s harem – guard access to that most virtuous of women, the Old Lady of Threadneedle Street. It was James Gillray, in 1797, who first personified the Bank of England as an old lady with a dress made of paper money, sitting on a pile of gold. In his cartoon, entitled
Political Ravishment: or the Old Lady of Threadneedle Street in Danger
, Gillray shows the Old Lady resisting the advances of Prime Minister William Pitt, who had demanded that the Bank redeem its notes not in gold, but should print £1 notes instead.

Top hats and pink tailcoats might not be the way a modern brand agency would seek to project the image of the guardian of national monetary policy. But the ‘Pinks’, as they are known, are part of the fabric of the Bank of England: inexplicable, quirky and unyielding, like the institution itself. Marble-lined halls, mosaics depicting the founding of sterling, ancient weather vanes – all add to the aura around Britain’s central bank, founded over three centuries ago, in 1694. This long history, even more than the £150 billion of gold stored in an underground vault that once served as a wartime canteen, underpin the institution’s hardy credibility. And in central banking, credibility takes centuries to acquire, and just a few moments to lose. In the current crisis, stability, independence and credibility are all being tested.

As the euro threatened to collapse in 2011, I found myself ushered by one of the Pinks into the office of the governor, Sir Mervyn King. ‘None of us, neither you nor me nor any of the savers in this country have a crystal ball that will tell us where the world economy is going,’ he told me. ‘This is undoubtedly the biggest financial crisis the world economy has ever faced, and it’s continued now for four years. I do not know when it will come to an end.’

As the crisis raged through the American, British and European financial systems, the Bank of England was pushing the boundaries of monetary policy further than any other central bank. Behind the imposing façade that glowers over Threadneedle Street, the Bank was preparing an experiment in ‘financial repression’, an experiment that was to test the balance between credibility and calamity. It was called quantitative easing.

Every schoolchild is familiar with ‘The Magic Penny’, the morning assembly song:

It’s just like a magic penny,

Hold it tight and you won’t have any.

Lend it, spend it, and you’ll have so many,

They’ll all roll over the floor.

Only in Britain could there be a ubiquitous children’s song that invokes the concept of the velocity of circulation of money. After all, it was in Britain that David Hume and John Stuart Mill developed the quantity theory of money, the classical basis for modern monetarism. So it is entirely appropriate that Britain is currently conducting the world’s biggest experiment in the creation of magic money. Quantitative easing (QE), as it is officially known – or ‘printing money’ as it has been more colloquially described – has seen a flood of magic pennies wash through Britain.

By 2013, an additional £375 billion had been conjured into existence at the stroke of a computer keyboard in the Bank of England. But almost all the major economies have also dabbled in the monetary dark arts in the aftermath of the financial crisis. Although the European Central Bank has only reluctantly stuck its toe in the water, the USA, Japan and Britain have dived right in. It was widely assumed that QE programmes had run their course in the spring of 2010, but policymakers in the big Western economies had not done with printing new money, and further rounds of quantitative easing, known as QE2 and QE3, followed.

Yet even as the world’s central bankers cranked the handles of their magic cash machines, odd and unintended consequences – with social, political and even diplomatic implications – have arisen. It is far from clear that the experiment has worked.

‘No, it isn’t working.’ ‘It definitely has worked.’ ‘Not yet.’ ‘Yes, but not in the way I expected.’ These are among the answers from leading economists to the rather simple question, ‘Has QE worked?’ The IMF’s initial verdict was that QE is ‘not a panacea’. But, they said, it ‘does not have to be a curse’, adding that QE is ‘not a non-event’. Did anyone, anywhere, really know what was going on?

‘It was one of the many measures to get confidence back in the system,’ Alistair Darling, the former chancellor, told me. But as the man who had to sign off on the Bank of England experiment when it started in March 2009, his candour about our ignorance is almost shocking. ‘Nobody really knows what impact it’s having,’ he says.

Monetary policy is conventionally about raising or lowering interest rates. The target rates are the short-term interest rates used by the central bank to lend to commercial banks. When this ‘official’ base rate is lowered, typically this reduction is passed on in the form of lower mortgage and corporate borrowing costs for the medium and longer term. Think of the Bank of England lowering its base rate as monetary
price
easing. When that
price
– i.e. the interest rate – reaches close to zero, that might seem to be the end of the matter. The Bank can then switch its attentions to the
quantity
of money, shovelling more and more of it into the economy – hence the term ‘
quantitative
easing’. This more unconventional policy is meant to bring down all sorts of other, longer-term interest rates across the economy, such as government, corporate and household debt.

Imagine that Britain is suffering from economic scurvy. Our benign economic dictator, ‘King Mervyn’, knows that vitamin C is the answer, so he uses his monopoly control of the supply of oranges to bring down the price, and so encourages an increase in the consumption of oranges. Eventually oranges are as good as free, but still the scurvy scourge endures. What does he do then? He uses his magic skills to create even more oranges out of thin air, rents out a fleet of trucks and delivers thousands more oranges to every greengrocer and supermarket in Britain. Quantity still has an impact, even when the price remains zero. Such is the flood of fruit that it brings down the price of derivative products such as orange juice, marmalade and vitamin C tablets. King Mervyn cures scurvy.

In practice, money has been injected by offering to buy assets – almost exclusively government debt, in the form of bonds – off any holder of that debt, with the Bank’s invented cash. Pension funds and insurance companies in particular faced plummeting returns from their holdings of government debts as interest rates fell, giving them a strong incentive to do something more risky with their money – thus stimulating borrowing and investment.

That is the basic mechanism of QE. But to understand fully where the monetary mountain went, one needs to understand its origins.

Quantitative easing was an initiative of central bankers. In the weeks after the collapse of Lehman Brothers in September 2008, it was clear that British base rates, then at 5 per cent, were going to be cut quickly towards zero. World trade collapsed in a manner not seen since the 1920s. Once again, around the globe, ports were full of ships with no cargo.

The central bankers’ arsenal of stimulatory weapons had to be widened. Mervyn King later recalled the stark warnings made by Japanese officials at IMF meetings in the autumn of 2008. They told their international colleagues that they must at all costs avoid the mistakes made by Japan a decade before.

So, in principle, the Bank began to map out how it would use its unique power to create money, in order to buy up various assets. But, in Britain at least, there was a problem. The institutional structures of the economy had not been shaped with quantitative easing in mind. QE required a closer relationship between government and central bank than had been envisaged when the Bank of England was handed independence to set interest rates in 1997. The Bank needed the Treasury to indemnify any losses that might arise out of the asset purchases. That made it a little less independent, and in theory that could in turn have damaged its inflation-busting credentials.

At the time, however, inflation was a distant concern compared with the reality of a collapsing economy. Prime Minister Gordon Brown was now taking a keen interest, alongside Chancellor Alistair Darling, and between these two big political players, the Treasury and the Bank, a compromise was beaten out that would preserve Bank independence but allow QE to go ahead. This compromise took the form of something called the ‘asset purchase facility’.

In January 2009, as these institutional discussions were taking place, there was much grumbling from Opposition politicians. The office of George Osborne, then shadow chancellor, issued a press release saying that speculation about printing money showed that Gordon Brown had ‘led Britain to the brink of bankruptcy’ and that ‘printing money is the last resort of desperate governments… In the end printing money risks losing control of inflation.’ Vince Cable, the Liberal Democrat Treasury spokesman, referred to ‘the road to Harare’ and the ‘Robert Mugabe school of economics’ in relation to the risks he saw inherent in QE.

The then leader of the Opposition, David Cameron, was more measured at the time. He appeared to have taken some intensive tutorials in advanced monetary economics in early 2009. In January of that year, he regaled me with the finer details of Dutch economist Willem Buiter’s blog, and with his own appreciation of the difference between quantitative easing and qualitative easing. The former referred to the sheer amount of buying the central bank could do, the latter concerned an attempt to lower interest rates in specific markets, such as mortgage debt and corporate credit.

So this was a policy initiated and decided upon by the Bank, but with considerable input from the government. At the top of the Treasury the assumption was that the structure created would be used, as was the case in the USA, to buy a wide range of commercial, government and mortgage debt, but that operational decisions regarding such purchases would be left to the Bank.