The UK economy is, without doubt, struggling due to the backlash of the extended Coronavirus lockdown period. Just March of this year, an estimated 21,000 more businesses have filed for bankruptcy than March of last year. While some argue that these businesses would have failed with or without the emergence of COVID-19, experts believe that the global pandemic and the community lockdown have pushed many establishments over the edge. Three months forward to present time and even more, businesses have shut their doors permanently.
Given the data we have at this time, the UK is bound to be headed into a deep recession – yes, far deeper than where we are right now. Whether the recession we are preparing for will be far worse than 2008 one, nobody knows. However, it is safe to say that the UK government, as well as the Bank of England, are pulling all the strings they can to keep that possibility from happening. One drastic, and a rather controversial step, the Bank of England has taken Quantitative Easing.
Today, let me tell you what it is.
Quantitative Easing – Explained
Contrary to popular belief, Quantitative Easing or QE as economists often call it, is not as simple as curating thousands of bills and giving them to companies and banks to boost market activity. If things were that simple, the currency would lose its value altogether. While QE does involve the central bank “injecting” newly-curated money into the market, there are a couple of nuances that differentiate the QE from mindless giving.
First off, it’s important to understand why central banks like the Bank of England would resort to such a controversial method as Quantitative Easing.
The Bank of England, along with the other central banks that exist globally, act separate from the government. They are independent establishments that act as the regulator of currency used in the country. They are the only banks authorised to create and destroy money with due process. Anyone else trying to do the same will be convicted with serious charges as it is a grave felony to reproduce or destroy currency without authorisation.
Anyway, given that authority, the Bank of England is legally allowed to produce more money to help the economy “bounce back.” Someone who is not well-versed in economics, might ask: If the country is in such deep debt, why not just produce more money? The reason why this is not a viable solution is that more money does not equate to a better economy.
In fact, it has quite the opposite effect.
You see, when there is too much money circulating in the market, it begins to lose its value. It becomes smaller and less significant, and thus, prices of goods will go higher leading to hyperinflation. With that said, more money does not mean fewer problems. It actually makes more problems which is why one of the major responsibilities of central banks is to regulate the currency circulating in the market.
The only exception is when Quantitative Easing is initiated.
What happens is that a central bank would purchase treasury bills and bonds from the government, or corporate bonds and stocks from businesses using newly-curated money. In other words, they create new money, buy assets, and in turn, inject new money to circulate in the country. This is all to encourage an increase in market activity and therefore, help the economy recover from a big shock aka a major recession.
Banks can sell unwanted stocks or assets that are just sitting there earning very little, and they receive cash which they can use to do profitable activity (e.g. offer new loans). The same goes for the government when they sell treasury bills in exchange for cash which they can use to purchase from the market. By giving the government and banks an instant cash bucket to move, they can initiate new market activity.
Banks, for example, can opt to profit from the QE money to offer loans to people and smaller businesses. Those who acquired the loan will then start spending that money – on a new house, a new car, a business expansion, etc. This prompts economic activity and urges money to circulate in the markets again.
Furthermore, with more money circulating in the market, interest rates will begin to fall. With more banks receiving more money from selling stocks and bonds to the central bank, interest rates will get competitive – as most banks will try to entice borrowers with more promising rates. This drop-in interest rates would then encourage more people to acquire loans and seize the opportunity to spend more because the amount they have to pay back is considerably low.
All in all, the role of QE is to create a spark in the markets. It’s a small current that creates ripples in the economy. You can think of it as the central bank getting money from another dimension and discreetly injecting it into the market.
Are There Risks To Quantitative Easing?
Nothing in the world of economics is risk-free, and QE wouldn’t be as controversial as it is today if there were no significant risks involved.
First off, there’s no guarantee that banks will choose to “loan out” the money they acquired from the central bank. There are still conservative banks who would rather hoard the money because they are too wary of market conditions during a recession. They would forgo the opportunity to earn more from loan interests and just keep the money they’ve earned from selling assets. Second of all, the risk of inflation is not zero. Inflation still happens during QE, and it is even safe to say that it is inevitable.
However, central banks do have contingency plans when things go awry. Quantitative Easing efforts often end with recalling the money the central bank has injected into the market once the economy starts to pick up. How do they do this? One way is through reselling the treasury and corporate bills, bonds, and stocks they have acquired through QE and essentially “destroying” the money they receive in turn. This way, theoretically-speaking, the status quo is regained.
Here is the most recent news surrounding QE in the U: https://www.bbc.com/news/uk-53093127. I also talk more about this in my weekday Podcast, Uncover Wealth Radio. If you’re interested to know more about UK business updates, be sure to hop on my next LIVE and do say hello. You can also reach out to the Annette & Co. team if you want a FREE consultation for your business.
For more information about this matter, be sure to check out Episode 161 of Uncover Wealth Radio. If you’ve missed the LIVE broadcast, you can always revisit the episode here on our website, Annette & Co.