Just like the bailouts, quantitative easing has started small. However, if the history of the Federal Reserve and the Bank of England and the US and UK governments are a guide, this is only the thin end of the wedge.
People with large mortgages should be cheering on quantitative easing as the banks blow open the momentary spigots to “allow lending to resume in the economy”. This will not solve the structural flaws in the UK economy because you cannot solve the problem of too much debt with more debt.
Most logical citizens know this to be true from their own experience of managing a household budget. However, quantitative easing will take the strain of households and will eventually deflate mortgage debt to more sustainable levels.
Quantitative easing is basically the printing of money. Something that is rare derives its value from its rarity if it isn’t backed by another asset.
Think of the Mona Lisa painting. It is valuable because it is the only one. If someone went back in time machine tomorrow and convinced da Vinci to paint 100 Mona Lisas, they will all be worth roughly 100th of the value of the current unique Mona Lisa.
The same is true of currencies.
When the system is flooded with more currency, the value of the currency goes down. In this scenario, wages must increased to compensate. Zimbabwe is a good example of this. In Zimbabwe, you need roughly $1 billion to buy a can of coke. With quantitative easing, governments always tell us they will stop before it gets to this situation. Let’s look at their track record.
They didn’t stop the credit bubble until was vastly too big, they haven’t been able to stop the credit implosion until it was vastly too small and in order to reflate the economy, it is unlikely given prior track record, that they will be able to stop the quantitative easing before the currency has shrunk significantly in value.
It isn’t impossible in this scenario to see a time when the value of the average mortgage today being equal to only a few months wages. In this scenario, the banks will be the big losers but the mortgage holders will be the big winners. They will be able to buy off their mortgages for a smaller and smaller proportion of their income should quantitative easing get out of control.
The only time in history in which quantitative easing did not get out of control was in Japan in its post-1989 bear market. The reason inflation never took off in Japan was because of a large amount of savings in the country. The US and the UK don’t suffer from the pesky problem of having large amounts of savings and so quantitative easing here is very likely to result in the debasement of the currency over the long run and in a reduction in the average mortgage value in relation to the average wage.
Measuring house prices today in pound notes makes absolutely no sense in our new economic reality. Look towards average wages to find a good indication of where the bottom of the market will be. As quantitative easing gathers pace, the ratio between the average wage and the average property price will continue to shrink until property becomes the value bet of a lifetime. At this point, the floor will be determined by a rental yields. How low this floor will be shall be determined by bond yields and interest rates.
