By Michael Baxter, economics writer
Did you know that the FTSE 100 peaked on December 30 1999? If share prices are any guide to the economy, that means surely that the UK economy must have peaked at the end of the last century too. It didn’t, but maybe that is the point; maybe shares tell the true story, and show the growth years of the noughties for what they were – built on hot air.
But the index is moving close to the heady level seen over a decade ago. Does that point to recovery?
On January 29, the FTSE 100 closed at 6339, the highest closing price since January 2008. It is just 382 points shy of the millennium high set on the 31 October 2007 and 591 points off the all-time high of 30 December 1999. To put that in context, the index has risen by 734 points since the middle of last November. At one point in March 2009 it was down to 3512. So if the stock market is any guide at all, it seems to be telling us that the recovery is underway.
Perhaps it is.
But quantitative easing (QE) may have something to do with it. When the Bank of England unleashes QE, it goes out and buys government bonds. This forces their price up (or yields down). This, in turn, makes equities look very cheap.
Throughout the course of the second half of the 20th century, equities typically paid out lower dividends than bonds paid out a yield. If you want some history, it was not always thus. During the first half of the 20th century it was the other way round. Equities were seen as risky, so they were cheaper to compensate investors for their risk.
A couple of years ago, the relationship between equities and bonds flipped again. Some said the cult of equities was dead; that we had another 50 years of cheap shares, and little growth in stock markets to look forward to.
Through pushing down interest rates, the Bank of England is quite deliberately trying to force certain asset prices up. This has encouraged investors to buy shares. It probably stopped house prices from crashing too. The Bank of England hopes this will make us feel richer, and encourage us to start spending more, creating an economic recovery.
A number of people say QE has been a disaster for those with pensions. The truth is that it has been a disaster for some. For those living off interest on savings, and for those trying to buy an annuity, QE has indeed been bad news. But for those who are not yet at that stage, it could be said that QE stopped one mighty crash in share prices. Such a crash would have been bad news indeed for pension values.
Some say QE has also had the effect of pushing up gold, and maybe even encouraged some speculators to buy oil.
Returning to shares, you can say yes, they are up, but are they up because of QE, and what will happen when the Bank of England reverses QE, and starts selling bonds as one day it says it will?
This is why some say the UK central bank is just blowing bubbles.
There is another point. There is a lot of money out there, and it has to go somewhere. Up to now it has been sloshing around the banking system, much of it finding its way into bonds.
But at a time when interest rates are less than inflation, sitting on bonds is a guaranteed way to lose money.
Maybe investors are just fed up. They desperately want an excuse to put their money into equities. So when we get a hint of good news from the US and China, a wall of money falls against equities pushing up their price.
Maybe this is the stuff that the recovery will be made from.
But don’t you think that a sustainable recovery requires a more dynamic labour force, innovation, businesses willing to take risks, and for wages to start rising in tandem with growth. Maybe what we really need is for entrepreneurs to go out there and create wealth. To not merely get on their bike, but – as it were – manufacture it too.
And rather than the Bank of England playing at the game of buying bonds to get risk appetite up, perhaps it – along with the government – needs to go straight for the economic jugular, and use some of that QE (£375 billion has been spent so far) to support and create entrepreneurs.