There are many reasons that the fate of Cyprus is being followed so closely in Britain. One is sympathy for those who are about to pay the price for the sins of a banking sector that was at one point seven times the size of the island’s economy. Another is shock at how the island, to which Britain granted independence just 53 years ago, now finds itself caught between Berlin, Moscow and Brussels. But the real lesson of Cyprus can be applied closer to home: when governments run out of money, they come after other people’s. Everyone is looking at Cyprus and asking: how safe are my savings?
In Cyprus, at least, when the government decides to help itself to people’s savings, it’s called theft. In Britain, it’s called ‘quantitative easing’. It may have been shocking for Cypriots to wake up and find the government proposing to steal 6.75 per cent of their savings — but at least the ploy was declared in advance, then defeated in parliament. The new idea — seizing about a third of accounts worth more than €100,000 — is similarly transparent, albeit still shocking. But in Britain, though no one likes to admit it, the state purloins the wealth of its citizens to an extent which makes the deal that Cypriots rejected look quite mild. It just does it less conspicuously.
It’s all down to the games played with interest rates, and a policy — QE — which sounds so mind-numbingly dull that you may be tempted to stop reading as soon as you encounter the letters. John Maynard Keynes had an apt description for what is happening. ‘By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens,’ he wrote. ‘The process … does it in a manner which not one man in a million is able to diagnose.’
Let’s return to some basic finance. Money is used as a medium of exchange, a way to buy stuff. It’s used as a store in value: a way to save to buy stuff in the future. Bank savings are using cash to store value. But in an inflationary world the ability of that cash in a bank to buy stuff erodes. Cash is not completely safe, because you don’t really get your money back. Or you do, but it’s worth a lot less. British savers have not had their money back for some time: interest rates have not kept pace with inflation. This is good for borrowers (including the biggest of them all, HM Treasury) but bad for savers and it hurts standards of living across Britain.
Take last week’s Budget. The Chancellor mentioned in passing that he would give the incoming Bank of England governor a new mandate: to focus on growth, and have greater ‘flexibility’ with inflation. In effect, George Osborne will tolerate greater inflation — which reduces the real value of the debt he has to wrestle with. This is his first tool. The second is QE, which uses digitally created money to ‘buy’ government IOU notes, or Gilts, thereby reducing the interest rate at which government borrows. The Treasury, nowadays, lends this money to banks (so-called ‘Funding for Lending’) and they, in turn, can depend less on borrowing from their customers. This means they offer derisory levels of interest, as anyone who is applying for a cash ISA will attest.
Sir Mervyn King, the outgoing Bank of England governor, has stressed the damaging effect of inflation on wealth many times. But still he has chosen to ignore his 2 per cent target inflation for 39 months. In 2010, UK consumer price inflation was between 3 per cent and 3.5 per cent all year. In 2011, it ranged between 4 per cent and 5.2 per cent. If your cash was sitting in a bank earning 1 to 2 per cent interest, then the higher inflation took the real value of your money away from you — as surely as a one-off Cypriot-style savings tax. But it was done without most people noticing.
The same is happening to pay. In 2011, the average salary for a full-time British worker increased 1.4 per cent, while inflation was three times higher. This helped the government, reducing the real value of its debts. But it hurt workers: in real terms, our salaries fell 2.9 per cent that year. And this is going by the government’s new measure inflation, CPI. Using the old one, the Retail Price Index, prices have shot up 17 per cent over the past four years. The average cash ISA has accumulated a pitiful 2.2 per cent interest. So the actual saver has been fleeced, without any furore or vote in parliament.
Again, this makes a one-off Cypriot 6.75 per cent off savings tax look mild. What’s happening in Britain will keep happening. Financial markets are telling us that RPI inflation will be about 3.5 per cent for years. It’s here to stay, while interest rates and pay rises are flat. The ‘ISA prisoners’ will continue to suffer.
This, the gap between inflation and pay rises or bank interest, is how states lighten the pockets of their citizens. Throughout history, when governments have encounted a debt crisis they couldn’t solve, politicians have succumbed to the temptation to inflate it away.
Britain has the ability to manipulate the interest rates because the Bank of England has the freedom to adopt a strategy: forcing interest rates as low as they can go and nailing them to the floor to keep them there. Meanwhile, QE keeps the government borrowing rates low. Without QE, Osborne would face higher interest rates on his debt — currently costing about £50 billion a year. The artificially lowered rates will have saved the government about £9 billion by 2015/16 — but it doesn’t take an economics degree to know that, while the central bank can print money, it can’t create wealth. For every winner there has to be a loser.
Low rates, like inflation, transfers wealth from savers to borrowers. The Pension Corporation estimates that just the first £200 billion of QE increased pension fund deficits by £74 billion. Private sector pensions were in decline anyway but QE has killed them off entirely.
It gets trickier still. Government regulators are forcing pension funds to buy Gilts. So ministers can divert a chunk of the nation’s savings, forcing savers to accept dire interest rates and allowing the government to borrow even more cheaply. This policy is a direct subsidy and a classic method for politicians to take cash from their citizens. The ones being mugged, Cyprus-style, are all the current and future pensioners forced into buying low-yielding British government debt. The banking collapse in Cyprus has been summed up as ‘Iceland without the fish’. In many important regards, Britain is Cyprus without the transparency.
After the Budget, the newspapers used case studies to demonstrate the financial consequences to particular family groups — a couple, a single man, a family of four etc. Osborne is lucky that so few in the press have woken up to what’s really happening: that the action is taking place by nailing interest rates to the floor and quietly tolerating higher inflation. This has a far more profound impact on the British public than playing with beer or fuel duty. ‘We are supporting the economy with another £50 billion of QE’ and ‘We want the Bank of England to pursue growth’ sounds more elegant than ‘Give us your savings!’ — but it amounts to the same thing. We have had the boom, then the crash — and now we have the pickpocket state. And we’re all feeling the pinch.
Listen to Fraser Nelson and Jonathan Portes discussing the great savings robbery (at 0:48)