Dec. 5th, 2008

peterbirks: (Default)
"Quantitative Easing". That has a nice official sound to it, doesn't it? Certainly better than "crank up the printing presses!"

Quantitative easing is, in fact, the Friedmanesque "helicopter option", whereby you print lots of lovely new notes, put them into a helicopter, take off and then scatter the notes all over the north-east, or north-west, or the countryside. Perhaps, in a first for the UK, some of them might actually be scattered over London, although I wouldn't hold my breath on that one.

This would, I think, be the first time since the Barber/Heath administration that the Bank's balance sheet was expanded in such a fashio, and I wonder if Gordon Brown is willing to take that step. It would be the final admission that cutting interest rates has indeed been "pushing on a piece of string".

The problem is, everyone wants results yesterday. There have been few headlines on the fact that the actions taken in September did indeed achieve some restoration of interbank liquidity - LIBOR has dropped from more than 6% to less than 4%. At the time, everyone (including John Authers of the FT) was proclaiming that the moves had had virtually no effect. But they did.

Although, from a personal point of view, I'm all in favour of the BoE and the Treasury (and the ECB and various European governments) pressing the panic button and starting up the printing presses, from an objective macro-economic viewpoint, I think that it would be a disaster.

The fear is that bogeyman, Japan-style deflation. But I suspect that this misses the point. After all, we have had deflation in the UK for nigh-on a decade in certain goods (clothing, TVs, other white goods). In theory, this would have led to people holding off on white good purchases "because they will be cheaper tomorrow". But I haven't noticed that happening.

In other words, falling prices does not necessarily lead to a vicious circle of less consumption. Japan-style deflation won't happen here (although it is a threat in Germany) because we (and the US) are not natural savers and do not have a natural current account surplus.

Many of the current stimuli, therefore, are fighting the wrong problem.

The real problem is that, although we are not natural savers, we are natural borrowers. Consumption is not falling because we are putting off buying something that we can get cheaper tomorrow, but because all of our credit sources (remortgaging, in particular) have dried up, and those nasty lenders now want some of their money back. The Treasury doesn't need to encourage UK consumers to spend. It just needs to stuff money in their pockets.

But that (printing more money) just shifts the systemic problem (that we in the UK have consumed more than we produced for over a decade, and that the debt now needs to be repaid) elsewhere. It shifts it to the value of money. That over-consumption is repaid by debts being written off and savings being wiped out. Inflation is, in its own way, the best "let's start with a clean sheet" in the business.

Germany (and Japan) cannot cope with that kind of solution, which was one reason that Japan suffered as it did in the 2000s. It was, as it were "too fair" -- punishing borrowers and not punishing savers. One only need recall the impact of the Treaty of Versailles in 1919 to see that punishing the errant is not always the best solution, even for the non-errant.

However, all that said, for the printing presses to start now will guarantee inflation within two years rather than three.

And, remember the phrase. It's "quantitative easing". Keep a google check going on it. If the mention of it increases dramatically over the next four or five months, then you can be ready to shift out of gilts by the end of next year, 'cos good ol' inflation will be just around the corner.

Then again, inflation is just around the corner anyway. The mortgage cuts and the fall in the price of petrol has put a lot of money in people's pockets -- so much so that the 2.5% cut in VAT looks increasingly pointless and stupid -- and forthcoming redundancy payments will add to the short-term boost to the economy (it's best to spend redundanncy money as fast as possible so that you can qualify for means-tested benefits). Printing more pound notes will just speed up the process. The BoE has not been pushing on a piece of string, and its actions have had an impact. It's just that the impact hasn't shown itself straight away. That's how the economy works.


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