Thursday, January 08, 2009

Worse Than The Disease?

Mr UK Economy doesn't like his treatment

Doc, thank God you've come - Nurse Peston says you've now pushed my interest rates lower than they have ever been in my entire life*. That can't be right! Surely you've already administered a huge cut in rates, and it hasn't worked. Should you really be cutting my rates even more? I thought the problem was that my banks just won't lend. How will cutting interest rates help?

Now look, I'm the Doctor. You just lie back and leave things to me. We're going to try out the very latest treatment regime - we call it Quantitative Easing.

Quantitative easing?! I don't want to be a guinea pig in some mad experiment! I'm too young to die.

Ha ha. It's absolutely nothing to worry about. It's just the term we medics use for "printing money". We simply administer a small electric shock to your Bank of England, and it starts to print vast quantities of cash. Then it uses the cash to buy up all that nasty stuff that's doing your body so much harm - overpriced gilts, junk bonds, bombed out equities, sub-prime mortgages, credit card arrears, second-hand Mondeos, feral children - in fact anything at all that will inject a bit more money into your sclerotic old veins.

But just a cotton-pickin' minute, Doc - surely that will spark an humongous rise in my inflation rate - it always has before. And won't that mean that my savings deposits will shrivel away? Just like they always have before.

Well, no, not this time, old chap. You see, this time you are facing the black hole of deflation, so we can print as much cash as we like with no inflation risk at all. We just have to get that money pumping round again.

Pumping round!? I'm no expert, but isn't my money supply already pumping round like crazy? According to my heart monitor, it's growing by 16.3% pa, which as far as I can see is the highest of any major economy anywhere! In fact, it's pumping round so fast I can hear a terrible rushing noise inside my head. Are you sure you're a real doctor?


*OK, strictly speaking, a 1.5% Base Rate is only the lowest since the Bank of England was founded in 1694, but it's generally believed rates were higher in the centuries before then so it probably is the lowest since British moneylending got started.

The fact is, however they dress it up, our policy-makers are in danger of slipping the surly bonds of sanity:

  • We have already had a massive rate cut in the last four months, and history tells us the impact won't come through for at least 6-12 months: the sensible course is to wait before cutting rates yet further - we could easily overdo it
  • The money supply is already growing at a scary rate: broad money (M4) is up 16% over 12 months, and over the most recent 3 months it grew at an annual rate of 25%+
  • It isn't expensive money that's restraining bank lending, but a lack of confidence; and watching the authorities scurry round turning every control they can find up to max in a pre-election binge is not going to restore anyone's confidence
  • Although bank lending has stopped growing, despite what everyone is saying, it's not collapsing: here's the series for bank loans outstanding to non-financial companies:

As we've blogged many times, the blunt truth is that we have to go through some collective pain. We have lived on credit for far too long and the reckoning has arrived. We simply have to face up to that.

What we really don't need is for the government and the Bank of England to make things even worse by stoking up an inflation disaster. It's all very well pointing to the risks of deflation, but right now, today, prices are still going up by 4%pa. And money growth that is well into double digits is telling us inflation could well move even higher over the next 1-3 years.

As we saw in the 70s, we can easily have recession and inflation side by side, and that seems to be precisely where we're now heading back to.

Don't worry because the authorities will claw back all this monetary growth before we get there?

Yeah. Right.

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