Thursday, November 05, 2009

It's Very Simple - We're Skint

Just like the ones the Bank of England has installed

On a day when the Bank of England announced it was printing another £25bn to tide the government over the next couple of months, eminent monetary expert Sir Stuart Rose explained our central problem from a technical perspective:
“We are skint."

Yes, indeed. Sir Stuart has put his finger on the Big Issue. He continued:
“This Government and the future Government have got to make some hard decisions about refilling the coffers”.
Spot on.

Which is why the Bank of England's decision to extend its Quantitative Easing (QE) programme yet further is so very worrying. It is allowing the government to put off all those hard decisions in the short term, at the cost of making them even harder to take when they eventually become unavoidable.

 We've blogged our central concern about QE many times: that it is a huge experimantal gamble with our future inflation prospects; nobody has a clue how the Bank will manage to put the printing press into reverse when the time comes, or even how we'll recognise that time; and all of history tells us they won't manage it (eg see here).

 But QE has another equally worrying dimension. It has allowed the government to fund itself by printing money rather than issuing gilts*, thereby avoiding facing up to the discipline of the international bond markets.

 As we know, QE was initiated to "get credit flowing again". The idea was that the banking collapse had broken the normal credit pipeline. Banks were no longer prepared to lend even to viable businesses, let alone private customers, and the economy was dying of thirst. So the Bank of England would step in to flood the financial sector with cash, thereby hoping to get things moving again.

 But in practice, the Bank has done its flooding not by investing in the debt of cash-strapped companies, but principally by purchasing government gilts in the open market. Here's its own summary (to end-September):

So since March the Bank has printed around £175bn of this extra cash, and virtually all of it has gone to buy government debt.

 Now, by some spooky coincidence, £175bn just happens to be exactly what the government projected in its April Budget as being its total borrowing this year. And by an even spookier coincidence, today's announced £25bn increase in QE for the rest of the year just happens to be the borrowing overrun the government will announce in its forthcoming Pre-Budget Report (don't believe me? just watch).

 Yes, we really have got a government financing the largest budget deficit in the developed world by running the printing press.

And even if we somehow manage to put the whole process into reverse before inflation takes off, the Bank will then be attempting to sell back all the gilts it's now buying at a time when the government is still issuing shedloads. Which is a surefire recipe for a huge hike in gilt yields (long-term interest rates), and an explosion in government debt interest costs.

And you know the really odd thing? Virtually the entire economics establishment seems to think it's fine. Indeed, Tyler has just listened to the New Statesman's economics correspondent telling BBC R5 listeners that it's a "no-brainer". Even though there's virtually no evidence QE is supporting the economy as intended, and even though he couldn't explain how the Bank would ever know when to stop.

Very scary.

Extraordinary measures like QE may have been justified while it looked like we were tipping into the Second Great Depression. But we are through that now. What we are looking at from here is a miserable decade of slow grinding recovery. It may even turn out to be a Japanese-style "lost decade".

But it is a dangerous delusion to think we can get ourselves back on a growth path by running high budget deficits financed with a supercharged printing press. That is the age-old recipe for inflation, crises, and decline.

Instead, we need to listen to Sir Stu. We really are skint, and we really do need to take some hard decisions to refill the coffers. And just so we know, here they are:
  1. Public spending must be cut by around 15% (ie £100bn pa)
  2. Taxes on enterprise and employment must be slashed - we have to earn our way back to prosperity 
Nobody's saying it will be easy. It won't.

But continuing to print money in the vague hope that we can somehow get the economy back to sustainable growth is going to make our longer term problems a whole lot worse.

*Footnote Yes, OK, the government has continued to issue gilts. But since the Bank has been buying them back at the same time, in effect, net issuance has been close to zero.

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