The beast awakens

"Now it is true that some – often corrupt – governments have resorted to “printing money” in order to finance their spending when taxes are hard to gather.

But if the monetary policy committee chooses to finance asset purchases through the issuance of central bank money, it will not be to finance the government’s budget deficit."

Charles Bean, deputy governor, Bank of England

So, nothing to worry about then. Since the UK government is not corrupt, printing money by the UK central bank won't create inflation. Brown is not Mugabe, Britain is not Zimbabwe, so the old maxim that money creates inflation doesn't apply.

Moreover, Mr. Bean is going to buy commercial paper, not government paper. The MPC is going to help firms and leave Her Majesty's government to sort out its financing mess on its own.

With these assurances in mind, there are seven questions I would love to ask Mr. Bean.

Question one:Next year, the UK government wants to run a fiscal deficit of 8 percent of GDP. Give or take a billion, the UK government will have to issue ₤120 billion of new debt. What will the Bank of England do if the government can not sell this debt without long term government yields beginning to rise?

Question two: Suppose the government, in its desperate desire to run this huge deficit, allows rates to increase. As Mr. Bean knows, this will put upward pressure on all interest rates. In turn, this will crowd out private expenditure in favour of public consumption. Will the Bank of England accelerate money creation on order to keep government yields down?

Question three: What will the Bank of England do, if as is likely, investors begin to sell UK gilts as long term inflationary expectations begin to rise?

Question four: Assuming that the Bank of England want to prevent Gilt yields rising, will it begin to buy government paper in order to put a floor under bond prices via quantitative easing? The temptation will be strong; after all, we wouldn't want to see a run on UK government paper.

Question five: If private sector investors starts to seriously dump UK gilts, is the Bank of England prepared to become the buyer of last resort for government paper?

Question six: If the UK bond market collapses completely, is the Bank of England ready to become the primary source of funding the government deficit?

Question seven: Suppose the bond market does collapse; the BoE has become the primary source of financing the governments huge deficit; and inflation has begun to spin out of control; when will the BoE tell the government that it wants to stop buying government paper in order to prevent the UK from drifting into a hyper-inflation?

Today, Mr. Bean and his colleagues might feel confident that a quantitative easing won't lead to monetary disaster. He thinks he can start out by restricting this quantitative easing to buying up just commercial paper. But the government debt market does not live in isolation. Before he can say "Milton Friedman was right" he will end up supporting Brown's massive deficit plans by extending quantitative easing to include the purchase of government paper.

Returning to Mr. Bean's sly dig at corrupt governments, the Central bank of Zimbabwe did not wake up one day and say "lets hyper-inflate". It got there by stages. When confronted with those seven questions, it consistently came up with the wrong answers.

Like all policy makers, Mr. Bean lives under the delusion that he can control the economic forces unleashed by unrestricted monetary growth. It is a common enough delusion, held by all central bankers who ended up debauching the currency.