Monday, 16 February 2009

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.


CityUnslicker said...

good questions - bit of a leap to say if the bond market collapsing. If that happens then the world is screwed, what we do here in blighty won't matter much.

Anonymous said...

One word - Assignats.

Google it.

Mark Wadsworth said...

Either I missed something or this bit does not compute: "Will the Bank of England accelerate money creation on order to keep government yields down?"

People chat gaily about the BoE buying government bonds, but the BoE are the Government and The Treasury and the Royal Mint are all just parts of the government, it's all the same thing, how can a government issue bonds to itself, all it can do is redeem privately held bonds with cash coins notes, or finance spending with cash coins notes?

And seeing as cash coins notes are government securities like government bonds, albeit non-interest bearing and small denominations. And printing cash coins notes creates inflation and causes interest rates to rise, as Bob has shown us.

So returning to my point, money creation will cause yields to rise, whichever way you look at it.

Anonymous said...

Can we get Alice a seat at the next BoE press conference? I would like to see the answers to these questions. Even if the BoE refused to answer some of them, that alone would tell us a lot.

Anonymous said...

"One word - Assignats."

Thanks for that anonymous.

Anonymous said...

Assignats -from Wikipedia

Assignats were paper money issued by the National Constituent Assembly in France during the French Revolution. The assignats were issued after the confiscation of church properties in 1790 because the government was bankrupt. The government thought that the financial problems could be solved by printing certificates representing the value of church properties. These church lands became known as biens nationaux. Assignats were used to successfully retire a significant portion of the national debt as they were accepted as legitimate payment by domestic and international creditors. Certain precautions not taken concerning their excessive reissue and comingling with general currency in circulation caused hyperinflation.

Originally meant as bonds, they evolved into a currency used as legal tender. As there was no control over the amount to be printed, the value of the assignats exceeded that of the confiscated properties. This caused massive hyperinflation. In the beginning of 1792, they had lost most of their nominal value.

This hyperinflation was stirred up by repeated food shortages. Instead of solving the financial problems, the assignats became a catalyst for (food) riots. Instability continued after the abolition of the monarchy, exacerbated by the wars France faced. This situation impeded the implementation of good financial policies that would reduce debts. Bills such as the Maximum Price Act of 1793 aimed to regulate inflation.

When the Directoire came into power in 1795 the Maximum Price Act was lifted. Hyperinflation reemerged and in the next four years Paris was the stage of yet more riots.

The inflation was finally solved by Napoleon in 1803 by introducing the franc as the new currency. By this time, the assignats were basically worthless.

Anonymous said...

Printing extra money is a desperate measure and it won't work.

We have to face up to what Brown has made us and the sooner we do this the better - so at least our kids might have a chance of making a good fist of things when they grow up.

Brown out. Austerity bill forthwith.

Howevever, some of us knew all along that this was where NuLab and the Kirsty Allsops were bringing us.

UK Housebubble is the perfect name for this site by the way. Housing was Brown's fake trump card and the vast majority of 'professionals' have proven themselves not to be very clever after all.

Anonymous said...

He thinks he can start out by restricting this quantitative easing to buying up just commercial paper.

What prevents the banks from producing more commercial paper once the central bank commits to buying it?

AntiCitizenOne said...

Anonymous said...

Stalin to Bean to Mugabe...

Rory Bremner eat your heart out.

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