Quantitative easing

11 March 2009

As I have repeatedly written before, I don’t understand finance or economics, but ‘quantitative easing’ or, as helpful journalists put it, printing money, seems a very unsound method to combat recession. It gives the impression that the government, the Treasury and the Bank of England have run out of options and trying something drastic in the hope that it works. According to what I have read, the state is buying back their bonds for cash (newly printed money). Cash then should circulate around the economy and ease the crunch and thaw the freeze. But will it work? I hope it works, otherwise the consequence are dire: being a natural pessimist and cynic, if I were a betting man, I’d say quantative easing / printing money won’t work.

The powers that be must know that Britain is in a deflationary spiral. Only in deflation would they consider such a measure. Since in normal circumstances, an increase in the the amount of money in circulation would, as far as my non-economist mind works, result in inflation. To my simplistic mind then, it’s OK to pump in more money because prices are falling, and deflation and inflation will cancel each other out.

The state can only get away with printing money as long as it retains credibility: if I, as an investor, were to believe that the government will simply print money to redeem the bonds I hold, then that definitely sounds very fishy. Then inflation will be a problem, since I won’t invest in British state bonds unless I get a good rate of interest to compensate for the risk (i.e. lack of confidence). Even if this does not happen, will the money actually circulate within Britain and reach the businesses and individuals who need access to money and credit? Newly available money might just go into repaying debts without leaving the finanical sector. Or invested in the stock market and promptly lose value.

It might not work, and there are very large risks associated with this course of action. Again, probably made dumb by reading the newspapers who are out there to scare you and me out of our wits, I have a terribly uneasy feeling that this will lead to the collapse of sterling and inflation, caused by and following on the ballooning public debt. Government will have to borrow more – tax receipts will be lower and expenditure (social security) will go up – and Britain must compete with other countries which are financing their stimulus packages by borrowing. What matters is the basic economic strength of each country. Natural resources such as oil and gold might help, so too would a solid manufacturing base or a sound balance of trade. I don’t think Britain is in a good position. To put it bluntly, I’d rather lend money to Germany than to Britain. The UK economy has been too heavily reliant on the financial sector. British public, individual and corporate debts are high and many Britons owe money unlitamtely to people outside of the country. Britain also does not have the protection of a strong currency either: sterling had been horribly over-valued for past years and is finally dropping to a sensible level, however, I don’t think it’s possible to rule out a sudden collpase in its value.

So a horribly parlous state of public finances, (hyper-)inflation out of control, collapsing currency ... I doubt that it will get that bad but I feel that it is a very risky thing that the government is doing now.