Jeremy Warner: Everything else has been tried. Now King goes nuclear

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The Independent Online

Outlook Lights, camera, action. Yesterday's decision to sanction £150bn of "quantitative easing" by the Bank of England has been a long time in the making, but the moment is no less historic for it. Nothing quite like this has been attempted in Britain before, though it is by no means the first attempt within these islands to expand the money supply by printing more banknotes.

Received wisdom is that the authorities are doing the right thing. Should we accept that they are?

With yesterday's further 0.5 percentage point cut in interest rates, the Bank of England has run out of road with conventional monetary easing. Theoretically, rates could go the whole way to zero, but as the Governor of the Bank of England, Mervyn King, has pointed out, any further action risks being counter-productive. This is because once rates hit zero, banks lose the ability to earn a margin between deposit and lending rates and therefore become operationally unprofitable. The effect might be further to reduce their propensity to lend.

As it is, it is the end of "free banking". In any case, to ease monetary conditions further, the Bank must start pumping money into the economy. Growth in money supply, a natural offshoot of economic growth, has ground to a halt over the past year. The Bank of England hopes to recreate this growth by artificially injecting new money into the system. If all the £150bn sanctioned is used, it would amount to an increase of 5 per cent in broad money, and an astonishing 80 per cent increase in base money, or notes and coins in circulation plus bank reserve accounts held at the Bank of England. Potentially, then, quite dangerous stuff, and in any case there are few guarantees that it will work as it is supposed to.

One possibility is that banks and other financial institutions that avail themselves of the facility will merely hoard the cash they get from selling government and corporate bonds to the Bank of England, rather than feeding it out into the wider economy. Banks are still terrified of running out of cash, and are determined, with regulatory encouragement, to rebuild liquidity pools. The initiative may therefore have little, if any, effect.

There are also two major risks. One is that showering the country with £150bn it didn't know it had might prove inflationary. Mr King says he's alert to the possibility and is determined to stop any inflationary surge in its tracks. But will he be able to? A quite breathtaking quantity of ammo has been thrown at the deflationary threat over the last three months, of which yesterday's monetary action is only the latest example. All over the world, policymakers have been firing off their fiscal and monetary cannon as if invaded by some kind of alien species. You have to believe that eventually it will work, and when it does, it might do so at terrifying and unstoppable speed. The dangers of a sudden mini-boom followed by an even more calamitous collapse should not be underestimated. Jean-Claude Trichet, president of the European Central Bank, is not ruling out quantitative easing for the eurozone, but as was apparent from his press conference yesterday, he's not at all keen on it for the reason given above.

To judge by all this panic-stricken policy action, anyone would think that we were already in the midst of a second Great Depression. In fact, we haven't even had a month of falling prices yet. This is not yet a deflationary world, or anything like it. British inflation, as measured by the Consumer Prices Index, is still a full one percentage point above target. Mr King would say that he's taking this action to guard against the deflationary threat, rather than to address its present reality. Yet is he not in danger of tilting at windmills, or at least of over-reacting?

My other main concern is that these actions are little more than a socially divisive and politically motivated con-trick. No wonder the Government is so keen to sanction the printing of money. It helps fund the deficit, and if it succeeds in creating a temporary boom, it will be just in time for the next election. Yet where does it leave the savers and pensioners who are seeing their incomes reduced to penury by this Alice in Wonderland manipulation of interest rates?

It's illegal under the Maastricht Treaty for the Bank of England to create money to buy gilt-edged stock directly from the Government. But what's being proposed amounts to pretty much the same thing. Any gilts issued by the Government from here on in benefit from the fact that the Treasury's 100 per cent owned subsidiary is creating money to buy these assets in the market. The deficit thus becomes partially under-funded, as well as benefiting from artificially depressed borrowing rates. Savers are being casually disadvantaged to help fund an already bloated public sector whose soaraway growth is a major part of the crisis. It's like the Mad Hatter's tea party. It's going to take years to clean up the resulting mess. Twinkle, twinkle, little bat...

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