Much of the new money the Bank of England has "printed" to stimulate the UK economy is ending up abroad where it will be of no benefit to UK households and businesses, according to an analysis of the Bank's "quantitative easing" programme.
The Bank is in the process of purchasing about £75bn of government securities, or gilts, over a three-month period, the first instalment of a massive £150bn programme. The Bank is effectively converting these government securities or gilts into cash and bank balances which, it is hoped, will be used to support lending and spending in the UK and boost the economy.
But City experts analysing the scheme for The Independent say large quantities of money will simply end up abroad because so many of the gilts are held by foreign investors. They fear that they will hoard the cash, which will be of no benefit to the British economy, or dump it in favour of safer currencies, which could cause a run on sterling. More than a third of gilts are owned by foreign entities, official statistics reveal, and there are doubts about how effective the policy will be if that sort of proportion of the new money is diverted abroad.
Colin Ellis, an economist at Daiwa Securities, said: "In principle, creating new money to pump into the economy is the right thing to do when interest rates are already near zero and further monetary stimulus is required. But the Bank of England may, possibly inadvertently, be buying up gilts from foreign investors – who, according to the latest data, held over £190bn, or 36 per cent, of UK Government debt. If the Bank is pumping its new money abroad, it is clearly not going to UK households and businesses, and will not help boost UK demand."
Even if relatively little of the cash leaks overseas there is a strong possibility that the banks, as with previous attempts to bolster them, may end up "hoarding" the cash to shore up their own beleaguered positions, with little extra lending to companies and first-time buyers.
Recent speculation suggests that many UK pension fund managers – large holders of gilts – are reluctant to sell up and buy riskier assets such as shares instead, given the current dire economic environment.
Last week, the Bank made a successful start by buying £2bn of gilts, having received offers for £10bn-worth. Next week, it is planning a further two auctions, of £2bn and £3bn. Yet the Bank does not necessarily know the ultimate fate of the money it is handing out.
Even if a UK banking group sells the gilts, there is no easy way of telling whether the bank is selling those gilts on its own behalf, or more likely, on behalf of a pension fund or institutional investor in the UK or abroad. This uncertainty about the ultimate destination of bank money makes the policy hazardous. Recently, statistics released by the Bank suggested a significant outflow of funds from London over the latter part of 2008, which amounts to some $1trn ($1,000bn), 15 per cent of total foreign deposits.
Sterling has lost more than a quarter of its overseas value since mid-2007, an indication of loss of nerve by investors, some of whom have openly talked about the UK being "bust" and following Iceland's unenviable example into insolvency – hence the jibe doing the rounds in the City that London may soon become "Reykjavik on Thames".
George Soros, the man who "broke the Bank of England" by helping to force sterling out of the exchange rate mechanism in 1992, has been selling or "shorting" sterling for much of the past year or two. The fall in sterling has not, as ministers and the Bank hoped, saved British exports, which are if anything falling as global demand and international trade flows evaporate.
Even Germany and Japan have recorded sharp deterioration in their trading positions – and some believe that if those champion exporters cannot sell abroad then there can be little hope for the UK.
Mr Ellis added: "There may be implications for sterling: for example, if foreign investors that have sold their gilts and then want to switch their funds into one of the two global reserve currencies, the dollar and the euro. All of this suggests that the Bank of England may well yet be forced back to the drawing board and may have to consider even more radical measures in order to stimulate nominal spending. Quantitative easing is easier said than done."
More radical measures might require the Government to inject more cash directly into the hands of consumers, and find ways of bypassing the banking system altogether as it becomes more desperate to get the economy moving and avoid the sort of deflation that floored the US and the UK in the 1930s and Japan in the 1990s.
Vince Cable, the Liberal Democrats' Treasury spokesman, warned: "This may be another failed and ineffective initiative, especially when set against the size of the economy. It might be better if the Government used its shareholding in the nationalised banks to get the banks to start lending."