Britannia Radio

TELEGRAPH    4.12.08
Bank has little option but to ready the printing presses
At times like this - with central banks dropping interest rates to 
unprecedented levels - it is tempting to say the textbooks are being 
dusted down for a hint about what to do next.

By Edmund Conway, Economics Editor

But the truth is that there are no textbooks for this kind of 
situation. The Bank of England has never before cut interest rates 
below 2pc, but this is precisely what it now looks set to do. The 
Federal Reserve likewise is poised to slash borrowing costs towards 
zero, while the European Central Bank has finally joined the rate cut 
bandwagon, slashing borrowing costs by 75 basis points.

The world's great central banks are in uncharted territory. Although 
Japan experienced deflation - and zero interest rates - in the early 
1990s, it failed dismally in its attempts to drag itself out. There 
is no textbook way of preventing debt deflation taking hold, but in a 
zero interest rate scenario there are three avenues a central bank 
can take:

1. Use speeches and statements to indicate that interest rates will 
stay at zero or thereabouts for an extended period of time.
2. Buy assets, whether this be government debt, corporate bonds or 
things like houses and mortgage backed securities.
3. Expand the central bank's balance sheet aggressively, another way 
of injecting money into the economy.

Options two and three both amount to what is known as "quantitative 
easing" - printing money, getting it into peoples' hands and ensuring 
that they go out and spend it. It is an attempt to control and target 
the volume of money flowing around the system rather than its price, 
and would mark a major step change in central banks' operations.

According to Professor Peter Spencer of the University of York, the 
best way to do so in the UK is what is known as "under-funding" the 
fiscal deficit. The Treasury has to raise billions of pounds worth of 
cash next year. In normal times it would raise this all by issuing 
government debt. However, if it raises some of the cash merely by 
getting the Bank to print it and not "sterilising" this by issuing 
gilts, it is, in effect, injecting extra cash into the banking system 
and high street.

"When credit is being rationed the interest rate is meaningless," he 
said. "At the moment we have a fiscal policy which leads to the issue 
of huge numbers of gilts, which people are prepared to hold. If the 
government started to under-fund, we would all find ourselves tending 
to hold money rather than gilts - and money burns a holes in peoples' 
pockets."

This may have to happen alongside direct purchases of troubled assets 
or even property. Either way, the Bank's indication today that it 
would need to consider "further measures" to kick-start bank lending 
underlines the fact that it is now considering radical new measures.

In doing so they are only following the lead of the Federal Reserve 
chairman Ben Bernanke. He has now gone some way toward carrying out 
plans two and three, by both buying securities and expanding the 
Fed's balance sheet. However, this should hardly come as a surprise. 
In 2002, as a Fed Governor, Mr Bernanke insisted that "a central bank 
whose accustomed policy rate has been forced down to zero has more 
definitely not run out of ammunition."

His "unconventional" options included buying up government bonds and 
handing out loans to banks at low or zero interest rates, and if all 
else fails, he added: "The US government has a technology, called a 
printing press."
It may soon prove the time to use it, on both sides of the Atlantic.
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TELEGRAPH   4.12.08
1930s beggar-thy-neighbour fears as China devalues
China has begun to devalue the yuan for the first time in over a 
decade, raising fears that it will set off a 1930s-style race to the 
bottom and tip the global economy into an even deeper slump.

By Ambrose Evans-Pritchard, International Business Editor

The central bank has shifted the central peg of its dollar band twice 
this week in a calculated move that suggests Beijing aims to offset 
the precipitous slide in Chinese manufacturing by trying to gain 
further export share abroad.

The futures markets are pricing in a 6pc devaluation over the next 
year. "This is clearly a big shift in policy and we are now on 
alert," said Simon Derrick, currency chief at the Bank of New York 
Mellon.

The move follows a Politburo speech by President Hu Jintao warning 
that China is "losing competitive edge in the world market".

China has allowed a crawling 20pc revaluation over the past three 
years. Any reversal risks setting off conflict with the incoming team 
of President-Elect Barack Obama in Washington. Mr Obama called China 
a "currency manipulator" during the campaign, a term that carries 
penalties under US trade law.

Outgoing US Treasury Secretary Hank Paulson is viewed as a "friend of 
China". He called for a stronger yuan this week before embarking on a 
visit to Beijing, but the plea was couched in friendly terms. This 
soft-peddling may soon change.

Hans Redeker, currency head at BNP Paribas, said China's policy 
switch could set off a dangerous chain of events. "If they play this 
beggar-thy-neighbour game, it will cause a deflationary shock for the 
whole world," he said.

It makes sense for countries with current account deficits such as 
the UK, US or Turkey to let their currencies fall, but China has the 
world's biggest trade surplus.

Michael Pettis, a professor at Beijing University, said it was "very 
worrying" that a pro-devalulation bloc seemed to be gaining the upper 
hand in the Communist Party. "I really do believe that we are on the 
brink of a very ugly period for trade relations," he said.

China has relied on exports to North America and Europe as its growth 
engine, making it acutely vulnerable to the contraction in global 
demand. Mr Pettis said this recalls the role played by the US in the 
1920s, a parallel fraught with danger. "In the 1930s the US foolishly 
tried to dump capacity abroad, but the furious reaction of trading 
partners caused the strategy to misfire. China already seems to be in 
the process of engineering its own Smoot-Hawley," he said, referring 
to the infamous US Tariff Act in 1930.
China showed restraint during the Asian crisis in 1998, holding the 
line against domino devaluations across the region. It may yet hold 
the line this time.

However, this crisis is more serious. The manufacturing sector has 
seen the steepest decline since the records began, with devastation 
sweeping the textile, furniture and toy sectors. Civil unrest has 
begun to rock the Guangdong and Longnan regions.

Beijing has slashed rates and unveiled a fiscal stimulus of 14pc of 
GDP, but most of the spending comes in the form of instructions to 
local governments to spend more - but without giving them the money. 
Does China really intend to step in to prop up global demand? The 
jury is out.