Britannia Radio

Thank heavens that the Telegraph has a business news section.  For   
the main section,  once it has dealt with the Real IRA attack,  
resumes its attempt to ape the tabloid press, relegating the  
continuing and mounting crisis to its ghetto , the business section  
where an army of highly respected economists holds sway1

Today I start with A.E-P’s  look at the eurozone where the ECFB  
coming later to the recession than the rest of us is playing catch-up  
unsuccessfully.   A.E-P is one of those economists who favours QE on  
the grounds that high level of indebtedness and deflation are the  
greatest threat.

  Others disagree and think that deflation is shortly due to give way  
to uncontrollable inflation,  which is worse. Personally I agree with  
both and think that the crucial question is whether the Bank of  
England is capable of judging the tipping moment when deflation  
ends.  With the time lag inherent in any measures taken getting this  
right is unlikely.  Therefore I think that the half-tranche of QE is  
more than enough.

Roger Bootle in his fairly technical piece shows little confidence  
that the Bank can get that judgement right.  But he also says that if  
the first tranche doesn’t work, the second will be deployed and the  
third and subsequent debasing of the currency will follow.  Move over  
Mugabe.

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  TELEGRAPH            9.3.09
1. Thanks to the Bank it's a crisis; in the eurozone it's a total  
catastrophe

    By Ambrose Evans-Pritchard

The Bank of England may have averted a catastrophe. If ever there was  
a time when this country needed its own monetary authorities – acting  
with wartime urgency – this is the moment.

Those nations with fossilised or timid central banks clinging to  
outdated ideologies are not so lucky. Even less lucky are those such  
as Spain and Ireland that have surrendered policy to a body that is  
deaf to their pleas and constitutionally obliged to ignore the  
welfare of their particular societies.

They face crucifixion.

Spain's agony is already well advanced. Industrial output has fallen  
24pc. Some 352,000 people have lost their jobs in two months. BBVA  
expects unemployment to reach 20pc next year, touching 4.5m. Premier  
Jose Luis Zapatero can do nothing as long as Spain remains in  
monetary union.
He cannot devalue to claw back 30pc in lost labour competitiveness  
against EMU's German bloc, or take emergency steps to slow the  
property crash. In an odd lapse last week – perhaps a slip – he  
advised Spaniards that the best thing to do in these dark times was  
to ****.

Yes, it is dangerous for the Bank of England to buy up a third of all  
long-dated gilts. But it would be even more dangerous to allow  
deflation to run its course in an economy where debt levels have  
reached such extremes. Debt and deflation are a deadly mix.

The errors that led to our current predicament are well-known. A  
small army of economists – Austrians [eh?-cs] , Monetarists, and  
Keynesians – warned that central banks were playing with fire by  
fixing the price of credit too low and ignoring asset bubbles. The  
$6.7 trillion in reserve accumulation by China, Japan, and the petro- 
powers drove bond yields too low for safety.
Credit signals were gravely distorted.

In Britain, Gordon Brown poured petrol on the fire by pushing the  
fiscal deficit to 3pc of GDP at the top of the cycle. Wretched man.  
However much we rage at Sir Fred or Citi-wrecker Chuck Prince, let us  
not forget that this crisis was confected by governments. To blame  
the free market is to miss the bigger point.

But I digress. We are now faced with the post-debt wreckage. The task  
at hand is to hold our societies together as best we can. One dreads  
to think what would have happened if the Hoover-Brüning nostalgics  
had succeeded in blocking every remedy.

As it is we have seen industrial production collapse in every region.  
The drops in January were: Japan (-31pc), Korea (-26pc), Russia  
(-16pc), Brazil (-15pc), Italy (-14pc), Germany (-12pc). Falls that  
took two years from late 1929 have been compressed into five months.

Those who say this is nothing like the Great Depression are  
complacent. Household debt is higher today, and UK banks are in worse  
shape. (No bank of size failed in the British Empire during the  
slump). Britain's economy contracted by 5.6pc from peak to trough in  
the early 1930s (Eichengreen). Some put the figure at nearer 8pc. We  
may surpass that this time.

America suffered worse. Real GDP fell 28pc. But the worst occurred in  
the second leg, after the heinous policy blunders of late 1931.  
Reading contemporary accounts, it is clear that hardly anybody – not  
even Keynes or Fisher – realised that the world was slipping into a  
depression during the first 18 months.

Nobel laureate Paul Krugman says the Fed has been as far behind the  
curve today as it was then, given the faster pace of collapse. It is  
bizarre that Ben Bernanke has not started to buy US Treasuries a full  
three months after he floated the idea, despite a yield rise of 80  
basis points.

He has been stymied by the hawks. Kansas chief Thomas Hoenig said  
last week that the top priority is to drain liquidity before recovery  
later this year sets off inflation. Well, Mr Hoenig said last May  
that inflation psychology was gaining a hold "not seen since the  
1970s and early 1980s" with a risk that inflation would become  
"embedded in the economy." The price spike broke within weeks. If his  
model was wrong then, why is it right now?

As for the ECB, it has not reached the starting line. Jean-Claude  
Trichet insists that there is no danger of deflation in Europe. What  
is the weather like on his planet, asked Mr Krugman.

The ECB has cut rates to 1.5pc, but since they need to be minus 1pc  
on the Taylor Rule, this leaves the breach as wide as ever. The  
Bundesbank is blocking any serious move towards quantitative easing.

Given that Germany's economy is imploding (Deutsche Bank sees 5pc  
contraction this year) one wonders if the Bundesbank would be less  
hawkish if the D-mark still existed. Even their hard-money brothers  
at Switzerland's SNB are cash printers these days.

So has monetary policy in euroland been paralysed by squabbles at a  
calamitous moment, blighting every member state? Almost certainly.

I'll take the Old Lady of Threadneedle Street any day, warts and all.
=================
2. Bank must react quickly to avoid the pitfalls in quantitative easing
         
    By Roger Bootle

The amounts of money that the Bank of England is going to inject into  
the economy in its programme of Quantitative Easing (QE) are huge –  
£75bn at first and up to £150bn in total. Once the Bank has completed  
this, it will have expanded its balance sheet by about 80pc. Will  
this be enough?

This policy has already caused gilt yields to drop sharply. So far so  
good. But if QE is going to significantly increase demand for goods  
and services in the economy it will have to achieve more than this.  
What would mark a success would be if the banks used the extra  
liquidity to fund increased lending. But in current conditions that  
is unlikely. The banks are more likely to sit on extra cash, as they  
did in Japan.

But that isn't the end of the story. By concentrating its purchases  
at the medium and long end of the market, the Bank will be buying the  
gilts largely from the investing institutions, rather than the banks,  
which hold mainly shorter dated stock. This means that there should  
be a boost to the broad money supply, as well as an increase in  
banks' liquidity. Suppose the Bank buys gilts from the Prudential,  
which banks with, say, HSBC. The Bank will credit HSBC's account at  
the Bank and HSBC will credit the Prudential's account with HSBC.

So private sector bank deposits, which form the bulk of the broad  
money supply, will have gone up.

If HSBC decides to use the extra cash to buy assets in the markets  
then there will be a further increase in the broad money supply, and  
since this will do nothing to reduce the stock of central bank money  
in the system, the same thing can happen again, and again, as the  
money is moved around the system, in a way which is familiar to  
students of basic economics. In this way the eventual increase in the  
money supply may be a multiple of the original injection of central  
bank money. But this isn't necessary to get a boost from the policy.  
All that is necessary is that the system should react to the original  
increase in the broad money supply.

But why should it? According to the theory, the Prudential will feel  
uncomfortable with its extra money holdings and will want to use them  
to buy assets. In doing so, it will bid up asset prices and this will  
encourage extra spending on goods and services.

For all the monetarist mumbo-jumbo, this process is anything but  
mechanistic. There are three stages in it where expectations and  
state of mind are critical. First, the Prudential has to want to use  
the money, rather than simply hang on to it. Second, even if it does  
decide to buy assets, the next stage is the reaction of asset prices.  
With the world on the brink of a proto-depression and a flood of bad  
news engulfing us daily, extra purchases of assets might encounter  
ready sellers, so that asset prices did not rise.

And thirdly, even if asset prices did rise, would consumers respond  
by spending more because they feel wealthier, and/or would companies  
invest more in real assets because the financial terms were more  
attractive? Not necessarily.

When you look at fiscal and monetary policy, where the extra money  
holdings should end up is with those people who are the beneficiaries  
of the Government's deficit – taxpayers, benefit recipients,  
companies which pay tax and companies which work for the Government.  
Normally, we could be expected to respond by increasing our spending.

But these are not ordinary conditions. The Government's deficit is  
spiralling up because the economy is spiralling down. In other words,  
the extra money we are left with by the Government through the VAT  
cut, or because companies are paying less tax, is readily swallowed  
up by the other influences on our affairs.

Accordingly, it is not inevitable that our money holdings will rise  
in this process. So how is the Bank to judge whether or not the  
policy of QE is working? The first sign of success will be an  
increase in the broad money supply. If that doesn't happen, we  
haven't even got to first base.

But then what? If the broad money supply channel is working then you  
should expect to see asset prices rising. If the extra supply of  
liquidity is working then you should expect to see bank lending  
rising. If, after the three months which the Bank has set itself to  
complete its purchase of gilts, asset prices and lending are no  
higher, then the policy will not have worked and will not be going to  
work. So the Bank would have to increase the dose.

The policy will work eventually, simply because there is no limit to  
the amount of its own money that a central bank can create. At the  
moment the psychology and expectations of the major actors in the  
system are acting against the thrust of the Bank's actions.

When they turn, the Bank's policies will be effective. And then the  
Bank will have to shift pretty swiftly into reverse. There is  
enormous scope for making a mistake – in both directions.
==============================
SHORT REPORTS
Telegraph
Tories could ask Bank of England to take over bank regulation from FSA
The Financial Services Authority, the City watchdog that failed to  
avert the credit crunch, could be scrapped under a Conservative  
Government.
The Tories will this week publish a review of financial regulation  
that raises the possibility of abolishing the FSA and returning  
banking oversight powers to the Bank of England
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Overvalued euro set to plunge 'within months'
Spread betting companies have reported a huge wave of short euro  
trades in the last two weeks, leading to speculation that a  
significant correction in the currency will come in the next few months
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Restoring higher VAT rate will cause havoc, warn retailers
Industry body cites Christmas trading fears.
The British Retail Consortium, the retail industry trade body, has  
called on the Government to delay the VAT increase scheduled for  
December 31, arguing that it will cause havoc with store groups'  
Christmas trading.
VAT is due to go back up to 17.5pc at the end of the year after it  
was reduced to 15pc last November in a largely unsuccessful attempt  
to boost consumer spending.
However the BRC has said that Chancellor Alistair Darling has chosen  
"the worst possible time of year" to reverse the cut. The body  
estimates that it will cost retailers around £90m to reintroduce the  
17.5pc rate.