retailworld
13-01-2009, 14:45
The Bank of England cut interest rates to the lowest level ever seen last week. Up until now, in its 315-year history, the Bank's key rate had never been below 2%. Now it sits at 1.5%.
The Bank is slashing rates because it wants to get money moving around the economy again. And rates are already sitting at between 0% and 0.25% in the US. But there's a slight hitch - it's not working as well as the authorities had hoped. Banks aren't lending, people aren't spending and we're being threatened with deflation, which can - if it lasts - prices keep falling, companies make less money and more people are laid off.
This raises a big question. What can you do when interest rates hit 0%? The answer, which the government is apparently considering, and the US Federal Reserve is already doing, is quantitative easing. Or, more simply, printing money.
"Isn't printing money what they did in Weimar Germany? Does this mean we should invest in wheelbarrows?" asked a friend the other day, after seeing the headlines. I wouldn't invest in wheelbarrows just yet - quantitative easing is done electronically. But to all intents and purposes, it amounts to the same thing, and has the same aim - to increase the amount of money getting into circulation, get banks lending again and ultimately get people and businesses spending again.
So how do they do it?
Fundamentally, the authorities flood the system with money, in the hope that banks will start to lend some of it out. Tracy Alloway on the FT's Alphaville blog put it very well: "It's kind of like forcing a three year old to share by showering him with more sweets than he could possibly eat by himself."
One key way in which the central bank does this, is by buying assets - usually government bonds, mortgage-backed securities, or other financial instruments - from the banks. The banks then have more money available to lend. Or they buy them in the open market, which drives down the returns on these assets, which makes it cheaper for companies and the government to borrow money.
So where does the money to buy these assets come from in the first place? Well, that's where you get the "printing money" aspect. The central bank just creates it out of nowhere.
Will it work?
That's the $64 trillion question (billions don't seem to cut it these days). Obviously there are plenty of examples where actual money printing (Zimbabwe and Weimar Germany) has gone hideously wrong.
But quantitative easing hasn't always resulted in hyperinflation. The biggest experiment with this policy was in Japan between 2001 and 2006, when the country was battling to escape deflation.
No one is sure whether it worked or not - the problem with interventions is that you can't know what would have happened if you'd left well enough alone. Certainly Japan is still battling with deflation and has slipped into recession along with the rest of the world - but many commentators suspect deflation and the state of Japan's banks, could have worsened without it.
So why should it work this time?
If by "work", you mean "encourage inflation", then there are a number of reasons why it's potentially different this time. For a start, as James Montier at Societe Generale recently pointed out, Japan didn't adopt quantitative easing until about seven years after its first brush with deflation. The US Federal Reserve (and potentially our own government) has rushed to the printing presses before inflation got anywhere near zero.
The Fed has also intervened in different ways. It is buying mortgage-related debt from banks specifically to bring mortgage rates down and may also buy government bonds directly (which would effectively be the government writing a cheque for itself to spend on the massive economic stimulus package that Barack Obama has planned - which really is money from nowhere).
But should we do it?
It's telling that the main advocates of quantitative easing - Fed chief Ben Bernanke is a classic example - are those who believe there was nothing wrong with the path we've been following for the past decade or more.
Those people believe, or at least profess to believe, that all of this - the housing implosion, the collapse in commodity prices, the subprime scandal - was a shock. But it was the inevitable, and fairly obvious, result of relying on debt as a driver of growth for too long.
A recession is nature's way of telling you that your economy is headed the wrong way. You've made too many of the wrong investments and now it's time to clear those investments away and replace them with more productive ones.
There's no reason for banks - even if they had the money - to want to lend to most businesses at a time when we're in recession. People talk about wanting to free up mortgage lending, but looking at history, house prices have a lot further to fall yet. Buying a house right now would be a bad investment - so why should banks be keen to lend against them?
The point of dropping interest rates and printing more money is to encourage banks to lend more and people to spend more. That's not what's needed just now.
The British public as a whole need to pay off their debts and build up their savings, the economic model we've been following was not sustainable. The longer we put off rebalancing that, the harder it will get to wean ourselves off artificial stimulus.
For example, you could make the argument that one of the reasons that Japan has been in the doldrums for so long is precisely because the government has been propping up the economy for so long that it can't do without constant stimulus packages to keep it going.
The other problem, of course, is that governments become far more involved in monetary policy - forget bank independence. If quantitative easing works to boost inflation, car sales, house prices and the rest, how are we supposed to trust politicians to "take their feet off the accelerator" as it were?
The threat is that if there's no concrete plan for taking away the extra stimulus, then foreign investors will lose faith in the currency, which could lead to hyperinflation, not to mention an even worse slump.
Printing money safely - if there is such a thing - requires a government that you can trust to act responsibly with the nation's finances. Judging by the way that both Barack Obama and possibly Gordon Brown are embracing the notion that you can spend your way out of recession, there's little chance of that.
John Stepek is the editor of MoneyWeek (http://www.moneyweek.com/)
The Bank is slashing rates because it wants to get money moving around the economy again. And rates are already sitting at between 0% and 0.25% in the US. But there's a slight hitch - it's not working as well as the authorities had hoped. Banks aren't lending, people aren't spending and we're being threatened with deflation, which can - if it lasts - prices keep falling, companies make less money and more people are laid off.
This raises a big question. What can you do when interest rates hit 0%? The answer, which the government is apparently considering, and the US Federal Reserve is already doing, is quantitative easing. Or, more simply, printing money.
"Isn't printing money what they did in Weimar Germany? Does this mean we should invest in wheelbarrows?" asked a friend the other day, after seeing the headlines. I wouldn't invest in wheelbarrows just yet - quantitative easing is done electronically. But to all intents and purposes, it amounts to the same thing, and has the same aim - to increase the amount of money getting into circulation, get banks lending again and ultimately get people and businesses spending again.
So how do they do it?
Fundamentally, the authorities flood the system with money, in the hope that banks will start to lend some of it out. Tracy Alloway on the FT's Alphaville blog put it very well: "It's kind of like forcing a three year old to share by showering him with more sweets than he could possibly eat by himself."
One key way in which the central bank does this, is by buying assets - usually government bonds, mortgage-backed securities, or other financial instruments - from the banks. The banks then have more money available to lend. Or they buy them in the open market, which drives down the returns on these assets, which makes it cheaper for companies and the government to borrow money.
So where does the money to buy these assets come from in the first place? Well, that's where you get the "printing money" aspect. The central bank just creates it out of nowhere.
Will it work?
That's the $64 trillion question (billions don't seem to cut it these days). Obviously there are plenty of examples where actual money printing (Zimbabwe and Weimar Germany) has gone hideously wrong.
But quantitative easing hasn't always resulted in hyperinflation. The biggest experiment with this policy was in Japan between 2001 and 2006, when the country was battling to escape deflation.
No one is sure whether it worked or not - the problem with interventions is that you can't know what would have happened if you'd left well enough alone. Certainly Japan is still battling with deflation and has slipped into recession along with the rest of the world - but many commentators suspect deflation and the state of Japan's banks, could have worsened without it.
So why should it work this time?
If by "work", you mean "encourage inflation", then there are a number of reasons why it's potentially different this time. For a start, as James Montier at Societe Generale recently pointed out, Japan didn't adopt quantitative easing until about seven years after its first brush with deflation. The US Federal Reserve (and potentially our own government) has rushed to the printing presses before inflation got anywhere near zero.
The Fed has also intervened in different ways. It is buying mortgage-related debt from banks specifically to bring mortgage rates down and may also buy government bonds directly (which would effectively be the government writing a cheque for itself to spend on the massive economic stimulus package that Barack Obama has planned - which really is money from nowhere).
But should we do it?
It's telling that the main advocates of quantitative easing - Fed chief Ben Bernanke is a classic example - are those who believe there was nothing wrong with the path we've been following for the past decade or more.
Those people believe, or at least profess to believe, that all of this - the housing implosion, the collapse in commodity prices, the subprime scandal - was a shock. But it was the inevitable, and fairly obvious, result of relying on debt as a driver of growth for too long.
A recession is nature's way of telling you that your economy is headed the wrong way. You've made too many of the wrong investments and now it's time to clear those investments away and replace them with more productive ones.
There's no reason for banks - even if they had the money - to want to lend to most businesses at a time when we're in recession. People talk about wanting to free up mortgage lending, but looking at history, house prices have a lot further to fall yet. Buying a house right now would be a bad investment - so why should banks be keen to lend against them?
The point of dropping interest rates and printing more money is to encourage banks to lend more and people to spend more. That's not what's needed just now.
The British public as a whole need to pay off their debts and build up their savings, the economic model we've been following was not sustainable. The longer we put off rebalancing that, the harder it will get to wean ourselves off artificial stimulus.
For example, you could make the argument that one of the reasons that Japan has been in the doldrums for so long is precisely because the government has been propping up the economy for so long that it can't do without constant stimulus packages to keep it going.
The other problem, of course, is that governments become far more involved in monetary policy - forget bank independence. If quantitative easing works to boost inflation, car sales, house prices and the rest, how are we supposed to trust politicians to "take their feet off the accelerator" as it were?
The threat is that if there's no concrete plan for taking away the extra stimulus, then foreign investors will lose faith in the currency, which could lead to hyperinflation, not to mention an even worse slump.
Printing money safely - if there is such a thing - requires a government that you can trust to act responsibly with the nation's finances. Judging by the way that both Barack Obama and possibly Gordon Brown are embracing the notion that you can spend your way out of recession, there's little chance of that.
John Stepek is the editor of MoneyWeek (http://www.moneyweek.com/)