Wednesday, September 16, 2009

When will the Money Printing Stop?

Having already posted today, this is more of a note than a full post. I have noted recently that the UK inflation figures yet again defied Bank of England expectations of deflation. Whilst their recent inflation report was full of caveats on inflation vs. deflation, the original justification for quantitative easing (QE-Money Printing) was a deflation scare. As I have pointed out in many posts, the target inflation rate has barely been missed throughout the entire period of QE, and the predictions of deflation have never come to pass. The requirement for the Bank of England to write a letter of explanation to the chancellor is if the Bank of England misses the inflation target by 1%.

Yet again, inflation is still sitting stubbornly close to the target, such that no letter is required. This from the Telegraph:
The Consumer Prices Index (CPI), which is the Government's preferred measure of inflation, dropped to 1.6pc from 1.8pc in July - the lowest level since January 2005 according to data from the Office for National Statistics (ONS). It was the third month in a row that CPI was below the 2pc target.
As it is, the main cause of the fall in the rate of inflation is lower gas and electricity prices, which have fallen by considerable amounts. If we turn our minds back, it is apparent that the high prices with which these price falls are compared were extremely high prices resultant from the spike in prices of oil, which I predicted would fall back.

It is also noteworthy that the reason for continuing inflation is the higher prices of imports, which was my suggested reason for continued inflation when considering inflation versus deflation. The weakness of the £GB was always going to have a counterveiling impact to the shrinking of the economy. This point is of particular note for the US, now that the $US is sliding. In the case of the UK, I pointed out that currency weakness would take a while to show up in import inflation, as prices and contracts will take a while to adjust (e.g. when a contract is signed, it takes often takes a long while before the contracted goods are actually delivered at the pre-inflation price). The same will apply for the US, with time lags in inflationary pressures.

Returning to QE, it is interesting to see that the media have been distracted from the original purpose of QE, now that the predicted deflation has not taken place. This is from the FT:

Although six months is a comparatively short time to judge QE, Mr King can already point to some signs of success, but these are balanced against other more negative indicators.

On the positive side, government and corporate bond yields have fallen, boosting company borrowing in the capital markets. Indeed, sterling corporate bond issuance has surged to an annual record, with three months still remaining of the year.

Ten-year gilt yields are only 3 basis points lower, at 3.61 per cent, than the day before QE - but Charles Bean, the Bank's deputy governor, insists that they would have been 50bp higher without QE.

Investment grade sterling bond yields are 2 percentage points lower, at 6 per cent, than in early March, although euro-denominated corporate bond yields have fallen just as sharply with the help of the European Central Bank's injections of liquidity into the money markets.

QE has also boosted the equity markets, although it is difficult to quantify how much money investors have switched into shares from their gilt sales. The FTSE 100 has risen 38 per cent since the launch of QE, but a lot of the gains were due to an improving world economy and resilient corporate profits.

Like so many commentators, the deflation scare that was the justification for QE is quietly being forgotten. It is not clear why the memory of so many journalists and commentators are so short. With the notable exception of Liam Halligan in the Telegraph, it seems that the origins of QE are of no importance.

Throughout the policy of QE the Bank of England has sought to generate confusion over the role of deflation and inflation as their justification for QE. This is an excerpt from a previous post, where I highlight the kind of methods being used:
If we remember, the bank targets CPI, not RPI. However, in the Bank of England inflation report from February, it might be noted that the RPI is discussed in the report, even though the CPI is the target for inflation. You will note how the measures are blurred in this passage.
Deflation is sometimes used to describe any fall in the general level of prices (as measured in the United Kingdom by the CPI, RPI or the GDP deflator), however short-lived. A more economically significant phenomenon, however, would be a sustained period of negative inflation.

The RPI is likely to fall temporarily over the coming months (Section 4.1). This period of negative retail price inflation would be unusual (Chart A) and predominantly reflects the much lower contribution from mortgage interest payments, following the recent large falls in Bank Rate. The MPC’s central projection is for its target measure, annual CPI inflation, to remain above zero throughout the forecast horizon. (p33)
Whilst there is no direct statement of targeting of RPI, the way in which the whole passage is put is somewhat grey. The same section of the report then goes on to warn of the dangers of appears that the Bank of England is subtly conflating the two measures, and they even use a chart which is designated as the 'ONS composite index'. (p33) One of the interesting points is that an argument for printing money directly follows this discussion of RPI and deflation:
Periods of low inflation, associated with weak demand, may limit a central bank’s ability to use conventional monetary policy to stabilise the economy. But if reductions in official interest rates do not prove sufficient to meet the inflation target, policymakers still have other options available to them to stimulate the economy, if necessary (see the box on pages 44–45 in this Report). (p33)
In a previous post, I have explained exactly why there is no element of QE that might justify the policy. This is beyond either a summary or quote, so I would recommend those that have not already read the post, to read it now.

Yet again, despite no indication of serious deflation, there is no indications of any halt to quantitative easing. Why is this? More to the point, why is it that so many in the media are sitting back and watching the monetization of government debt continue with so little concern? At this point, the press should be filled with outrage. Instead, they appear to accept this policy as if it were perfectly normal. Have they not noticed that the policy justification has failed to materialise?

Exactly how or when QE might stop, and under what circumstances, continues to be opaque. It seems that nobody seems willing to give the answers, and the press does not appear to be concerned. In the interim, the government continues to spend money still wet from the printing say that this is a bad situation is an understatement.....


  1. Instead, they appear to accept this policy as if it were perfectly normal. Have they not noticed that the policy justification has failed to materialise?

    The point has been made before that the reason why there is no catastrophic deflation is actually because of the QE and government intervention in the economy.

    From any impartial point of view, the failure of deflation to appear could possibly be proof of the success of QE.

    Steve Keen discusses the latest economic data on Debt Watch:.

    There is no doubt that the immense government stimulus packages across the world have slowed the rush into Depression. But the force that caused the crisis in the first place—excessive private debt accumulated in a Ponzi Scheme laundered through share and house-price bubbles—is still with us. Until that debt is addressed, the downward rush of deleveraging is likely to resume as soon as governments wind back their spending in the false hope that the crisis is over.
    I’ll finish with an extract from what has become one of my favourite daily reads—the “News from 1930” blog. On Thursday September 4th 1930, the Wall Street Journal reported that the Harvard Economic Society said there is “every prospect that the [business] recovery … will not long be delayed.”

  2. By the way, your SDRs post was very interesting. It's a pity you didn't keep it up for long! That subject needs debate...

  3. I too wonder like Lord Keynes if the QE is causing this "stability" we see. The money that is generated has to go somewhere, and I do not think they would let it go just anywhere as they would lack controls.

    Could they be targeting things in the CPI basket etc that are easy to inflate so as to keep up appearances in the figures? or could some other thing lead to similar effects?

    The questions that have to be asked if there is a targeting of various things via QE, besides exactly what and how much, are; are they targeting the right things to keep the economy going; what side effects could there be of those particular items being inflated; and is concentrating the money lead to other areas being neglected and if so what are the side effects of that?

    As I pointed out in a comment in your China post, the US is experiencing debt deflation.

    Is this because the QE is being pointed in the wrong areas, because it hasn't touched the root causes, or because of unique circumstances that are not applicable to the UK?

    I think it is quite correct that the threat of deflation is being used as an excuse to print money, but just because they are overstating the case in various ways to justify the QE, it doesn't mean there couldn't be deflation happening. That the government figures and words could be shown to be misleading doesn't mean they are necessarily wrong, just that they are very worried about it and the effect on confidence on the prospect of deflation. They have a natural instinct to try to keep it quiet if it may not be good news, this is just one example among many with this government in particular.

    I think that the extra money is muddying the waters about exactly how the economy is really performing, do I appreciate this update and the analysis, I just wonder if the QE is being used in a way that would make certain figures themselves not tell the whole story.

  4. Lord Keynes & Lefty Feep:

    With regards to QE preventing deflation and creating stability, even the BoE does not claim any success, and by their own formulation the effect would not be seen for 6 months.

    The difference between the US and UK is that, up to recently, the $US has not seen a substantial devaluation. As I mention in my post, now that the $US is really sliding, inflation will (with a time lag) start to climb in the US.

    Where is the money? Sitting in reserves, ready to be unleashed on the market as soon as any confidence returns.

    A short answer, but I hope that it answers the question.

  5. On Zero Hedge they asked the Fed for some clarification on QE:

    The answer was less than clear, but I was curious as to your thoughts on the chart. Are there any arguments why all of those programs that impact reserves should not be included under the heading of QE? If the Fed purchases any security with freshly printed bills, is that not QE? If they simply exchanged one asset for another no new money is created and hence no QE. Not sure if I have this correct or not...

  6. The question I asked about the difference between US and UK was why the US QE is not stopping the deflation, and I'm not sure what the declining value of the dollar has to with that precisely, so you will have to expand that a little or post a link because I haven't quite figured out the link between a sliding dollar and deflation, which is in wages credit and rents as stated in the link. That inflation will go up eventually as it slides I agree.

    The questions I asked are asking the question of whether what the BoE is doing exactly what it says it is doing with the QE or is it using it already to boost stocks and other things in ways that could interfere with the figures.

    Pure speculation I know but can you see exactly where the money is going, and not have to rely on the BoE's word that it works the way it says it works? I do realise there are a lot of different reasons the markets could have gone the way they have without government manipulation, but I was interested to see if you could provide an answer that could show if it was or not.

  7. There is an excellent new post at Steve Keen's Debt Watch:

  8. I tried to post this earlier, apologies if it's doubled up - this may be helpful:-

  9. I am currently using your fundamental understanding of this crisis to do a slightly more shallow but focused pounding of property writers who spout out optimistic vested interest nonsense. Your blog has an entire network spread of impacts. Thanks :)


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