Monday, February 16, 2009

It's Official - The UK Government is Now Bankrupt

You would think that news that the UK government is bankrupt would be headline news around the world. When I quote the piece of news that announces the bankruptcy, you may say 'huh?', and like the newspapers, initially find it difficult to see it. I will start with the news itself, which was tucked away in the financial section of the Telegraph:

'Charlie Bean [the Bank of England Deputy Governor] put his weight behind the pound's 25pc fall over the past year in an unusual comment on the pound. Mr Bean also confirmed that the Bank is poised to start buying government bonds in a drastic attempt to resuscitate the stricken economy.'
If we translate this, it means is that the Bank of England is going to print money to directly finance the operations of the UK government. This is the action of a government that is now literally bankrupt. The bank is not going to buy the bonds to 'resuscitate the stricken economy' but will buy them because nobody else wants to buy UK government bonds. There are not enough people willing to lend to the UK government. It is bust. It is bankrupt.

The UK government can not fund itself without borrowing - it can not service its existing debt without borrowing, and it can not pay for its activities without borrowing. When the lending stops, it goes bust. Or it prints money.

You will have read lots of stories that 'quantitative easing' (printing money) is being undertaken to fight deflation, but it is not. It is the last desperate gamble of governments to save themselves and their collapsing economies. For those that believe that printing money and lending it to the government is about fighting deflation, read on....

In July of last year, I posted that I believed that the UK government was effectively bankrupt, and that this would reveal itself as the coming crisis progressed. Ever since that early post, I have watched in horror as the UK government has poured ever more money into ever more and ever larger bailouts. In July of 2008 I had this to say:

One certainty is that, in a years time, the UK banking system will still be in crisis, as will be government finance. Unemployment will still be climbing, consumer confidence will be rock bottom, and house prices still falling. Businesses will be closing down in large numbers. All of these events were put in place over the last few years, and can not be reversed.

I identified that the first bailouts would be followed by even greater bailouts, and that the banking crisis would simply be transferred onto the government. As just one example, I asked the following at the start of September:

The reality is that the UK has been bailing out the banks for some while, through the special liquidity schemes. How long can this go on?
This was before even more money was poured into the bailouts. I then went on to say in the same post:
In the case of the UK, I wonder whether the UK government will have the financial wherewithal to actually have a choice in the matter. When the next credit crisis strikes, I expect confidence in the UK economy to be at a very, very low point, and the only way the government will be able to finance the bail outs will be through 'printing' money, with all of the negative consequences that entails.
As a sense of perspective, this was written at the time of the bailout of Fannie Mae and Freddie Mac in the US (I have added the italics in this quote). The situation that I predicted at that point in time is exactly the situation that is now confronting the UK.

In recent months I have also been pointing out the impossibility of continued government borrowing. In particular, just about every country in the OECD is going on a massive borrowing binge, and all at the same time. My question is very simple - how are all of these governments going to simultaneously raise the money to finance their borrowing? The US alone is looking to raise $US trillions. In such circumstances, potential lenders will have a huge range of choice on where they put their money, and they will look to put their money where they believe it will be safe.

As we are all aware, the £GB has been plunging in value, the UK is seen by many as the economy that will be hit hardest by the economic crisis, and (even before this article) was discussing the option of printing money. Amongst all of the choices of which country to lend to, the UK is going to towards the bottom of the list. At the same time, due to the lunatic and endless bailouts, government borrowing is spiralling ever higher. At a time when there is intense competition between countries for finance, with an ever growing need for ever more borrowing, it is inevitable that the UK government would be unable to continue to borrow enough money.

As a result, the printing presses are about to turn....

Back in December of 2007 I wrote a post called 'Money Printing Economics - the UK and US as the New Zimbabwe?'. At the time I wrote this, I could still put a question mark on the end of the sentence. This is what I said at that time:
Now we come to the crux of it. If the government prints enough money, this will provide an potentially unlimited amount of liquidity to the banking system, and the banks can then use that money to buy government debt, thus financing government borrowing. Meanwhile, the government can continue to service its expenses and keep repaying the debt owed to overseas creditors. In other words, the government will appear not to default. However, overseas investors will not see it this way. They will see it as it is - a default. Instead of failing to repay, they will be repaying the debt obligations in what can only be termed 'comedy money'.
As it is, the government is not even using the banking system as a conduit for the printed money, but will be financed directly by money fresh off the 'printing press'. Putting the situation bluntly - the UK is now the new Zimbabwe.

I have, in many posts, discussed the results, implications and consequences of printing money. If you would like to know how a central bank prints money, I give an explanation in Note 2 at the end of a post which can be found here. However, the method is not important, and it is just as easy to think about the central bank as if it were printing money by printing physical bank notes, as the effect is exactly the same.

I will try to explain what printing money actually means, through simplifying the process (for regular readers of the blog, you may want to skip the explanation, as I have explained this before). As we are all aware, the UK has an output of goods and services in many sectors. However, for the sake of simplification, I will just use the example of milk, and will describe the UK's output as if it were only milk, and will use small numbers to make it as clear and as easy to understand as possible.

In this illustration, we will say that the UK has a total output of milk of 100 litres, and that there is a total amount of £100 in the UK economy. In this example, therefore, the price of milk will be £1 per litre. If we then imagine that the government prints another £10, so that there is a total of £110 in the economy, we have a problem. The amount of milk has not increased at all, but the amount of money available to buy milk has increased. Instead of having £100 chasing the 100 litres of milk, we now have £110. In this simplification, remember, there is only the 100 litres of milk to buy with the money.

The only thing that can then happen is that the milk will increase in price from £1 per litre to £1.10 per litre. In other words, if you increase the money supply without increasing output, then you have a situation of inflation.

In addition to this, printing money has lots of other nasty effects. The first of these is that printing money is a form of taxation, and I will explain how this works.

As we have noted from the milk example, if you print money without increasing output, you are effectively devaluing money. Yesterday, your £1 could buy you a litre of milk, today that is not possible. If you are devaluing money, where has the value gone? The answer is that part of the value of your £1 has been transferred onto the newly printed money. If you then ask who has this newly printed money, you see that it is the government that holds it. As such, what you have is a situation in which the government is placing a tax on every unit of currency, and transferring that tax into the newly printed money. This means that there is a tax on every coin and banknote in your pocket, a tax on every £1 that you have in your bank account, and a tax on every asset that you hold that is denominated in the £. In other words, it is a tax on everything.

Another effect of printing money is that it a method for governments to default on debt. If you imagine that you are an overseas investor, and you have lent the UK government £1, then the value of that money was equivalent to being able to buy one litre of milk (using the milk example again). If you imagine that the government is running out of money, so that it has only £0.90 left to pay the lender, they will have a choice. Either they can pay back part of what they owe the investor, which means partially defaulting on the debt, or they can print money and give £1 to the investor. In the case of giving the lender £0.90, this is not enough to by a litre of milk, which means that the lender has lost money. However, if the government prints money, as in the example I gave earlier, then the investor will have his £1 returned, but it still will not buy the litre of milk, as milk has increased to £1.10. In both cases the effect is exactly the same, and in both cases the government has defaulted on debt.

Essentially, however it is spun, government money printing is fundamentally dishonest.

Then there are the effects that this has on an economy. Before discussing this, I have seen a lot written about Japan, and how they managed in recent times to print money without subsequent hyper-inflation. This is given as a justification for why it will be okay to print money in countries like the UK, and the US. If you go to my post here I explain why Japan 'got away with it', and if you go to the notes at the end of the post I explain why countries like the UK will not 'get away with it'.

Returning to the effects on the economy, we have established that inflation follows money printing. This is a situation of monetary inflation, where the output of goods and services is not increasing, but where the number of units of money chasing those goods is increasing. What then happens is that the cost of living goes up, as everything becomes more expensive. In a situation of a collapsing economy (the case of the UK), many private sector workers will be very upset at seeing their standard of living eroded, and some of them may be brave enough to strike and demand more pay. Many others will not, as they will fear for their jobs. However, some of those strikers will actually get more pay. That increase in pay will feed into higher costs and eventually higher prices for the output of their sector. This is inflationary.

In the meantime, government workers will also be upset at seeing their standard of living declining. The difference here is that, they will not have the same fear for their jobs as the private sector, and will therefore be more likely to strike. As they are in the position of running 'essential services', and/or the unions in this sector are strong and powerful, they are very likely to succeed in gaining pay rises. If we remember why the government is printing money in the first place, which is because it can not afford to pay for its commitments, it becomes apparent that this will be very problematic. The government is already unable to pay these government workers without printing money, so paying them more means that they will have to print even more money......which further feeds into inflation.

All the while this is going on, the government is effectively devaluing the currency, such that on foreign exchange markets the value of the £GB will be falling. As the value of the £GB falls, the cost of all imports will climb. Again, you have substantial inflation. On top of this, as the inflation starts to kick in, you start having capital flight, which is where people realise that the value of their money is being destroyed, so that they seek to put their money in other currencies that are more likely to hold their value. In order to do this, they will have to sell their £GB in exchange for other currencies, which means that there is a flood of £GB into the world market, which in turn further pushes the value of the currency down even faster and harder. This in turn feeds into higher inflation, and the situation becomes self-perpetuating into a downwards spiral.

So what will the government do with inflation out of control and a collapsing currency? Inevitably there will be widespread discontent and hardship that results from this inflation. The government is in a position where they believe they must 'do something'. On past performance, based upon the way that they have systematically destroyed the UK economy such that they created the situation, they will yet again do exactly the wrong thing. They will try to command the economy back into shape. In order to do this, they will impose controls on international capital flows to try to lock capital into the country. They will also impose price and wage controls to try to stem the inflation.

Of all of these, the most worrying of the possible actions will be the price controls. In particular, it is very likely that they will try to impose controls on the price of food and energy, as the inflation in the price of these items will be the most immediate concern. Price controls, unfortunately, will always result in even greater problems than they are supposed to solve. All you have to do is think of yourself as a dairy farmer, for example and imagine that the government decides that you can not increase the price you charge for milk (sorry, back to milk again).

In this situation, you will see the economy inflating around you, but you will not be able to inflate your milk prices at the same rate. This means that you will be becoming poorer, as the value of the milk you sell will be falling relative to everything else. In this situation, it becomes increasingly pointless to actually continue in the business of selling milk, because you will start to lose money. As a result, the output in your sector will fall, and then there will be shortages.

It is at this point that the situation is completely out of control, with the government imposing ever more 'controls' on ever larger parts of the economy. What happens then, I am not sure...but I do not think it will be a happy situation.

This last section is speculation based upon my best guess of what the government will do. It is also possible that someone will have the courage to lead the government out of its self-created crisis. The answer, of course, is to switch off the printing presses, and accept a period of significant hardship and austerity. However, my speculation is based upon the action of the government to date, in which they have continually sought to pretend that they can control the economy and turn back the clock to the 'good times'.

I have mentioned a couple of times in this blog that I sometime have difficult believing the implication of what I am myself writing. In particular, the rational part of me says 'this is the reality', but the irrational part of me refuses to believe it. Occasionally, such as seeing the article quoted at the start of this post, reality is hammered home. In this case the reality is that the government is now going to try to finance its operations through printing money. This really is the Zimbabwe solution, and however many economists witter on about various justifications, funding a government with printed money is a road to disaster.

The real tragedy of this is that it was completely avoidable. Whatever happened, the UK was going to have to face a very hard time, but there was never any need for it to become as bad as it will become. If the government had shown the courage of leadership, had accepted the underlying reality of the depth of economic problems, it could have set about the essential reform of the UK economy. Instead of this, they chose to delude themselves, and delude the public into thinking that everything could go on as before.

Another tragedy lies in the media. They should be screaming with outrage at what the government is doing, but instead they are wittering about bankers bonuses, and other populist nonsense. They have let themselves be steered away from the reality of exactly what is going on. As I said at the start of the post, the UK government has now effectively declared its bankruptcy, but the headlines in two of the major UK newspapers are 'Archbishop: Christians are seen as mad by society' and 'US agents charge cricket mogul with $8 billion fraud'.

Quite simply, I despair.....

Note 1: I found an interesting article in the Telegraph, in which they report the following:

Last month, the Institute for Fiscal Studies warned that it will take more than 20 years to pay off the debts being run up by the Government during the current crisis.

Calculating that public debt had already risen by £10,000 for every family in the country, the IFS warned of a "tightening" on tax and spending that will have to continue until the early 2030s.

If nothing else, it gives a good sense of scale to the lunacy (italic and bold added by me).

Note 2: In the unlikely event that governments were actually able to meet their insane level of borrowing, just think about the impact of that borrowing on the world economy. For simplicity, we will pretend, for a moment that there is no money printing, and imagine that the total amount of money in the world economy is therefore fixed. If you then were to imagine that the world economy has a total of 1 million units of money, and then think of what governments are doing, the insanity of their actions becomes apparent. Effectively, they taking ever larger slices of that pile of money into their hands for their various stimuli. As such, if the government borrows 500,000 of the total units of money available, then there is 500,000 less available for investment in business. If there is less investment in business, then there is less growth in the world economy.

In the meantime, the 500,000 units of the total is being spent by the government propping up insolvent business (banks, automakers etc.), and being spent in areas that will not create any long term economic growth. In other words, it will be spent on activity which will not solve any problems at all, except in the very short term. By denying this money to private business, they are simply restricting the potential for growth in business overall, and thereby destroy the chances of eventual recovery.

Note 3: Arguments against this post are very welcome. I really would like to believe that I am wrong. If you can convince me I am wrong, I will be genuinely grateful. I really, really do not want to be right.

Note 4: I remember a comment which mentioned that the blog is very popular with farmers. My suggestion to farmers is that they organise and prepare to defend themselves against price controls - have the arguments ready, and if need be, have plans to face down the government. The same for the energy sector. I could be wrong about price controls, as there is no deterministic reason for them, and this is speculating on what actions individuals might decide on. However, bearing in mind that such price controls would devastate your businesses, you may want to take a precautionary approach, and prepare anyway. My best guess is that such controls might appear in about a years time if that is the course that is followed, but that is nothing more than a wild guess.


  1. I'm not convinced by the hyperinflation scenario (not that I completely dismiss it).

    We have to remember that the QE being attempted here and abroad is going on against a background of global debt deflation. There was an article in the Telegraph recently that suggested that the ECB had estimated that the exposure of European banks to toxic debt in emerging markets (mostly Eastern Europe) was to the tune of Euro 16.3 trillion. (This figure was removed from the article quite quickly and with no explanation why).

    QE is not being attempted against a stable global currency floor. "Money" is disappearing from the system at an astonishing rate. Personally, I would not be confident to definitely call either a hyper-inflation or perma-deflation scenario, but I tend to think the latter is more probable.

  2. I hope you're wrong too. But I don't think you really are.

    I can't see anything wrong with your arguments. They are very similar to my own opinions, except that yours take the pessimism to its ultimate point, whereas I've tended to pull back in the hope i've "missed something".

    Whatever the case, we are in a very deep hole. But despite this, the country still (presently) seems to be grinding on. Haltingly, yes, but it hasn't ground to a stop yet.

    One thing you've not taken into account is the political situation. Labour are polling incredibly low. As pressure mounts and it becomes more and more obvious they are just making things worse, we may see dramatic changes.

    A new leader of the Labour Party? A new party in government after a snap election? The effect of events like this are unknown, since a different leader of any sort may be able to take desperate measures to pull back off the brink.

  3. In the past there has been a lot of money sloshing around the system that was created by banks via fractional reserve banking and debt. With the credit crunch, that money is disappearing from the economy. I think it is probably safe for the government to replace it by printing money as long as they are careful.

    Also, I think that a period of inflation is completely necessary as it is the only way all the outstanding debt can be paid off. Instead of deflating the property/debt bubble, you inflate everything else to match those crazy levels.

  4. Thanks for clearing this up Mark - I've been scratching my head about the arguments for QE for some time.

    There is currently a big PR groundwork exercise going on for this money printing phase. Earlier this morning, Charlie Bean told the FT that he was disappointed that some sections of the media are calling the quantitative easing a Zimbabwe-like policy measure. That article has now been changed to be more 'on message'. Mr. Bean now "mounts a robust defence" of quantitative easing. Righto, if you say so, FT.

    Interesting too, is the sudden switch in the media towards quoting RPI at 0.1% as being a justification for printing more money - some articles no longer even mention CPI (which inconventiently is not moving down very fast at all - unless you count the erm ... 0.1%).

    As with yourself Mark, I'm not a conspiraloon. But quite frankly, there are just too many statistical conveniences and half-baked pseudo-economic justifications for QE floating around. Bits of the story just don't match up. For example, what is the transmission mechanism for getting the freshly printing money into the economy? Is the government going to be the mechanism if the private sector doesn't want the debt (as is likely to be the case)? An Independent article here mentions that the government will probably have to be the "borrower of last resort", but that article fails to explain how this would make the money printing scheme any different to printing money to finance government spending.

    Might they be planning to fund cheap mortgages through their Northern Rock vehicle with the freshly printed fifties? Don't underestimate the government's determination to get house prices rising again! This would explain why they're having trouble getting the EU Competition Commission to let that particular gambit pass!

    And finally (sorry this comment has turned into a bit of a tirade), why exactly are falling prices now A Bad Thing? We've been told low inflation is a good thing. But now, all of a sudden the government has sold the idea to the media (and they've lapped up) that low prices are A Very Bad Thing, because the price of milk and bread might go down, and consumers would then stop buying milk and bread in the hope that it will decrease in price and start a deflationary spiral (but presumably go hungry in the meantime, unless I missed something ... ?)

    You're dead right - the justification for QE just doesn't add up.

    EDIT: Don, I'm not surprised that EUR16.3tr figure was removed quickly. Money is going to be printed to try to fill in some of that hole.

  5. Thank you for the comments so far.

    I am surprised to see the expressions of support for QE from some commentators. For Don and others, I think your idea of 'money disappearing' takes me straight back to my discussion of fractional reserve banking. It is this belief that money that never existed is disappearing that prompted me to write about FRB.

    The base money supply can not disappear, unless the central banks make it disappear. It can only be transferred. The remainder of the so called money is bank IOUs with no meaning. However, having spent two long posts trying to deal with this issue, I am not sure I can make a sensible summary here.

    rjmunro: Inflation may reduce the value of debt, but at what cost. It comes at the cost of all the savers.

    General point:

    Printing money in this way destroys the value of money through inflation/hyper-inflation. I am genuinely puzzled how it is possible to justify this destruction of the value of money?

    To those that are proposing that this is a good thing, can I politely suggest going to a bank, take out £100 in £10 notes, then every week for 9 weeks, take out a note and set it on fire. At then end of the 9 weeks, you will have completed the same task as hyper-inflation will achieve.

    As each £10 note is burning, you may wish to contemplate the arguments in favour of inflating out of the crisis.

    (perhaps I should have put this point in the main post)


    Thanks for the link on Bean. I looked at the article, but there did not appear to actually be any defence! Did you notice how little he had to offer?

    Quote: But he insisted the aim would be limited to pushing “up the rates of growth of the supply of money and credit”. End Quote

    I think that we can all agree that the rate of growth of the money supply will be a result - is that a defence? It is simply stating what we know.

    As for the Independent article you link to, the name Keynes appears yet again....when will the economists and politicians learn that Keynesianism is the problem?

    Overall, I am afraid that I have to agree with all of your points. I have been in some long discussions with a friend regarding deflation, and it really is not a bad thing at all. I have a post on the subject in mind, so will not try to support the point for the moment.

    Steve: I agree that the political situation is shifting, and hope that somehow a real leader might emerge with the courage to actually deal with this. However, I have yet to see any policy from any of the major parties that addresses the problems. We can but hope.....

    General Point 2:

    The real reason for this comment was to link to an article. The word Zimbabwe seems to be gaining ground as the description of this QE lunacy:

    The article is about the flooding out of fiat currencies into gold....It seems that a lot of people are getting very worried indeed.

    Another article:

    This article says shares fell over fears that government have not done enough to save the economy. Excuse many $trillions will be enough.

    This seems to now be the argument. Drop $trillions into x,y,or z. When the economy continues to tank, just suggest ever larger amounts of money. How much money before everyone says 'enough!'

    I would love to hear the answer....

  6. CE,

    re this blog being popular with farmers, and on topic:-

    I know the 'slejpner' guy quite well.:) You have tried to teach him some of what he thinks he knows.

    Farmer John

  7. Cynicus,

    I don't own my own house, have massive debts from student fees and credit cards, have no savings and have never aid into a pension.

    Isn't a period of hyper-inflation just what I need to level the playing field a little?


  8. Re. Paul's comment about milk and bread: I think these would be safe for the reasons you suggest - people need to eat, and preferably before the food goes off - though if the £GBP fell we'd have to produce most of our food here rather than importing much of it - this would lead to shortages, and hence hyper-inflation (or rationing?) in this sector. But deflation means that people put off all those other non-essential purchases. So basically it seems that the government wants to encourage us to buy all the stuff we don't really need (much of which causes great environmental degradation and rapidly ends up in landfill) to keep the economy going. It reminds me of George Bush saying that good Americans must go shopping. Irresponsible spending & consumption is not a good solution long-term for so many reasons - if we use up the planet's resources "just to keep the economy going" there will be fewer, and therefore more expensive, resources left on which to base the economy

    Also, we have had years of inflation, surely some deflation is good to balance that out. Inflation only allows us to fool ourselves that we are richer because we got a pay-rise, when actually it is the highest paid that get more of the new money, hence effectively funded by the lowest paid (since a % pay rise on a small amount is less than the same % of an already large amount). For fairness' sake, I would therefore welcome some balancing out.

  9. Regarding the debate on whether hyperinflation will or will not occur:
    I think its fair to say that now the BoE is going to be funding HMG borrowing the possibilities for the UK lie on a spectrum of at best stagflation and at worst hyperinflation.
    Personally I think it will almost certainly end up somewhere in the hyperinflationary part of the spectrum but cannot see it being as bad as Zimbabwe or Wiemar. But who knows, time will tell…

    Ultimately what would/could bring about an end to HMG printing money as the longer it goes on, the bigger the drop in living standards if it ends as the more the currency will have depreciated?

    Regarding the outcome of increasingly expanding price controls:
    It is quite obvious where that would end. The Government would impose a direct command economy (effectively rationing) since as you say it would not be possible to limit prices in one area without negative knock on effects in other areas. A socialist utopia: indeed it would not be pleasant.

  10. Any data on how much food the UK imports?
    I have a similar feeling, rationally it all makes sense but I don't want to believe it's going to happen.
    The question, however, remains as to what to do now, which currency is 'safe'? Dollar, Euro and Pound governments are faced with massive budget deficits. RMB, Won etc are currencies of export-reliant countries, they'll make sure to keep their currencies 'in line'. In fact most countries will have to come up with a coping mechanism as Europe and the US are their biggest export markets.
    Not really sure about the Yen, either.
    Any data on how much of the deficit is financed by foreigners?

  11. I think Argentina is a better model for what is going to happen to Blighty. I think that the public would better understand this metaphor rather than Zimbabwe. "Don't cry for me Argentina."

    I am depressed by the media's acceptance of QE. The Times is a c**p outlet. The Telegraph is good but Edmund Conway has gone all soft. The FT is just pathetic, except Alphaville. The Indie seems to understand the danger. The Economist is wishy washy.

    There is a great book called The Two of Me by John Birtchnell, in the book he says the Two of Me are made up of the Rational Outer Me and the Emotional Inner Me. I have struggled between my two Me's and the Rational continues to show me the disaster we are heading toward. The Emotional Me wants it not to be. When we read and watch the media we should understand that they are struglling with these two Me's and our only hope for educating them is via blogs. We have the power to shape opinion and it is up to us to show insight ad help the pundits understand why they are struggling against the co-operative. The ruling elite are like the Borg from Star Trek - with our Rational and Emotional we shall fight them. National Salvation is at stake.

    Keep it pumping Cynicus!!!!!!!!

    Death to Bubble Addicts

  12. It is completely wrong to say that the government is simply printing money. The central bank is buying government bonds. Yes, the central bank must create this money but the bonds can easily be sold back to the government effectively reducing the money supply if required.

    QE is essential because there is simply more goods and services than money. This has been the problem for years, except credit chased the goods and services.

    QE only sounds bad, but it's not. It should have been done months ago.

  13. First of all an apology for not replying to all of the comments, but I have just a moment.

    I have had a comment from Joe Cowan who suggests that QE is okay because, if need be, the 'bonds can easily be sold back to the government effectively reducing the money supply if required'

    I have one simple question here. With what will the government buy the bonds back??

    A very quick response, and I hope to get to some of the other responses later (time allowing).

  14. Mark,

    With regard to me "supporting" QE, did you read this link that I posted in reponse to one of your previous posts?

    (Forget the picture of Marx - it isn't a Marxist article)

    This is the most persuasive article I've read on the deflation issue. The author comes at the FRB issue from a completely different angle from you. His research indicates that credit is NOT an inevitable product of a fiat currency, but rather that fiat currency is the inevitable product of a credit economy. This insight stems from his observation that banks issue credit BEFORE the corresponding fiat currency is printed. In other words, in a credit economy the tail wags the dog.

    I really think you need to read this article. You may of course find flaws in it and be able to dismiss the case it makes. But to me it feels intuitively right.

    As such, I don't support QE as such, but I do find the deflationist argument more persuasive.

    (P.S. apologies for the capital letters - I'm not shouting - just not confident about using the italic tags)

  15. "I am genuinely puzzled how it is possible to justify this destruction of the value of money?"

    1. Because we don't have any of this money. The Chinese (& a few others) have all of it. We'll be burning the Chinese £10s more than our own.

    2. Money itself is useless. Money is there to enable things to be traded.

    It's not that I disagree that too much inflation (hyperinflation) is a bad thing - there is a balance to be struck - but I can't see any other way out of the debt crisis.

    Of course, the debt crisis is only one of several that are all interlocked and have all hit us at the same time. There's also peak oil, the complete loss of domestic industry and the fact that everyone seems to believe that they are entitled to things and don't have to work any more.

  16. Although I agree with some of your points and am against QE (which has never worked), I have to take issue with the following:

    'The bank is not going to buy the bonds to 'resuscitate the stricken economy' but will buy them because nobody else wants to buy UK government bonds.
    There are not enough people willing to lend to the UK government.'

    This may well become true in the future, but is simply not the case at the moment. Gilt auctions continue to be reasonably well received, and Gilt yields remain lower than the German equivalent at all points on the curve except the very long end, where they are marginally higher.

    At this stage, they are not proposing QE because there are no buyers for gilts, rather out of a (misguided in my opinion) view that it will benefit the economy.

  17. Hmmm, if the money is not being spent and is just used to inflate banks that do not lend, how is this inflation? If and when the economy does pick up this could become a problem, as squeezing inflation out is a difficult. But since most of the world in in the beginnings of deflation, the money printing should help to stabilize it.
    The wise citizen can always hedge though, gold, commodities ect.

  18. I keep coming across the term "wall of money" coming at us, which fuelled the great boom. Where did it come from? It seems to me that it was actually our own money, paid to the Middle East (+ Russian) oil producers, being "recycled" because they had no productive use for it. Therefore, it would seem, a default would pile the major part of the loss on the heads which caused it; so let's go for it! Let's do as Brown suggests, co-operate, jointly act and default en masse.

  19. I agree with the thrust of your argument and you're cleverer at economics than I but you don't give much weight to the point that the crisis is all about 'relativeness'. Who is better positioned than who. I think his comment: "Amongst all of the choices of which country to lend to, the UK is going to towards the bottom of the list" is off the mark. UK might not be in the top 3 but I think it's in the top 5.

    1) You overlook that the UK gilt market has the steepest yield curve of all the major markets. This means that foreign investors can buy gilts and hedge the currency back to base and pick up yield over and above the domestic market.
    2) You can perhaps more safely lend to, say, Belgium (as an example) but if you're a foreign government (seeking greater influence) wouldn't you prefer having political clout over the UK rather than Belgium?

  20. A very rushed reply.

    Ptolemy, many thanks for your comment. My question is this. Do you think the government will wait for a failed auction, or would it not be the case that even a reasonable possibility of a failed auction would be enough.

    Also, there are many forms of gilts, and different market reactions to different gilt issues. Hopefully, I can find the time for a fuller answer later.

  21. Currency Expert video on CNBC. Well worth watching Cynicus:


  22. Ptolemy: Sorry for the short reply earlier, but I do have a little more time to respond.

    As I understand it, the recent auctions have seen UK pension funds buying, as they need to get out of the stock market.

    Quote: 'The past months' stock market falls have hit long-run projected investment returns at British pension funds, which have high fixed liabilities for pensions due to be paid out.'Unquote.

    In this case, the pension funds do not have the concern about currency risk as their liabilities are £GB. They just want the return to be fixed in £GB. Furthermore, this looks like a one time shift. The pension funds can only move out of the stock market once (being simplistic, but I hope you know what I mean).

    In other words, this is not a sustainable source of finance. The UK needs Asia and the oil states to be buying.....the fact that pension funds have filled the hole can only be temporary. The government needs overseas buyers if it is to continue to support the debt mountain it is building....

    More to the point you may want to read this article:

    The article reports that the 300 year old system of auctioning UK bonds is being changed to allow direct investment. Right now. At this moment in time. Why would that be?

    Of course, all systems need to changed/adapted with time, but why this moment in time, when stability in markets is what matters?

    As I said in my previous reply, the government will not wait for a failed auction....they will act before that happens..

    Above all, does it not strike you as a coincidence that, as the government borrowing reaches record levels, as the currency is falling like a stone, as the economy is in freefall, as the governments of the world are all issuing monstrous amounts of debt, government operations will be funded by printing money?

    Do you really believe this is not about the fact that the government can not raise the money that is needed?

  23. Don:

    Thanks again for the link. An interesting perspective which I did read the first time around. I agree with the idea of the tail wagging the dog - up to a point. It has always appeared to me that the central banks will expand base money in response to demand for money.

    My own view is that, as fast as overseas wanted to lend into the Western economies, the money supply was adjusted to facilitate this. It returns to one of my favourite themes, that the central banks were watching the wrong measures - inflation.

    In doing so, they expanded the money supply, without understanding that one day that money might become 'active' in the market, by which I mean actually being used to buy goods/services rather than being used as a store of value. It is one of my (many) problems with the central bank system. I hope you are grasping my point here, as this subject really requires a lot more explanation.

    This is one of the reasons that hyper-inflation is inevitable - there is a huge base of money, but not enough to buy with it. At such a moment in time, the central banks are going to print even more money...

    I have been talking about these problems with a friend recently, and have been thinking about some of what Adam Smith has to say about money. My conclusions from this are becoming increasingly radical, and I hope to post on the subject at some time (if I am not distracted by events).

    Does this respond to your points? Regardless of what the banks are doing, there is more money out there than can be realistically used to buy 'stuff' with, and the central banks are adding to the pile.

    Death to Bubble Addicts: Thanks for an interesting link. It is nice to see that I am not the only one making these predictions.

    Vygo: I do not think that you would win overall in hyper-inflation. Nobody such times, you will find that your debts are wiped out, but that does not mean the overall mess in the economy as a result of hyper-inflation will not hurt you.

    Anonymous: I am not sure about how much food the UK imports, but read many years ago that we long ago gave up being food independent. With regards to the amount of borrowing funded by overseas lenders, a good starting point is to just look at the reserves overseas....

    General: Apologies, I am out of time for more responses, and have had to rush through these. There are many other interesting comments but...

  24. I think there is one upside in the QE. That is an upside for the less credit worthy nations - the UK will not spam the global market with as many bonds as it would otherwise, so other nations will have better chance at selling theirs.

  25. Wow, I think the best part about this post is the comments section - a colourful spectrum of intellect coming together to unravel and speculate... The internet really is the agora of our generation!

    I have a couple of points -

    Re. your last post, MattInShanghai made the point that you were drifting into geo-politics, which is true, and in my opinion fine, unless you are aiming adhere strictly to economic analysis and conjecture... But why do that when the theatre which we are observing is populated with many more players with complex associations than those of a purely transactory nature?

    The social, political and economic are inter-related, even though (I'm fairly confident that I am quoting Marx correctly) 'the economic is the hub around which the rest of the wheel spins'.

    So, the question of which country to lend to becomes more complicated if we view the the whole of the stage and all the players, and not just where the treasure chest is sitting on it.

    The UK may be the bankrupt aristocrat, and the US may be the broken King, but they are King and aristocrat never-the-less and it will take time for their influence & power to wane. They will support each other and encourage old friends and allies to pitch in too, and they will collaborate for as long as there is civil order and it is mutually beneficial to do so.

    Brown has already courted the Middle East, and has invited China into the UK's stately home, but how impressive were the trinkets and prestige to the would be creditors?

    My guess is that they are enjoying being courted, but that they are sitting on their hands to the extent that they can - the problem of the Dollar is the reason why they cannot dislocate themselves entirely...


    Interesting response to the excessive banking bonuses.


    We must print more money, says Bank
    Governor appeals for urgent action to salvage Britain’s shrinking economy

    You couldn't make it up, that's it.

  28. Apparently, the figures for the amount of our own food we produce is somewhere between 60% and 75% depending on whose figures you believe.

    Allow GM foods, scrap the stupid EU ban on important pesticides, and delegislate farmers where possible and that could be reversed.


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