Quantitative treason

Everyone knows that you can’t just make money, rather, like matter, it only ever changes form. And historians will tell you about how any attempt to contravene this rule ends in disaster, as with the economies of Zimbabwe and The Weimar Republic. But Gordon Brown, in spite of this, is currently implementing plans to do just that; create money. Is the UK set to follow the historical precedent and fall into the vicious cycle of hyperinflation and political instability?

There is a key difference between the process of quantitative easing and the actions of Weimar and Zimbabwe which makes it far less likely to trigger a crisis similar to theirs: Whereas the latter two simply printed cash to help redress government debts, quantitative easing proposes to do the opposite by buying already existing government bonds from firms with the money created. The advantage being that the government is not simply creating a surplus of money in the economy, which threatens to devalue the currency as a whole, but is simply releasing money secured in assets.

{{ quote On high streets now, the shadow of deflation can be seen in constant sales and falling prices which in the short term can help to promote spending but, in the long term, if confidence does not improve, can turn into a dangerous spiral }}

In addition to this, quantitative easing is aimed at filling the hole presently existing in the money supply, which has suffered drastically from the banks’ reduced extension of credit, causing consumers to save their money in spite of drastically low Bank of England interest rates. What is needed then is an increase in the money supply to create confidence, encourage banks to start lending again and trigger consumer spending; quantitative easing.

The necessity for an increase in the money supply is exacerbated by the threat of deflation. On high streets now, the shadow of deflation can be seen in constant sales and falling prices which in the short term can help to promote spending but, in the long term, if confidence does not improve, can turn into a dangerous spiral as people prospecting causes the value of money to rise out of proportion. Thus the UK needs quantitative easing in order to check the internal value of the pound. In other words, right now the UK economy actually wants inflation, not on the scale of Weimar or Zimbabwe, but the two percent per annum that Blair’s government pledged itself to.

However, as with all things economic, where there are winners there are also losers. The unfortunate cost of this regenerative package is the value of company pension funds. Many firms’ pension schemes are financed by the yields from government bonds so the government’s forced purchase of £75 billion of these bonds is sure to dramatically cut the amount paid to dependant pensioners in annuities. Thus more pressure will be placed on the state pension fund which is a serious concern during a decade which will see the mass retirement of the baby-boomers (the large generation of those born in the post-war period).

Brown has stated, however, that it is his long term intension to sell the bonds back to the public once the economy has stabilised and has stressed that this is only a temporary measure, which again separates quantitative easing from the policies of Weimar and Zimbabwe. So company pension funds are not lost permanently but the issue is whether the country will be able to support the needs of so many pensioners in the meantime. Clearly, this creates more fears for the government financial deficit and adds to the concerns over rising taxes in the future to pay the bill.

But all this could be to no avail. Some economists have observed that if interest rates are at practically zero percent and there is still no sign of the banks releasing more money into the market then quantitative easing may not be sufficient to tip the balance and start them spending. Some have argued that, in the current climate, confidence is still too poor for quantitative easing to have any effect and that the injection of money may just end up sitting in accounts, further adding to the dangers of deflation. It is even possible that the government’s actions are worrying consumers and thus are more harmful than beneficial.

The question then is not what the effect of quantitative easing will be on the money supply, that much is assured, but whether the demand already exists or whether it is the case that it will stimulate its own demand. Either way, the economy is once again reliant on the average consumer’s desire to spend to lift it out of this hole.