The Governor of the Bank of England, Mervyn King, has lost his attempt to extend quantitative easing (QE) to £200 billion.

The minutes of the Bank’s monetary Policy Committee for this month illustrate the gaping divide between the deflationists and their opposite numbers, the inflationists.

Quantitative easing is a term covering the Bank buying up Treasury bonds (gilts), issued by the Government to fund its borrowing requirement. Mre simply, it’s “printing money”.

The process is a bit like a snake eating its own tail, with one part of the government process buying up the debt of the Government. In normal times, it’s widely regarded as national suicide. Not now, apparently.

King’s move has already spooked the markets, with the pound sinking against the dollar. Stock markets around the world are also retreating on a general wave of disbelief that all the talk of green shoots can be sustained. The reality of the world’s huge over-capacity will bite in the autumn on the back of more massive job losses.

The Governor’s pessimism arises because the risk of “another large stimulus might be less than the possible costs of acting too cautiously.”

Mervyn King, Governor of the Bank of England has suggested more British banks may have to be nationalized in order to get them lending normally again. The alternative is many years of sub-trend growth.

Here’s the statement:

“The measures taken over the past six months were designed to stabilise the banking system and prevent failure. What’s become apparent is that nobody knows what level of capital they need to hold in order to be willing to make judgements about lending on the same criteria as you would regard as normal… In the long run, the only way to overcome this is for banks to get back to a position where they’re sufficiently well-capitalised that the degree of risk aversion that they exhibit towards their lending practices returns to a more normal level of risk aversion and not the extreme risk aversion which is being exhibited today.

“Higher capital would resolve that. How much capital, we simply don’t know. There was an interesting contribution from Alan Greenspan which suggested that several percentage points extra capital would be needed in American banks over and above the levels that regulators are pushing them to to get them to a more normal lending state.

“What’s very important to distinguish between and to my mind this is the big lesson of the last three, four five months, is that there is quite a big difference in practice between the levels of capital that banks need to be stabilised – in the sense that the creditors are reassured that the banks can continue as viable entities – and the levels required to persuade banks to exhibit normal levels of risk aversion. How big that gap is is absolutely impossible to say. I know of no scientific basis on which you can set that figure, but it looks as if it will be quite big.

“And what that means is that it will take time for the banks to get that extra capital. They are bound to be cautious about the rate at which they expand lending. It is a difficult problem to deal with. If the banks are going to continue as private sector entities they will naturally behave in a risk averse way for a while. That’s one of the lessons of history in terms of balance sheet problems.

“They could put in more public sector capital if they decided to do so but that has to be a judgement for government, and it does have ramifications for the Government’s shareholdings in banks because the amount you’d need to put in would undoubtedly be significant relative to the size of privately owned capital at present, and that does raise a whole series of awkward questions – but that is a matter for the Government.”

Not a nice prognosis and signs that the recent “bull” market and green shoots could all be in vain.

John Evans

Gordon Brown, former British Chancellor, now Prime Minister, has come in for weighty criticism in recent days for his failure to spot and stop the runaway disaster that is the British economy.

Lord Turner, new head of the Financial Services Authority (FSA), blames Brown when Chancellor for the failure of regulation which led to catastrophic losses at Northern Rock, HBOS and RBS.

“They existed within a political philosophy where all the pressure on the FSA was not to say ‘why aren’t you looking at these business models?’, but ‘why are you being so heavy and intrusive, can’t you make your regulation a bit more light touch?’,” he said.

“We were supervising people like HBOS within a particular philosophy of the way you do regulation, which I think in retrospect was wrong. I think (the FSA’s actions were) a competent execution of a style of regulation and a philosophy in regulation which was, in retrospect, mistaken.”

Similarly, Bank of England Governor Mervyn King claims he has been shouting warnings for years about risky lending without any response from Brown.

It is on the record that Brown delivered a speech in the City urging them to take even greater risks.

The Prime Minister is now trying to cover the mess up by throwing the kitchen sink at sacked RBS boss Fred Goodwin’s enormous pension. Significantly this was done as the Treasury unveiled its third bank bailout in the form of a £325 billion insurance scheme for desperate RBS.

Meanwhile the head of the Audit Commission, Steve Bundred, warned that public debt is at “Armageddon levels” and will exceed two-thirds of the entire annual economic output of the country.

As Brown heads for Washington to try to convince the new adminstration to set up a “global regulatory system” the rest of us should ask why we should believe him now when he failed so spectacularly for 12 years.

Deflation is now the biggest, persistent threat to Western economies. Inflation, recently the major enemy, has swiftly retreated, as widely predicted.

In Britain, many are now waking up to the gravity of the situation. Former Chancellor of the Exchequer, Ken Clarke, has dismissed comparisons with the 1970s, ’80s and ’90s, likening current conditions explicitly with 1929/30.

Normally cautious Bank of England Governor, Mervyn King, forecasts a 2 percent contraction in the British economy next year, with interest rates falling rapidly to nought percent for the first time in history.

Deflation is now the enemy we must all factor in to our expectations in the near-to-medium terms. So why is deflation necessarily worse than inflation?

In an era of massive indebtedness, both private and public, deflation increases the burden. As incomes decline, debts remain the same — at levels signed for in better times. It’s the exact opposite of the apparent wealth created during periods of rapidly rising house prices.

Professor Peter Spencer of York University says, “It is going to be absolute murder in Britain if inflation turns negative. The big difference with past episodes is that we are now much more heavily indebted. Few people owned their own houses in 1930s. Debts were miniscule.”

Another symptom of deflation is that consumers wait for lower prices before shopping, causing job-losses in the High Street and yet more bad economic news. Japan’s “lost decade” of the 1990s is the technically-perfect example of this psychology of fear taking hold. It is still suffering.

So what can be done either to pre-empt or cure the curse of falling prices across the board?

Curiously, Keynesianism which, in its misinterpreted version is disastrous in normal times, does hold out some hope in depressive conditions. Expect central banks to start printing money soon and dropping it from helicopters, if they haven’t started already. Want to buy some rising stock? Buy helicopter shares. [This is not financial advice.]

If you’re one of those noble souls who saved assiduously during the asset bubbles, you will just have to stand by and watch the profligate oafs who caused the problem clean up, while your own responsible hoard of value drains away.

It’s just not fair, but it will probably have to happen “for the greater good”.

You have only one consolation: you can give the politicians who presided over the madness a good kicking at the next electoral opportunity.

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