Thursday, March 5, 2009

Excellent explanation for why depression will stick with us

Bank of England ready to pump money into UK economy

The Guardian's political commentators are living in cloud-cuckoo-land but their economic pieces are much better, particularly when certain bloggers pipe up: GolemXIV is always good, as is ChrisWoods here. It's easy to sum up why present policies will fail and why house prices will continue to fall (dramatically). Quantitative easing merely causes insolvent banks to hoard new money - they will NOT lend it out. There will be no effective increase in the money supply. HOWEVER, the bond and forex markets will, at some point, take fright at the possibility of inflation and at the fact UK plc is a busted flush. Inability to fund the public sector in the gilt auctions will require massive interest rate rises to sell the bonds. Hello Japanese-style depression.

Posted by alphabetzoo @ 10:18 AM (2006 views)
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28 thoughts on “Excellent explanation for why depression will stick with us

  • The Casino table needs more chips to give to the losing gamblers.

    With every winner there has to be a loser, but if you keep supplying the chips the game can continue.

    The cold wet tramp and son looks on through the casino window wondering where he’s next meal is coming, as he’s begged money decreases in availability and value.

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  • from WSJ ~~
    “While the bank may not be physically printing bank notes, it would be increasing the amount of money in the economy by buying assets from banks without borrowing to fund its purchases — effectively creating new money.

    Investec chief economist Philip Shaw said the move “should in principle encourage the banks to lend to private sector agents such as households and businesses, stoking monetary growth and stimulating activity.”

    Whether the tactic will work, however, depends on the extent to which struggling banks pass on the extra funds, instead of hoarding them as reserves.

    Wall Street Journal ~~ http://online.wsj.com/article/SB123624432365738481.html
    ~~~~~~~~~~~~~~~~~~~~~~~~

    This may well sound a little trite, but I can assure it is not, it is intended to provoke original thought.

    If we the people (the larger community of which we are apart) can create money, why should we create it to give to the banks who then loan it back to us at interest? There is something fundamentally idiotic about this basic principle and practice. ~~~

    “The Bank of England revealed last month it had sought government approval for quantitative easing and Treasury chief Alistair Darling hinted in an interview published on Tuesday that it could begin increasing the money supply this week.”

    ~~~~ so the BofE sought ‘OUR’ government’s ‘APPROVAL’ ie approval from ‘OUR’ elected representatives to print new money!

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  • Quantitative easing by buying up gilts owned by banks giving them loads of cash for reserves worked quite well in 1932 when the first UK National Gov did it.That and coming off the Gold Standard started a huge house-building boom,particularly in the South of England.See on Net Alan Crisp’s post-grad thesis on The Working-class Owner Occupied House of the 1930’s (can be Google up as such).This from Introduction:
    “It was the severe crisis in the financial markets during the late 1920’s and early 1930’s and the government’s decision to take the pound off the Gold Standard which finally reduced the price of money.Bank rate was reduced from 5% in 1931 to 2% in April 1932 and the bank of England enlarged the cash base of the banks by buying or converting gilts,2,597million pounds’ worth of government securities were bought for cash or converted in 1932,compared with 8 million pounds worth in 1931”.
    Of course land prices were rock bottom because of the agricultural depression, so the developers could steam right in.So the analogy with now is not exact.

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  • Surely if the banks were nationalised they wouldnt be allowed to hoard money.

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  • alphabetzoo –
    GolemXIV is spot on in my opinion. Chris Woods’ suggestion of direct purchase of corp bonds is horrible though, this would be inefficient (capital allocation wise) and lead to further skewing.

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  • I still don’t see how this will work – I need an explanation from someone who knows please. If they simply buy banks bad assets with “new” money they just printed, then that is just giving money to the banks – it’s not “putting it into the economy”. It will only get into the economy if the banks lend it – but the only people that want to borrow are those that NEED money – i.e. these loans will turn into bad assets too. So my question is Why give it to the banks – why not just give it to the people via a tax rebate so it can either be spent without having to be repaid, or used to pay off debt so bad debts fall and a little confidence returns? What is so f***ing special about the banks that they get all this money and we get the resulting inflation?

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  • mark wadsworth says:

    @ Troy, it is a myth that printing money is bot government borrowing. A bank note is a government security just like a government bond, it’s just lower denomination, non-interest bearing, and redeemable at any time the holder wishes (i.e. he can use it to pay his tax bill).

    @ Alphabetzeoo, there’s a contradiction here (and I’m not sure which statement is correct)

    1. “Inability to fund the public sector in the gilt auctions will require massive interest rate rises to sell the bonds”

    Agreed, that is what I and most others are expecting.

    2. “Hello Japanese-style depression.”

    Similarly, most of us are expecting a repeat of Japan’s lost decade.

    BUT Japan did massive QE and zero interest rates for ten years or so, and although JPY slid gradually and continually, Japanese government bonds did not pay very high interest rates at all.

    So my question is – massive increases in gilt interest rates – yes or no?

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  • money should be spent into existence by our elected representatives

    ~~~~
    quote:-

    “Because financial institutions more often than not demand collateral to be held against loans, as a guarantee should a venture fail, there is no incentive for them to invest in workable projects above pointless ones. People now are borrowing vast amounts against their homes and lenders encourage this, standing to gain either money from repayment or property from repossessing.

    The rewards made possible by Usury can encourage all sorts of irresponsible investments, because from the financiers point of view, it appears sensible, being guaranteed to make them a profit, no matter what the result.

    When it doesn’t make any difference they don’t have to care.

    If we are talking about a fair way to share the resources in our world, then this is not it.

    The rot starts the moment the currency is produced. ”

    http://www.xat.org/xat/

    and again

    What the world financial systems are primarily involved in, is known as Usury, (loaning money at interest), which has been condemned throughout history for moral reasons, legal reasons, and for the detrimental effects this practice has on society.

    The major religions of Hinduism, Buddhism, Judaism, Christianity and Islam have all criticised the practice of Usury. So too have many of the worlds greatest thinkers like Plato, 1Aristotle, 2 Seneca,3 and Plutarch.

    Many pages, books in fact, have been written explaining why Usury is bad. The main contention is however that it allows the rich to get richer at the expense of the poor getting poorer. You might not begrudge a person making money for providing a product or service to the community. But Usury allows a person to get richer simply because they are rich. As a result whole countries are now in debt to the banking system.

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  • japanese uncle says:

    Reposting the following:
    ——————————————————————

    I wouldn’t be surprised to see the jobless rate hitting 20% mark eventually (by 2012), to intensify the workers’ struggle for survival involving massive wage cut. Meanwhile inflation will never kick in for the foreseeable future, as no sooner are the monies printed, than they are hoarded in the coffers of banks that call loans aggressively from the households 1.5 trillion in debt, never to be circulated for investment and consumption. By 2012 salary/wages will be 20-25% less than today, and quickly shrinking affordability will cause further price deflation in a bottomless spiral. Upward pressure due to increasing prices of imported goods thanks to GBP depreciation will be absorbed in part by harshly cutting costs including wage and in part by downgrading the quality of goods. I seem

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  • Damie Down Under says:

    The San Franciso fed published a paper on the Japanese experience in 2005 or 2006 on this. The paper concludes that a marginal reduction in interest rates was achieve and there was some benefit for weaker banks. However, the overall benefits were very limited. The paper is available on the San Francisco Fed’ website.

    In Australia, there is an economist called Steve Keen has website http://www.debtdeflation.com/blogs/2009/01/ . In this link is a blog entitled “The Roving Cavaliers of Credit”. It is long but well worth reading to get an understanding of the credit – money creation process.

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  • Troy. Hear, hear. Money-lending and charging of interest, as a practice, is the root of our economic woes. An ultimately unsustainable system which has to continuously expand to cover it’s liabilities, destined eventually to fail. The rich get richer and the poor get poorer, until systemic collapse at which point people realise they’ve been duped all along

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  • timmy t –
    Yep, the money only gets into general circulation if the banks use it, rather than leave it on reserve. However there is no reason the banks will start lending to anyone who asks for it, as you suggest (creating more bad debt), because they won’t be able to shift it off their books easily like they were doing. I think most of the money would stay on reserve to be honest. The point in giving it to banks is the idea that that will result in the most efficient allocation (if it gets allocated that is) – the problem with giving rebates is that you end up with inherent favouritism (most would favour the rich or the corporation, but there would be more specific inherent favouritism for certain businesses and people) which can only lead to even more problems. They should not be giving money to people or corporates or banks – they should be allowing the readjustment and waiting for fires to put out.

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  • Banks are amongst the biggest losers on the FTSE at the moment – why? If I’d just been given £75Bn for a losing ticket on last weeks lottery I’d be pretty happy.

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  • troy / doom & gloom –
    I would like to be more specific in my criticisms:

    1) There is no reason that the money supply has to continually expand. Deleveraging – paying off debts [esp early repayment] shrinks it. The QE is a counter-measure to the natural contraction – that is a problem unless there is a countering destruction in the near future.

    2) Interest is not a bad thing, but yes, usury is (i.e. somehow overcharging, or possibly tricking the prospective borrower in some fashion, like many mortgage holders in the U.S. possibly were).

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  • timmy t said “Banks are amongst the biggest losers on the FTSE at the moment – why?” –
    Because it’s not going to help them turn profits, and the market knows that.

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  • @Japanes Uncle

    I cannot see this or the next government cutting public sector wages. The sense of entitlement to regular wage increases and protected pensions in the public sector is still strong in this country. Privately employed people will be more flexible but even they wiould rather risk redundancy than a 25% pay cut I think – especially when the news is full of generous settlements for failed executives. I still suspect that inflation will be on us rather sooner than the government and BoE care to admit.

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  • alphabetzoo says:

    @ Mark Wadsworth.
    Sorry I was imprecise. I meant Japanese style depression (in terms of no growth, stagnation) not in terms of interest rates. Japan avoided interest rate rises because it was still seen as (in some sense) the wonder child of the world and it still exported lots of high-value stuff during a benign period of economic growth – we (and the US) have none of those advantages (and Japan no longer has the third & arguably the first and second). Countries with high public sector (or high total) debts are going to be hammered at some point. We are starting thuis whole QE process with already high debt levels (including the PFI nonsense).

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  • 51ck – at a global level, when x% interest is payable on the total monetary base, where does this interest amount originate from? I always assumed that the system was dependent on continuous GDP growth to meet this obligation. And surely this x% is added to the total monetary base, resulting in an increasing money supply?

    At a country level, the expanding debt obligation is being transferred from the private sector to the public sector balance sheet but this does not make it any more likely that these obligations can be met in the future.

    I don’t see a clear distinction between money-lending/interest charging and usury – it is just a question of degree. And I do not see that lending to individuals serves the interest of anyone except those involved in the finance industry itself (which is a large proportion of the population)

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  • 6. timmy

    You are missing the point. Print fiat money for the banks so the taxpayer can repay that with real money.

    It’s called Double Bouble and that’s without the interest on borrowing. Starting to get it now!

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  • Crunchy – no – explain please – preferably in words of one syllable

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  • 19. timmy
    Tut Tut.

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  • 19. timmy

    Tut tut.

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  • doom & gloom –

    I’m not sure anyone knows for sure, but here is what I think:

    Interest owed must come from future production. If there is interest owed then GDP does necessarily have to be positive (but not necessarily any more positive) – and yes this would imply an increasing supply if only the interest is paid, but it is not, there is also repayment and even deleveraging (as now & recently) which decreases the supply.

    I would agree that there is definitely a fuzzy element to the bounds between interest and usury, and this is why I promote anarcho-capitalism – I think in this system banks would probably become utilities (or close to this kind of business) rather than profit making machines; there would still be interest, but it would be competitive to the point of no (or minimal) margin (go to the BoE site and find out how hard it is to start a bank).

    If lending did not serve the borrower in any way why would any entity ever borrow? Borrowing allows one to pledge future work for receipt of an asset now, that is all. Personally I do not advocate borrowing or lending, but I see it’s use. The fact that the state backs the contract (credit – and this includes money itself [I promise to pay the bearer… / In God We Trust]) allows there to be more trust between the involved parties which does lead to periods of over-expansion, as we saw recently.

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  • Japanese uncle and others…
    For those of you knowledgable on currency movements. Please could you explain a bit about why GBP to depreciate (i dont fully get this). I am assuming that uk government conducting quantative easing will cause inflation, although there is a chance this may not happen if banks use it to bolster there balance sheets. If inflation does result, this i think will cause the GBP to devalue, but other major economies throughout the world are in the same boat with their own economies sinking, so does this not mean that all currecies will kind of keep in step with each other with the result that they will keep there same exchange values relative to each other?

    Also which currecies do people think will become stronger against the GBP and why?

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  • alphabetzoo says:

    @ andy_boy

    Indeed, all currencies can’t simultaneously depreciate, it comes down to (amongst other things) expectations about *relative* strengths of particular economies. So, for example, Australia has high levels of household debt (which bond and forex markets are more forgiving of) but public debt that won’t spiral (since ‘old fashioned’ Aussie banks never took on such levels of toxic debt that US/UK ones did and so don’t need to be bailed out) whereas US and UK will have (relatively speaking) mugh higher public debt (thanks to the governments taking on bank debts that can never be repaid). Thus the £ and US$ are likely to be less attractive compared to the AUS$. Japan didn’t suffer so much (despite large and increasing public debt caused by bank bailouts) in the 90s because it had thriving export sector, but UK doesn’t have that to fall back on. Thus not all ‘large public sector debt’ countries will be equally hard hit. The pound and US dollar are not (in my opinion) going to be good currencies in the long term.

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  • Crunchy – why will it be repaid this time around? It wasn’t last time they lent it – hence the BoE having to buy bad assets.
    Let’s say you are a bank and I am a typical UK resident… bear with me…
    You lent me money to buy a house, which I did. The house went up in value so I mew’d (you gave me more money). I am now unemployed and at risk of default so you have a bad asset. You have done this lots of times to the extent that you are in serious trouble and technically bankrupt.
    The BoE comes along and gives you a wedge of fresh £20 notes (still warm from the printer). My questions are:
    1. Are you seriously going to lend to me again?
    2. Why didn’t the BoE give me the money to repay the debt?
    3. Bearing in mind how badly stung you have been, what are you going to do with the money which will help this whole situation?

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  • 1 No, not untill the bottom has been reached. The banks will control that.

    2 You are not a bank and as such the end game would not work. This is about control.

    3 Wait for the bottom and buy assets very cheaply and wait for the next bubble.
    There is more to this one but that’s bad enough.

    Take it or leave it. IMHOpinion.

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  • 24. timmy

    Good questions. Tapped in reply through admin you may want to check later.

    My personal opinions.

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