Interest rate decision: the choices

Tomorrow the MPC will announce that Alastair Darling has given permission to the governor of the Bank of England, Mervyn King to begin quantitative easing. The Bank’s purchase of government gilts and assets is designed to increase liquidity and, ultimately, increase lending.

Firstly, this wont work. The only thing printing money is likely to achieve is an immediate devaluation of the currency and, with no significant exporting sector, is unlikely to act as a fiscal stimulus. But more on that tomorrow.

For tonight, let’s look at the three options available to the MPC re: interest rates.

1. 0.5 per cent cut

Expected by almost everyone. In spite of David Blanchflower’s assertion that the “transition mechanism of monetary policy is broken” the Bank is likely to continue easing central credit conditions in a bid to encourage lending.

Sterling is dead. Long live sterling

There’s an often quoted episode from the later days of the Weimar Republic.  A man walks into a cafe and orders a coffee. He drinks it and orders another one. The coffees are priced on the menu at 10million marks. The bill comes. It is 25million marks. When the man queries his bill the waiter replies, “Sir, if you wanted to save money, you should have ordered them at the same time.” This is an extreme caricature of what was very real hyperinflation.

Since the start of the week, when Blue Monday saw billions of pounds wiped of the share value of our very own bank, the value of the pound has fallen at its fastest since 1985. One English pound now buys you 1.3793 dollars, or, put another way, almost 40 per cent less than this time 18 months ago.

Concerns are being raised in global currency markets that Britain is in real danger of being declared bankrupt. Whispers are already getting louder that Britain could lose its AAA rating allowing it borrow swathes of cheap money in the short term. Several renowned voices are already way above whisper quiet.

These economists may have a point. The  potential liabilities incurred from a full blown nationalisation of RBS (which now looks near-inevitable) and further stake raising in Lloyds TSB/HBOS are twice our entire GDP. That’s £4,200,000,000,000.

The pound is set to plummet. But will Mervin King’s insinuated ‘qualitative easing’ (that’s flooding the market with cash to you and I) stop its slide? How, I find myself asking, can a currency undermined by excessive borrowing be allayed by more borrowing?

There are a few death-knell measures at troubled treasuries’ disposal. Cut interest rates to 0 per cent? Merv quietly admitted last night that this is on the way. In America, it’s already in place. Print more money? Don’t rule it out. Buy treasury bonds? Who wants them? Besides, taking Japan as the most recent model, such a measure is no guarantee of success.

The government is today considering all these most drastic measures in a bid to stave off deflation. It should be worried about hyperinflation. Michael K. Salemi, Professor of Economics at the University of North Carolina:

[Hyperinflation] occurs when the monetary and fiscal authorities of a nation regularly issue large quantities of money to pay for a large stream of government expenditures.

Remind you of anything? Large quantities of our money and ‘regular’ monetary tinkering – such as rate cuts – can skew a currency and ultimately devalue it further.

David B. Smith from the IEA reckons that recent interest rate cuts already “could fuel rapid inflation in the future.” With further monetary measures, the treasury “may have amplified the inflation cycle”. See.

So don’t get worried about the falling pound. You might see an awful lot of them around soon.

Britain is as safe as houses

Investment in British companies, currency and commodities used to be as safe as houses. Years of lax Labour tax on the super-rich made the City of London a haven for foreign billionaires, all eager to cash in on the square mile’s burgeoning profit margins.

As the Russians poured in, the Brits poured out, moving abroad and living the dream with a robust pound to back up their marble-pillared purchases.

No more. The Oxford Economics consultancy will publish results of a survey this week the recent sharp plunge in Britain’s economic performance, compared with a list of other national economies.

Last year, before the financial storm broke, Britons were better off than residents of the US, France, Germany, Italy and Japan. At the end of one of the most cataclysmic economic years ever seen, we are poorer on average than Americans, Germans and Frenchies. The pound now buys fewer dollars, as it does euros, as it does Argentinian pesos. I imagine.

Oxford Economics predict that in 2009, GDP per capita in Britain will be “24% lower than in America and will be over 15% lower than in Japan”. These two economies have virtually zero interest rates in common, compared with the 2% current in Britain.

Britain will fall below even Italy, an economy which has struggled heavily in recent years.

Economic performance and the strength of a currency are symbiotic, just ask the prime minister. Investors are shunning the pound as, in all likelihood, the economy and currency will slip further as we see public debt being ratcheted up. If 2008 was the year where people stopped bandying about the metaphor “safe as houses”, 2009 will likely see the death of that punning epigram, “sound as a pound”.

The fall in sterling should encourage exporters to expand their output, but this will not benefit a country heavily reliant on imports. Goods from within the Eurozone will become relatively more expensive as the pound heads for parity with the single currency.

Britain can no longer hold claim to being a world leader in economic activity or quality of life. The City can no longer wax lyrical about being the world’s financial services hub. And Britons will no longer be the richest on the beach. We look set for a chastening 2009.

What’s Hungarian for ‘bailout’?

Firstly, I must apologise for not posting in while: been in Brussels and away from my beloved laptop.

In a week where Gordon Brown failed to “save the world” the EU summit met to firmly reinforce its public image as a Union marred by mud-slinging and in-fighting.

A key point of discussions in Brussels was the proposed €200bn bailout planned across the EU’s 27 member states. It has been hastily assembled to counter the 5 percent drop in European industrial action and dampen the affects of recession in around 15 countries.

Germany have just come on board, not before deriding Gordon Brown’s planned VAT giveaway as “crass Keynesianism“. This, hopefully will be an example of how the EU can, when it wants to, move quickly and decisively, free from tangled bureaucracy.

The problem is, 27 different countries have 27 different priorities. 1 single plan is going to be difficult to agree and near impossible to implement.

What happens to Britain’s share if the pound keeps falling at its current rate? Our negotiating power will be compromised. France now has a bigger economy than us. Poland and Hungary are addicted to coal. How can the EU hope to manufacture a panacea of worryingly arbitrary size when there are different rates of deflation, currency exchange and manufacturing decline in different member states?

How will this money be allocated? When? Why €200bn? Why not more? Will this fix all our ailing economies? Is this another piece of legislation from a Union seeking to justify its relevance to an electorate in decline since the Seventies?
As usual, the EU’s efforts have raised more questions then they’ve answered?

Is it time to swallow our pride?

You might not have felt it, but today you took a serious kicking. The pound fell sharply for the third day in a row against the dollar as the FTSE contracted by 2 per cent.

Anyone who has money or family abroad, anyone who had wanted to travel to America, anyone with any bonds, shares or even a passing interest in the stock market should be concerned.

With Britain’s borrowing set to soar, Gordon Brown is risking a run on our currency, although of course you aren’t allowed to say it.

Why would any foreign investor look at Britain and decide that it will, for the foreseeable future, be a safe place for their money? They’d be mad.

What has made the pound a robust currency in recent, happier times is its versatility. It is independent to the other countries lumped together in the Eurozone. It can mediate between the euro and the dollar, and change sides as it pleases.

Now, in tough times, the pound looks isolated. It also brings with it that debt mountain.

Big chins on the continent have been wagging about Britain warming to the single currency. A quick denial followed, but it looks like an increasingly attractive option, at least financially speaking.

The ECB has the power to set interest rates centrally, meaning that trade and borrowing between member states is easier. As a single currency with multiple beneficiaries, it is in many countries interest to keep it strong.

Could Britain benefit from this co-operation? It looks increasingly tempting.