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Wednesday, 22 October 2014

Helicopters’ faint whirring heard in UK

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It is one thing when commentators burble on about the possibility of outright central bank financing of deficits, it is quite another when a viable candidate to lead the Bank of England is reported to be thinking along these lines.

James Saft, Reuters Columnist

Reported of course is different from said, but a speech last week by Adair Turner, outgoing head of Britain’s Financial Services Authority and a candidate to be the next governor of the BoE, may serve as a warning or a promise, depending on your view of money printing.

Turner, after ticking off the already extensive list of support the BoE has given to the Treasury and economy, held out the promise of more:

“We need to be ready if these measures prove insufficient, to consider further policy innovations, and further integration of different aspects of policy – to overcome the powerful economic headwinds created by deleveraging across the developed world economies.” (Click here to read Turner’s speech at the FSA City Banquet at the Mansion House, London.)

Nothing but a hint there, but shortly thereafter two respected journalists, Robert Peston of the BBC and Simon Jenkins of The Guardian, reported that Turner believes that the BoE should simply forgive some bonds issued by Britain which it owns.

Given the opportunity to back away from the suggestion over the weekend at the IMF meeting in Japan, Turner hung the idea on Peston, who referred to the idea as “helicopter money,” an image borrowed from a 2002 speech by Federal Reserve Chairman Ben Bernanke.

“The whole point of my speech on unconventional policies was to provide a justification of what we have done over the last three months in terms of unconventional policies,” Turner said.

“I pointed out there were other things we can do. As for the specific idea of cancelling gilts or permanent monetisation, I have to say that was reported by my good friend Robert Peston, but that was Robert’s idea, not my idea.”

That is not saying “never” or “I am not currently considering that.”

While that could simply be a canny would-be central banker keeping his options open, his approach stands in marked contrast to that of Bernanke, who went out of his way recently to combat fears that the US central bank was monetising or planned to do so.

“Monetising the debt means using money creation as a permanent source of financing for government spending,” Bernanke said, going on to stress that his support of the economy would taper or reverse when the bank sold Treasuries or allowed them to mature.

Inexorable

My guess is that, regardless of who leads the BoE, this represents an advance in what feels to be an inevitable slide. Once introduced, especially under current circumstances, the conversion of large-scale secondary market purchases of government debt by central banks to outright monetisation has an inexorable feeling to it. Firstly, monetisation is hard to resist in a situation of extremis. If a government fails to be able to finance itself at what it considers an acceptable price it is hard to see the central bank making things worse by selling alongside panicking investors. Far more likely is that the central bank plays the role of its own government’s lender of last resort.

Secondly, once we accept the rationale that conventional monetary policy is no longer effective and therefore quantitative easing is justified, it is simply another logical step to buy and destroy debt, rather than buy and hold. Given that the BoE owns UK bonds equal to about 25% of all debt stock and yet conditions are still, if not deflationary, pretty dire, the argument seems to apply as well now to monetisation as it recently has to temporary QE. Allowing bonds to mature, effectively tightening policy, makes no sense within this argument, if you accept it.

Bernanke’s preferred definition of monetisation, that it is “permanent,” is canny but hard to swallow. First, nothing is permanent, especially a government printing money; nature and markets will bring it to an end even if the central bank will not. As well, permanent hangs on the intention of the bank, which is harder to credit than its actions.

The somewhat terrifying prospect however is that, like conventional monetary policy, perhaps QE and its ugly cousin monetisation really don’t work in the current circumstances, at least as practised. It is not as if the evidence, based on the experience in Japan over decades and more recently in Britain and the US, is all that supportive.

This leaves behind the rump risk, which is inflation, or rather inflation fed by panic. It will not be easy to get everyone else, who after all still own 75% of UK bonds and 90% of Treasuries, to simply stand still while the central bank monetises.

Turner may well not get the job, and the BoE may never monetise, but when people in authority start talking about things that were before proscribed it is better to pay close attention.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)

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