mervyn king

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Helicopters Grounded?

Having recently uncovered in its own research that quantitative easing is enriching the richest 5%, and the British economy still mired in the doldrums even in spite of hundreds of billions of easing,  the Bank of England announced last week that it was grounding its fleet of helicopters dropping cash onto the big banks and suspending the quantitative easing program.

Yet, this may not be the end for British monetary activism.

Anatole Kaletsky wrote last month:

This week an even more radical debate burst  into the open in Britain. Sir Mervyn King, governor of the Bank of England, found himself fighting a rearguard action against a groundswell of support for “dropping money from helicopters” – something proposed by Milton Friedman in 1969 as the ultimate cure for intractable economic depressions and recently described in this column as “Quantitative Easing for the People.”

King had to speak out because the sort of calculations presented here last summer started to catch on in Britain. The BoE has spent £50 billion over the past six months to support bond prices. That could instead have financed a cash handout of £830 for every man, woman and child in Britain, or £3,300 for a typical family of four. In the United States, the $40 billion the Fed has promised to transfer monthly, with no time limit, to banks and bond funds, could instead finance a monthly cash payment of $500 per family – to be continued indefinitely until full employment is restored.

Has the Bank of England stopped one program in anticipation of beginning another? Will be the Bank of England begin to inject cash directly to the public, bypassing the banks?

It is more than possible.

Could this mean some kind of debt jubilee? That is less likely — policymakers seem to remain fixated on demand and consumption, when the greatest obstacle to economic activity is the total level of debt.

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Does the Bank of England Worry About the Cantillon Effect?

The empirical data is in. And it turns out that as I have been suggesting for a very long time — yes, shock horror — helicopter dropping cash onto the financial sector does disproportionately favour the rich.

The Guardian:

The richest 10% of households in Britain have seen the value of their assets increase by up to £322,000 as a result of the Bank of England‘s attempts to use electronic money creation to lift the economy out of its deepest post-war slump.

Threadneedle Street said that wealthy families had been the biggest beneficiaries of its £375bn quantitative-easing (QE) programme, under which it has been buying government gilts for cash since early 2009.

The Bank of England calculated that the value of shares and bonds had risen by 26% – or £600bn – as a result of the policy, equivalent to £10,000 for each household in the UK. It added, however, that 40% of the gains went to the richest 5% of households.

Although the Bank said it could not come up with precise figures for the gains from QE, estimates can be produced using wealth distribution data from the Office for National Statistics. These show the average boost to the holdings of financial assets and pensions of the richest 10% of households would have been either £128,000 per household or £322,000 depending on the methodology used.

Here are a few questions for Britain’s monetary overlords at the BoE:

  1. Are you concerned about the long-term social and economic implications of a monetary policy that enriches the rich over and above everyone else?
  2. Are you familiar with the concept of the Cantillon Effect whereby the creation and allocation of new money transfers purchasing power to whoever it is allocated to? Did you consider this effect prior to embarking on a program of quantitative easing to the financial sector?
  3. Given the financial sector’s awful track record in terms of blowing up the economy, fabricating LIBOR data for its own enrichment, and neglecting cash-starved small businesses, is the financial sector an appropriate allocator of new money?
  4. Now that the empirical record shows the policy of helicopter-dropping cash directly to the financial sector disproportionately favours the rich, have you considered changing course and adopting a different monetary policy that doesn’t favour any particular group?

Sadly, I expect to see the announcement of more quantitative easing to the financial sector long before I expect to see answers to any of these questions.

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The United Kingdom of Massive Debt

Perhaps it is unpatriotic of me to ask, but are France’s shrill politicians right? Is the United Kingdom the weak link?

From the Guardian:

The entente is no longer so cordiale. As the big credit rating firms assess whether to strip France of its prized AAA status, Bank of France chief Christian Noyer this week produced a long list of reasons why he believes the agencies should turn their fire on Britain before his own country.

France’s finance minister François Baroin put things even more bluntly: “We’d rather be French than British in economic terms.”

But is the outlook across the Channel really better than in Britain? Taking Noyer’s reasons to downgrade Britain – it “has more deficits, as much debt, more inflation, less growth than us” – he is certainly right on some counts.

Britain’s deficit will stand at 7% of GDP next year, while France’s will be 4.6%, according to International Monetary Fund forecasts. But Britain’s net debt is put at 76.9% of GDP in 2012 and France’s at 83.5%. UK inflation has been way above the government-set target of 2% this year and the IMF forecasts it will be 2.4% in 2012. In France the rate is expected to be 1.4%.

On growth, neither country can claim a stellar performance. France’s economy grew 0.4% in the third quarter and Britain’s 0.5%. Nor has either a particularly rosy outlook. In Britain the economy is expected to grow by 1.6% in 2012. But in the near term there is a 1-in-3 chance of a recession, according to the independent Office for Budget Responsibility. In France, the IMF predicts slightly slower 2012 growth of 1.4%. But in the near term France’s national statistics office predicts a technical, albeit short, recession.

There is one significant factor everyone is overlooking.

Total debt:

From Zero Hedge:

While we sympathize with England, and are stunned by the immature petulant response from France and its head banker Christian Noyer to the threat of an imminent S&P downgrade of its overblown AAA rating, the truth is that France is actually 100% correct in telling the world to shift its attention from France and to Britain.

France should quietly and happily accept a downgrade, because the worst that could happen would be a few big French banks collapsing, and that’s it. If, on the other hand, the UK becomes the center of attention then this island, which far more so than the US is the true center of the global banking ponzi scheme, will suddenly find itself at the mercy of the market.

And why is the debt so high? Well, the superficial answer is that the UK is a “world financial centre”. The deeper answer is that the UK allows unlimited re-hypothecation of assets. Re-hypothecation is when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations. In the US brokers can re-hypothecate assets up to 140% of their book value.

In the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated. Brokers are free to re-hypothecate all and even more than the assets deposited by clients. That is the kind of thing that creates huge interlinked webs of debt. And much of Britain’s huge debt load — particularly in the financial industry — is one giant web of endless re-hypothecation. Even firms (e.g. hedge funds) that do not internally re-hypothecate collateral are at risk, because their assets may have been re-hypothecated by a broker, or they may be owed money by a firm that re-hypothecates to high heaven. The problem here is the systemic fragility.

Simply, the UK financial sector has been attracting a lot of global capital because some British regulations are extremely lax. While it is pleasing to see the Vickers report, that recommends a British Glass-Steagall separation of investment and retail banking, becoming government policy, and while such a system might have insulated the real economy from the madness of unlimited re-hypothecation, the damage is already done. The debt already exists, and some day that debt web will have to be unwound.

Now Britain does have one clear advantage in over France. It can print its own money to recapitalise banks. But with inflation already prohibitively high, any such action is risky. If short sellers turn their fire on Britain, we could be in for a bumpy ride to hell and back.

UPDATE: Readers wanting to understand the true extent of economic degradation in some parts of the UK ought look no further than a recent post…