Jeremy Warner: Merkel slams Bank's loose money stance
Wednesday, 3 June 2009
Outlook By demanding that the US Federal Reserve and the Bank of England cease their programmes of "quantitative easing" forthwith, and that the European Central Bank avoids the temptation of adopting the same approach, Angela Merkel, the German Chancellor, has broken one of the abiding principles of German politics: that out of respect for central bank independence, all commentary on their monetary actions is strictly off limits.
But she also raises an important talking point, which is being swept under the carpet in policymakers' desperation to find a workable path back to growth. Are not the hyper-loose monetary conditions being unleashed on the world going to end up recreating the very same conditions that led to the credit crunch in the first place?
Germany's experience of the hyper-inflation of the Weimar Republic makes it highly suspicious of anything that smacks of printing money. Rigid adherence to the principles of sound money have served Germany well in the post-war period, with low inflation and a stable economy. Yet not all countries have followed them, and now there is a global economic crisis which is affecting everyone.
The last economic downturn was countered by the Fed, and to a lesser extent other central bankers too, with massive increases in liquidity. This created the backdrop to the credit boom and subsequent banking crisis. Ms Merkel reasonably asks whether we are not making the same mistakes all over again. "We must return to independent and sensible monetary policies", she insists, "otherwise we will be back to where we are now in 10 years' time."
She seems to have a point. Central bankers and governments are seeking to correct the economic implosion with a set of actions which are dramatically the opposite of what needs to be done in the long term. Shrinking private credit is being countered with a ruinous increase in public debt, including the potentially toxic creation of new money.
Governments and central bankers that pursue this course are following the Augustinian principle of Lord make me pure, but not yet. Ms Merkel demands immediate chastity. We've tried these apparently painless approaches before, she reasonably points out, and we know it only stokes even worse problems for the future.
Even the European Central Bank, which thus far has held back from the more gung-ho approach of its Anglo-Saxon counterparts, now threatens to apply the same hooch, with confirmation expected tomorrow that it is going ahead with a €60bn programme of purchases of covered bonds. Ms Merkel does not approve.
Yet though we all have a sneaking regard for her point of view, the general consensus in Britain and America is rightly that she is talking sauerkraut. How else does she propose to respond to the worst economic crisis since the Great Depression? Just to sit there chanting the principles of sound money while the economic tsunami engulfs us may be saintly, but Augustine was a saint too, and personally I'm with him.
On this side of the Channel, the debate centres not so much on whether quantitative easing (QE) is dangerously inflationary, but whether it is having any effect at all. Ever since the first cries of green shoots went up, I've counted myself firmly in the optimists' camp, yet it has to be said that there is not a great deal of evidence of recovery in the latest money supply numbers from the Bank of England.
Up until about a year ago, money supply was expanding like topsy, reflecting the growth in credit and nominal spending. Then came the full impact of the credit crunch. Growth in money supply plummeted and then began to shrink. To prevent this developing into a classic deflationary spiral, the Bank of England earlier this year embarked on its now famous programme of "quantitative easing".
Is it working? It is perhaps still too early to tell. The Bank of England always said that it would take time to know. All the same, the latest set of UK money supply numbers don't make encouraging reading. What they show is continued weakness in money supply, with the closely watched measure of M4 excluding other financial corporations (OFCs) registering a month-on-month rise of just 0.1 per cent in April. This is the measure of money supply that the Bank of England intended to inflate so as to get the economy going again. Despite the application of some £45bn of QE so far, money supply has barely grown at all, let alone returned to levels consistent with decent levels of nominal spending.
There are a number of possible explanations. One is that there is simply a lag effect and that eventually it will work. A second is that the situation might have been even worse without the QE, with money supply showing a marked decline. Another, which is disputed by the Bank of England, is that because the bulk of the sellers are for the moment foreigners – rather than the intended target group of non-bank, UK investors – it's all effectively wasted money. Rather than boosting UK money supply, the cash instead merely ends up in overseas pockets.
Whatever the answer, the Monetary Policy Committee, which meets this week to decide on what to do next, will be tempted to keep applying the medicine until there are signs of life. Once the Bank has burnt through the first £150bn sanctioned by the Treasury – equal to 10 per cent of total money supply – it will surely be asking for more.
And therein lies the policy trap. With oil and other commodities prices again rising strongly, there are already signs of renewed inflationary pressures. If QE does indeed turn out to have a pronounced lag effect, it might suddenly all come surging through in a year's time, when we could find ourselves in the midst of an inflationary mini-boom, but with cripplingly high unemployment to boot. Ms Merkel's analysis may turn out to be correct. Rarely has the policy dilemma looked more daunting.
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