Danger! George Osborne’s “Credit Easing!”

October 6, 2011

There is something very strange about George Osborne’s “credit easing” policy. He proposes to use a complex financial instrument in order to bring the UK economy out of a recession which was caused by a complex financial instrument.

When you look closely at the proposal, it sounds awfully familiar. The UK government will sell loans to small businesses, then package them together, and sell them onto the bond market in tranches.

In other words, his proposal to get us out of this mess is to use the same financial instrument as that was used to package the securitized mortgages, which then became toxic, and got us into this mess in the first place.

I’m not saying it wouldn’t work, but I am saying it’s ridiculous to blame the bankers for their complex financial instruments, when the Tory Chancellor of the Exchequer is proposing exactly the same instrument as a cure.
The other proposal is to use Quantitative Easing to buy the bonds of British banks. He hopes this will boost their capital which will cause them to lend to small businesses.

He hopes. How he must hope. There is no guarantee that the banks won’t hoard the money. And besides, why would they lend to small businesses in this country, when they could do safer lending to bigger businesses abroad? I mean, they’re not exactly civic minded.

The new QE idea is that if we pay over the odds for bank bonds, this will raise their market price, causing the yields on those bonds to fall. With a lower interest rate to pay, this makes it attractive for the banks to issue more bonds. In other words, a second bank bail-out, but done on the sly. Further to that, with no equity in return, it’s a free gift from us to them.

The Bank of England governor, who has been very quiet of late, has refused to issue the QE to private businesses, saying that he doesn’t want the BofE to be politicised. Can someone explain what he means by that? However, he has today agreed to print £75billion and pass it onto the Treasury, for them to purchase of the banking bonds.

So the proposal is to supply the banks with debt, in the hope that they supply more debt to small businesses. At the same time as this, the government will directly supply loans to small businesses, through the “credit easing” policy. These proposals are in direct contrast to the Prime Minister’s insistence that it was debt that got us into this mess, and that the only way get us out of this mess is to pay off the debt.

According to the Bank of England’s own analysis, the last bout of QE boosted the consumer prices index (CPI) by between 0.75 and 1.5 percentage points. In other words, it caused 1.25% inflation. The difference between then and now is that then it was necessary to create liquidity in the economy. Everyone agrees that the problem now is one of demand, not liquidity. This bout of QE will certainly be much more inflationary than the mere 1.25% last time. And as people get used to inflation, they get used to demanding higher wages, which causes inflation. This is how governments lose control.

It’s the elderly and the poor who pay for inflation. Women are especially sensitive to prices. So by bailing out the banks with free money, it will be these groups that pay for the bail-out, not the wealthy supporters of the Conservative Party.

However, this is the biggest hypocrisy of Osborne’s policy: Inflation would affect holders of government debt. By stoking inflation, Osborne would be inflating government debt away. The international markets know this and, in normal times, would flee to preserve their capital. But the market doesn’t have anywhere else to go and Osborne knows this. The Euro is in a mess, and so are the Dollar and the Yen. Emerging markets are hardly risk-free, even if they were accessible. The safe haven of gold has far further to fall than it has to rise. There is no obvious place of refuge. So Osborne can stoke inflation without much fear of the markets turning against us.

This blows a hole in his entire raison-d’etre. His continued opposition to Labour’s economic strategy has been, and still is, that the markets will turn against us if we spend to create growth. So why does he not fear the markets now?