7.10.10

Inflation: Politicians' Final Gamble

House prices are begining to crumble... despite the best efforts of government to prop them up by flooding the banks with money.

Governments are desperate to stop house prices falling. Supporting asset prices is the key reason the central banks have been printing money, expanding the monetary base, turning a credit crunch into a looming crisis of excess liquidity.

If you doubt, here’s the Federal Reserve:
“Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.” (Brian Sack, New York Federal Reserve Markets Group)

Homeowners have votes but the banks and their property developer clients have clout. So the other purpose of flooding the banks with money is so they won't have to foreclose on developers and knock the price of their vanity projects into a chasm.

PRINT AND BORROW

But asset prices for commercial property and homes are falling. If all that printed money is not able to keep asset prices inflated, what’s going on?

Governments are printing money and lending it, very cheaply to banks. However banks are not lending it on, partly because they don’t want the risk and partly because few companies or individuals are prepared to borrow on the terms available.

So banks are lending the money back to the government by buying treasury bonds. Yes, governments are effectively printing money and borrowing from themselves. Nonetheless, printing on go they!

The US has just committed to a new round of QE and the UK’s Institute of Directors this week called on the Bank of England to keep the printing presses rolling. Japan has cut interest rates to zero.

The west is prescribing different medicine for China. It wants the Great Exporter to revalue its currency upwards - which would inflict carnage on US and European manufacturers who use Chinese parts but that's another story about political boneheads.

NAPALM FOR THE ECONOMY

How will it end, if all this liquidity is not finding its way into the real economy but is, nonetheless, devaluing paper money?

At the IMF meeting this weekend finance ministers will plead with each other to stop the currency wars, the competitive devaluation that threatens to do for free trade what napalm does for vegetation.

If politicians go ahead and bring world trade to its knees, prepare for stagnation. But still, they hope that despite stagnation abroad they can somehow bring about inflation at home.

That combination, of falling national wealth and devalued currency, will at least allow them to pretend to the electorate that their home's still worth a bit.

Flooding the markets with liquidity propped up asset prices for a while but, the longer QE continues, the less effect it has because, all the time, the currency is falling in value. Simples!

Hang on, homeowners. If only the banks keep printing, house prices may fall now, but inflation will appear to push them back up eventually.






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