Britain's extreme QE is dangerously counter-productive

Members of the Monetary Policy Committee agreed to expand the UK’s “quantitative easing” program by another £50bn, taking the cumulative total to £325bn. Back in March 2009, when QE began, the UK’s base money supply was equal to 7pc of annual national income. The increase since then has been absolutely enormous - an additional 15pc of yearly GDP. British monetary policy, to say the least, is in uncharted waters. And yet there are many who advocate that the Bank should do at least £500bn of QE. This column has criticized QE since the policy was launched. My original objection was the sophistry of the Bank’s claim that the UK faced “an impending deflationary spiral”, unless it took the extremely radical step of creating virtual credits ex nihilo, then using them to buy-up government debt. This is true even though QE is suppressing official borrowing costs, by keeping demand strong. Yet very little of that demand is coming from genuine buyers exercising their independent judgment.

Since early 2009, the Bank of England has bought more than half the £475bn of IOUs sold by the UK government. Another £100bn or so were bought by high street banks either owned by the government, and/or forced to buy more in the name of “macro-prudential regulation”. UK pension funds, run by professional investors acting largely as they wish, have reduced their gilt holdings over the last three years. So QE is designed to pump money into badly-run banks above and beyond the headline “bail-out” numbers. It also means the government can keep borrowing at historically high levels while not immediately feel the impact in terms of more punitive borrowing costs. The Bank of England, meanwhile, continues to maintain the fiction that this latest dose of QE, just like all the others, is part and parcel of its on-going and unshakeable mission to steer CPI inflation towards its target. “Without further monetary stimulus,” the Bank said last week, “it is more likely than not that inflation will undershoot the 2pc target in the medium term”. Really? Over the coming months, with the VAT rise of January 2011 dropping out of the numbers, inflation may come down a bit. Or it would, if the price of oil and other commodities wasn’t set to remain firm. Even the International Monetary Fund predicts crude averaging $100 a barrel during 2012, with many commercial forecasters seeing prices much higher than that.

Link...