Osborne & King deliver another dose of Keynesian medicine as a deflationary depression looms

Faced with a rapidly deteriorating domestic economy and a worsening global outlook, George Osborne and Mervyn King used last night’s annual Mansion House dinner to announce a coordinated stimulus programme of around £140 billion.

Mansion House circa 1920

Mansion House circa 1920

Mansion House (left) sits opposite the Bank of England in London’s financial district and is the venue for The Lord Mayor of the City of London’s annual Dinner to the Bankers and Merchants.

During his speech at the annual Mansion House dinner the Chancellor, George Osborne, told his audience that he was working with the Bank of England (BoE) governor, Sir Mervyn King, to “deploy new firepower”.

We are not powerless in the face of the eurozone debt storm,” Osborne said, “Together we can deploy new firepower to defend our economy from the crisis on our doorstep… The government, with the help of the Bank of England, will not stand on the sidelines and do nothing as the storm gathers… We are rolling up our sleeves and doing everything possible to protect British families and firms.

Fearing that the escalating crisis in the eurozone could lead to a severe credit crunch and higher interest rates here in Britain, Osborne and King announced aggressive monetary policy in the form of cheaper loans to businesses and households.

As the Financial Times reports, “At the heart of the package is a BoE ‘funding for lending’ scheme to cut bank funding costs in exchange for lending commitments. The Treasury claims the programme, designed to address the rising costs of loans and mortgages, could support an estimated £80bn in new loans. In a further effort to counter worsening market conditions, the BoE will also on Friday activate an emergency scheme that offers six-month liquidity to banks in tranches of no less than £5bn a month.”

In addition Mervyn King stated that “the case for further monetary easing is growing”, giving his strongest signal yet that a new round of quantitative easing is likely to be announced when the BoE’s Monetary Policy Committee (MPC) meets next month (4 & 5 July).

A textbook response

Nothing about this latest announcement is at all surprising. Indeed the initiatives are part of what Sir Mervyn called “a textbook response” to Britain’s economic woes that combine tight fiscal policy with active monetary policy. The text book he mentions is of course The General Theory of Employment, Interest and Money by John Maynard Keynes, as it is his economic philosophy that King, Osborne and the other G20 finance minsters are so diligently following.

In his speech Mervyn King talked about the fact that the eurozone crisis had created “a large black cloud of uncertainty” that is hanging over Britain, Europe andthe world economy as a whole. He went on the say that “the black cloud has dampened animal spirits so that businesses and households are battening down the hatches to prepare for the storms ahead. The result is that lower spending leads to lower incomes and a self-reinforcing weaker picture for growth.”

Mr Osborne also emphasised that the lack of aggregate demand (spending) was having a detrimental impact on the wealth effect, stating that “the economic and political strains of deleveraging and balance sheet repair in the eurozone periphery may prove unbearable”.

Osborne and King’s new emergency measures are designed to kick-start growth by injecting cheap money via the banking system. Unfortunately this is the same failed Keynesian policy that they have been flogging since the Great Recession began back in 2008.

Policymakers continue to ignore the evidence that sustained economic growth doesn’t come about as a result of stimulating demand. It’s precisely the policy of cheap money (low interest rates) that led to the multi-decade spending spree that created the debt crisis in the first place. Far from being economic enemy number one, deleveraging and balance sheet repair (combined with radical policy reform) are exactly what we need right now.

Unfortunately, because the debt deleveraging process has not been combined with the necessary measures to unleash the productive private sector, it has led (as you would expect) to a sharp drop in economic output. The problem is, we continue to focus on GDP and as measure of national prosperity, rather than more useful measures such as real disposable household income.

Much more to come

Neither Osborne nor King offered specific details regarding how much the programs could be worth, though it’s been estimated that they could provide as much as £140 billion (nearly 10% of GDP) in additional liquidity, and if I’m right these stimulus measures are just the beginning.

Yesterday the Managing Director of the Institute of International Finance, Charles Dallara, sent a letter to leaders attending the G20 summit. In it he said markets “will be looking expectantly for evidence of a globally coordinated policy response targeted to revive growth prospects.”

Reuters also reported that central banks are preparing a coordinated package of stimulus that would be deployed by the G20 nations if the crisis worsened.

The bottom line

I have no doubt that push will come to shove very soon and that when it does we will see even more money printing in a desperate attempt to prevent a worldwide depression. This action will turn a sovereign debt crisis into a currency crisis and as the value of paper money is destroyed, so the value of gold will continue to rise.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>