In The Bank of England's incredible 315 year history no Governor has ever tried it, not even in very bad times before. Today Mervyn King will become the first man in British banking history to use the Fiscal Policy known as Quantitative Easing - for those of us who have not swallowed the Economics textbook it simply means to print more money.
Quantitative Easing (QE) - The Idiot's Guide
Imagine a pyramid made up of three layers of champagne glasses. QE is much like pouring in liquid into the glass at the top so that it overfills and cascades into the glasses below it which in turn fill and then overflow into the glasses at the lower level which also eventually fill and overflow. If you think of the top glass as the banks, the middle layer as business and the bottom layer of glasses as consumers, then what you see is pretty much the process of QE.
It's the idea that if you print a load more money, pour it into the banks, they will want to lend more to businesses who in turn offer us, the consumers, more credit.
Now the real dummies amongst us may point out that a great many transactions today do not use money and that therefore the process of printing more money will have far less relevance today than say in the period known as The Great Depression in the 1930s when the theory was honed.
All I can say is that the intelligent people who came up with this idea have pulled their heads out of the theory book, written all those years ago, and noticed that fact and have, of course, taken it into account. I think.
These intelligent people are the ones who have presided over the collapse of 5 major UK banks and pumped a great deal of money into the banking system already without any great effect but, keep quiet cynics, because now it's Mervyn King's turn - and he has kept a discrete distance from the fiasco to date, adding a few acidic words about policy every now and then. To a large extent, he has kept his credibility alive by doing so.
But today marks the start of his big gamble - one unprecedented in modern times. Let's all hope 'Big Merv' is right.
How Does It Work In Practice?
At midday today - as such is the pageantry of big banking business - an imaginary gong will go and the Bank will start to use its £75bn of new money it has printed to offer to buy £2bn of Government debt in the form of bonds from institutions.
It's some convenience to just go and print a load of new money and that's based on the concept of a 'Fractional Reserve'. This is vaguely about the notion that at any time The Bank of England has, say, £100bn in its coffers but it may print up to, say, £600bn of bank notes to go into circulation - remembering each bank note comes with a promise to pay the bearer the amount on the note its value should the bearer present it at The Bank. Fractional Reserve tells us that in practice no one ever does and certainly not at the same time - so we can print vastly more notes to go into circulation than their total promissory value held in the Bank's vaults. Quite how the Bank would pay these days as it no longer has any gold is another discussion entirely - but don't worry, our PM has thought of everything.
So the first of these bond auctions will start today and The Bank of England will be buying these £2bn batches of Government debt or Gilts. Two hours later, there will be a second stage when the institutions and banks will be allowed to participate in these reverse auctions - and similar activities will carry on twice weekly until all the new cash printed is consumed.
Gilt prices have risen sharply in the last few days as the financial system salivates at the prospect of more money being created out of thin air and being spent - it's just like a sucker walking into the East End with a wadge of new notes wanting to buy a car from Arthur Daley, there is not a chance in hell these Gilts will be a 'good deal'.
The top champagne glass is being filled starting today. The one snag in my analogy which is reflected in real life is that nobody knows how much the champagne glasses hold and so how long and how much money will it take to fill them all.
Deflation
This amazing gamble comes after The Bank has dropped interest rates to 0.5%, the lowest rate in history. This kind of Fiscal Stimulus goes into a new area known to some (i.e. me) as Fiscal Defibrillation - a series of very sharp and big jolts to the heart of the financial system to stimulate it into life. QE is the second major jolt, if you discount the meagre £1.3 trillion of bank bail outs, loans and guarantees on offer to the UK banking system. The disease that The Bank is trying to avoid is 'Deflation', the banking equivalent of 'MRSA' which is what the injured financial system may catch after its major surgery and tries to recover.
Thankfully, the financial system is not being treated by the NHS but by clever people like Mervyn King, Alistair Darling, Gordon Brown, Yvette Cooper and a host of really brainy, intellectual and incredibly greedy bankers. So our economy is in fine hands, as it has been for the last 10 years.
Deflation is a bit of a killer disease itself - it's the concept that just as the financial system is recovering then prices to start to fall rapidly - just as in the fire sales we have been seeing in shops. Consumers, of course, those irrelevant carriers of wealth that rich people would like to have, like lower prices - but we are not the important ones here. If bankers cannot make huge profits, where is the fun of loaning us money?
The perverse logic of deflation is that textbooks say that we, the evil consumer, will delay spending the cash given to us via our champagne glasses, in anticipation of yet lower prices - the concept that I will not go to the East End and buy that car off the nice man in the sheepskin coat and trilby this week as he will have a lower price next week. This of course has the effect of increasing the effect of the downturn.
When A Science Is Not Exact
The financial process of treatment and recovery is sadly not an exact science as we have seen so far from the vast bank bail outs across the globe, estimated at around $5 trillion and rising. Mervyn King grimly warns that he does not have any idea how long he has to keep printing money and how much will be needed to get us to spend again. All he knows, or should I say, thinks, is that eventually it will work.
That's why no one has ever tried it before. I don't know about you, but that really fills me with confidence.
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