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AUGUST 9th 2006
One thing is abundantly clear: modern economists do not understand inflation - not even the meaning of the word. Rising prices may or may not be inflationary. When demand backed by purchasing power exceeds supply, causing prices to rise as buyers compete and bid up prices regardless of the cost of production or intrinsic value, that is inflation. When prices are adjusted upward to reflect real cost of provision, that is not inflation. Prices may have been artificially subsidised previously, and the adjustment merely reflects the transfer of the cost to the actual purchaser, user or beneficiary from the taxpayer and/or the national debt. Additional costs may be revealed (environmental for instance or other) that had not been properly taken into account. That is not inflation. Counting the recent rise in the cost of a university education as part of the index for calculating inflation is wrong.

When a commodity of which the production is truly international and the market price is globally determined rises in price due to world demand, this is not inflation either as far as any particular currency or monetary calculation is concerned. It cannot be compensated for and it is not caused by mismanagement of a given currency. A replacement commodity and technology must be sought. In the case of an oil price fixed in dollars, it will be seen that such a price cannot be fixed in dollars and indeed is not - that is why it has risen as the dollar has fallen. The only proper reaction to a rise in the price of oil is to face the fact that purchasers will have to purchase less if they can no longer afford to purchase in quantities they are used to.

I fondly thought, when the guardians of the Euro and the Pound over the past decade gave up fiddling monthly with the interest rate, that they had learned their lesson. No such chance. They are now convinced that because there have been price rises in certain areas they should raise interest rates. Wrong. Such a raise could itself be inflationary, being an artificial demand from banks for a return on lending that will obviously exceed the possible supply, give the monstrous indebtedness of the average family. There may be a case for the Bank of England to raise the interest rate, should the pound need defending through a sticky patch when a proper landing is planned ahead. But chasing a false inflation target by raising rates when the pound is strong is a schoolboy howler.

Global inflation is a special case. It entes the picture now and affects 'global poverty' statistics and national price rises which may or may not result in a national currency inflation.

NOVEMBER 12th 2006

While an exceess of demand over supply may exist in unmovables (Fr. immobile = buildings = property) in a given geographical area, this is not necessarily indicative of inflation in movables - items that can be easily shipped or are information-based services.

Before reading the next bit, consider the fact that MPs are thinking about lowering the voting age.
What they should be debating is the exams young people should pass before they can vote and the exams adults should pass before they can stand for parliament. Mr Keegan's excellent article is worth a careful read.

MPC's self-fulfilling prophecy

William Keegan
Sunday November 12, 2006
The Observer

More than half the population does not know who sets interest rates in Britain, according to opinion polls conducted on behalf of the Bank of England. Asked whether the monetary policy committee (MPC) sets rates, a mere 4 per cent replied 'yes'. Just over a third (36 per cent) said 'Bank of England', which provides five of the nine members of the MPC under the chairmanship of the governor.

When one considers the amount of publicity the Bank has had since independence day in May 1997, these are pretty amazing findings. But perhaps it is not that surprising. The official bank rate announced by the MPC - raised from 4.75 per cent to 5 per cent last week in line with market expectations - must mean little to the huge number of people in this credit-mad nation who take up offers in the post to borrow at annual percentage rates in the usurious high teens.

The then chief executive of Barclays Bank caused a stir when he told a parliamentary committee that people were crazy to borrow at the rates charged by credit card operators such as himself; but then most of the population don't enjoy the lines of credit afforded by top City salaries and 'remuneration packages'.

Way back in the 1970s remuneration packages at well below current levels and other 'perks' were justified, or rationalised, on the grounds that the top marginal rate of personal income tax was 83 per cent and top salaries had been restrained by a series of incomes policies. Tax rates fell sharply during the 1980s, and incomes policies disappeared from view, but the disparity between the salaries and perks of the financial and industrial elite and the rest of the country expanded exponentially.

I suspect if the Bank added 'what is an incomes policy?' to its questionnaire, well over 50 per cent of respondents would say 'don't know' - it has been so long since we experienced them. Similarly with credit controls.

On Wednesday Mervyn King will introduce the MPC's quarterly inflation report for the 56th time. His polished performance is rehearsed the day before, so that he is prepared for almost every conceivable question from the press about the reasoning behind interest rate changes, future prospects and so on. A hardy annual, or rather quarterly, is a question (or several) about house prices. The governor always goes out of his way to emphasise that the task assigned to the MPC by the Chancellor is to aim at 2 per cent inflation (not a percentage point more; not a percentage point less) and not to target (I have given up fighting this word's use as a verb) house prices.

Nevertheless house prices, and the confounding of many a forecast that they would collapse, are a hot topic of conversation, not to say speculation, and the governor recently indicated to the House of Lords Economics Committee that he was uneasy that the official index 'targeted' by the MPC - the consumer price index (CPI) - excludes housing costs.

It was bad enough that the CPI was 2.4 per cent above a year earlier in September (against the target of 2 per cent); but the all-items retail prices index (used for wage negotiations, and, in September, the indexing of certain benefits) was 3.6 per cent.

The all items index includes mortgage payments, and I seem to recall that one of the historical reasons for introducing the other indices was the effort somehow to overcome the unfortunate fact that increases in interest rates, designed to cool the economy down and reduce inflation, have the perverse immediate effect of raising the all-items index and making the inflation picture look worse.

Interest rates were raised last week because most members of the MPC, led by the Bank's politburo, are worried not only that inflation is above target, but that it may boost demand for higher wages ('second-round effects' of the oil price rise of recent years, which has only partly been offset by the recent decline). The MPC is trying to influence 'inflation expectations' by demonstrating its determination to err on the side of safety. This has been the tenor of speeches by several members recently, the lone dissenter (now that Stephen Nickell has retired from the scene) being David ('Danny') Blanchflower, who is based in the US and commutes monthly. Blanchflower, like Nickell, is an expert on the labour market, and knows a rising unemployment trend when he sees one. He is also no doubt aware, as that other transatlantic commuter Sir Alan Walters was in the 1980s, of the overvaluation of the pound, which may well be associated with the poor industrial prospects painted by recent business surveys.

The fact of the matter, as former MPC member Christopher Allsopp has pointed out, is that the 3.6 per cent rise in wage earnings (in the three months to September, at an annual rate) is remarkably low, and hardly inflationary, especially in the light of manufacturing productivity increases of 3.5 per cent (second quarter, annual rate). Indeed, the main factor stoking up inflation expectations may be the majority on the MPC itself, who keep drawing attention to what might happen to inflation, thereby risking a self-fulfilling prophecy.

There are lots of forecasts of continuing growth, but it may be that the CBI-type surveys and the insolvency, bankruptcy and debt mountain statistics are telling us something.

Credit where credit is due - and there is plenty of it about: so far the MPC has done better than I expected. But there is a huge imbalance between supply and demand in the housing market, and rising interest rates are hardly calculated to increase supply, while being very likely to send the pound even higher.

Certainly, it would be paradoxical if it turned out that the MPC had indeed stoked up inflation expectations by its recent speeches and actions.

JANUARY 11th 2007

Today's interest rate took the City by surprise. That's the good news. Good to know the Bank of England has the wit to feel free to adjust rates at times other than the totally predicatble. The bad news is that even so the innocent will be hit harder than the guilty. It is global demand, more than truly domestic, that is causing UK inflation. It is clear that many prices including food has been rising due to the pressure of demand. The demand is from the booming part of the UK economy servicing the influx of spending power in the hands of those using these islands as a tax haven and a business centre, and those lucky and able enough to provide these services. The rest of the country waits in vain for the trickle-down to save them. But by putting up interest rates, the Bank hits those who are 'on the wrong side of the drag curve'. Another divisory pressure on society. If it did the job, this would be more acceptable, but raising the UK bank rate will not stem the pressure of global demand on local assets and supplies by those who can afford to demand less. Inflation, as I stated at the beginning, is caused by supply and demand being unrealistically related (as in the case of stimulated locusts arriving on the wind from afar).

APRIL 17th 2007
I am getting tired of repeating that rising prices do not always indicate 'inflation'. Today we are told that
"The Bank of England governor was forced to write to the chancellor explaining why inflation jumped to 3.1% in March above the target of 2%."

Inflation is a symptom, a disease of the currency. It causes a currency to lose its value. So why, when the UK Pound is rising against the Euro and approaching a record high against the dollar are we talking about inflation? Why should UK citizens be faced with punitive interest rates when our currency is competing well against the two major world currency blocks?

If, for some reason, it should be decided that demand in this country is home grown, and an interest rate rise is required, can we at least stop calling the reason inflation.  Unfortunately such an interest rate rise will not stop the global investment in UK propert and will only encourage further purchasing of the UK Pound as repository of liquid wealth.

The Bank of England should realise that it is chasing its own tail. We have decided on a very open trading and investment environment while demanding the Bank treat our economy in isolation and apply ruies that only make sense in a closed equation that no longer exists.

We should STOP PLAYING WITH INTEREST RATES. Realise that to run a country responsibly you have to take the reins of economic power in political hands on occasions. We decided to stay out of the Euro, that has its advantages and its problems. They have to be faced. Some wage demands are being caused by rising costs of essentials. Raising interest rates will not deal with that. Oil prices are rising in dollars. Raising UK interest rates will make it cheaper in Pounds but is that desirable when we are aiming to make economic engines more popular? The position is ambiguous. Interest rates should be left where they are at this time and adjusted only with regard to interest rates in other major economies to keep a realistic value of the currency.

JUNE 20th 2007
Nice to see that at least one broadsheet (The Independent, even though I have ceased to purchase it as I no longer wish to subsidise the use of the front page as a poster to advertise the prejudices of the editor), has decided to raise the issue that the reason for the rise in house prices in key areas is due to demand by holders of offshore funds exempt from the pressure of either tax or UK interest rates, As usual, the UK newspapers are the last to catch on to anything important happening in the 21st century, just as they were in the 20th. It is of little concern that successful entrepreneurs who risk their money creating new businesses can make a lot of money and keep some of it. That helps build the national wealth. But if they then pile it all into UK property and services in a privileged financial status and environment that causes the Bank of England's policy committee to raise interest rates according to a blind formula that penalises the average citizen, that is bad. It has been going on for some time, and it could have been foreseen before it even started. If journalists wish to keep government up to scratch they need to do more than notice that arms deals of more than 20 years ago were done under rules that might not be approved of today and then cause such trouble that our major defence manufacturer risks losing huge contracts in both Saudi Arabia and America to competitors who have no scruples whatsoever. Homer Simpson has nothing on Fleet Street.

JULY 5th 2007
Interest rates have gone up again to 5.75%. I think this is damaging, and if it is the only way that inflation can be tamed then we have to find another, as this makes no sense. Government debt as well as personal debt has to be curbed, and in theory (not my theory) this is one of the ways to do it. But there are parts of the equations that lie outside the theory and values that fall outside the equations altogether. Of course it will have a desired effect in some ways, but it will also create new problems which we do not have established means to solve. The global economic model is not what it was and, as I have pointed out in several contexts, the UK economy has divided into two. We have avoided a boom and bust cycle by having boom and bust simultaneously. The rise in interest rates will bring pain to those who need it like a hole in the head and those whose inappropriate borrowing has been encouraged by banks and institutions who were only to happy to lend their surplus profits from the booming sector in the 'sub-prime' market, secured by property.

Indebtedness is a greater problem than inflation as a UK national problem. Inflation is at the moment being caused more by global economic forces and international funds than by UK consumer demand sensible to UK interest rates. Government spending and government borrowing is complex in its effect under current circumstances. Some spending is not inflationary, some borrowing is less inflationary than other borrowing. However it should not be the purpose of Bank of England independence to relieve both Bank and Government of responsibility for managing the economic limits. Other European countries have severe economic problems too but they face them in most cases with more social solidarity.

AUGUST  8th 2007
It was fondly thought that a collapse in the US sub-prime market would not 'travel' so as to hit European and world markets. How wrong. Just as global forces can cause national inflation in specific areas, a collapse in a big enough specific national area can affect global liquidity. The US sub-prime market is very large and many organisations and funds world wide are invested in bonds linked to it.

AUGUST 16th 2007
About time a reality check kicked in. Key economies are strong but a major cause of inflation (true inflation - financial obesity caused by artificial demand) has been pricked. This should prevent the Bank of England from further pathetic playing around wih interest rates - the job is done for them. The central banks should stand back now and only act in concert in the last resort. It is going to hurt, but the wild west of hedge funds has got to end in a shoot out. There is going to be blood on the ground, some of it innocent collateral damage, but if it had gone on for longer it would have been worse massacre in the end.

SEPTEMBER 1st 2007
One result of this shakeout is that although a serious cause of inflation has been removed, there will be a cost to pay even if the central banks do not raise, and some even lower, interest rates. The high street banks will be much more careful in their dealings. Savers may not get do any better and borrowers will pay more. There will of course, one hopes, be intelligent exceptions and also (hoping again) they will not always favour those who need them least.

SEPTEMBER 4th 2007
Well, well, it is good to see that top bankers are aware of the problem...
This is from The Independent, yesterday.

Stephen King: To protect the innocent you may need to bail out the guilty

Published: 03 September 2007

When should you protect the innocent even though you may, in the process, let off the guilty? A pacifist would presumably say "always" because war, by its very nature, leads to the slaughter of innocents (or, in our world of media spin, gives rise to "collateral damage"). Those in favour of zero tolerance for all forms of crime might have to say "never" because no judicial system is ever going to weed out those who truly are guilty from those who are wrongfully accused. And then, to make things more complicated, there are those occasions when saving the life of one innocent person requires the loss of another (think human shields or life-threatening child-birth).

When policymakers consider such issues, they junk their natural moral absolutism and turn to the ethics of Utilitarianism, typically defined as the "greatest happiness of the greatest number". Utilitarianism is, of course, far from perfect, a point made forcibly by Aldous Huxley in Brave New World, but, for those who govern, it has the advantage of allowing decisions by numbers. Policymakers can think in terms of costs and benefits and reach a conclusion which offers the illusion of objectivity.

Policymakers' responses to the sub-prime crisis and the possibility of a credit crunch will, ultimately, depend on their views about the protection of the innocent and the punishment of the guilty. Admittedly, the choices won't be quite as wrenching as those faced in other spheres of public life but it's already becoming apparent that the Utilitarian calculations shaping policy decisions are beginning to shift. At first, the attitude towards the sub-prime problems was one of zero tolerance. There would be no bail-out because both lenders and borrowers should have known better. In a matter of days, though, policymakers' attitudes began to evolve.

When things first started to go wrong, the crisis was lodged firmly within the banking system. Many banks and other financial institutions owned collateralised debt obligations (one of a variety of structured products). The values of some of these structures were underpinned by sub-prime debt. These underpinnings clearly weren't terribly strong. It wasn't long before faith in asset-backed collateralised debt obligations was gone and, with it, liquidity dried up. No one wanted to lend to anyone else, because no one knew what exposures others had to CDOs and, indirectly, to the riskier end of the US housing market.

Liquidity crises, though, do not discriminate well between those who deserve to go bust and those who don't. Although, at first, the attitude from central bankers was from the Dirty Harry school of thought ("You gotta ask yourself one question – "Do I feel lucky?" – well, do you, bank?"), this approach quickly mellowed as the dangers of a liquidity crunch became all too clear. Central banks injected liquidity, the Federal Reserve cut its penalty discount rate and the liquidity crisis began to ease.

The debate has since moved on. The big fear now is the onset of a credit crunch. In simple terms, a credit crunch can be regarded as a tightening of monetary conditions for a given level of policy rates. In other words, lending standards in the financial system tighten independently of any decisions made by the central bank. For the man or woman on the street, this may imply higher borrowing costs, bigger required down-payments for the purchase of a property, a lowering of maximum income multiples for mortgages, tougher foreclosure conditions and so on. Put another way, even if interest rates aren't particularly high by historic standards, the ability to borrow (and to renegotiate terms on a favourable basis) is reduced.

This, in turn, may have a series of negative effects on the broader economy. If people cannot borrow so easily, demand for the new car or the loft conversion may begin to decline. Tighter mortgage terms may mean people have to spend more of their income repaying their mortgage, leaving less available for the trip to the local restaurant or ball game. In time, these downward multiplier effects may lead to rising unemployment and, eventually, the onset of recession.

It's for this reason that President Bush chose to step in last week. His proposals to expand the role of the Federal Housing Administration in order to help with the refinancing of sub-prime mortgages and his call for lenders to show greater flexibility towards some of their more distressed customers are recognition of the potential severity of a possible crunch (and its associated loss of votes): "I've made this a top priority to help our homeowners navigate these financial challenges so that as many families as possible can stay in their homes."

Soothing words, perhaps, but they don't quite deal with the underlying policy problem. Central bankers (more so in Europe than in the US) have been worrying for a number of years about the degree of excessive risk-taking within the financial system, whether reflected in rapid money supply growth, incredibly high correlations of returns across both asset classes and geographies, the innovation of structured products or the emergence of private equity (which, supposedly, turns base metal into gold). We may now have the makings of a credit crunch but, arguably, its foundations were laid during the earlier credit "bubble" – when financial conditions were unusually lax for a given level of official interest rates. Perhaps central bankers were also in the wrong, refusing to raise interest rates quickly in the light of the US housing bubble (and similar housing bubbles elsewhere), all too happy to argue publicly that the gains in house prices were simply a reflection of welcome financial innovation rather than of lax lending standards.

If a credit crunch develops, it will ultimately reflect a revised view of the risks associated with the various products that sprang up in the earlier credit boom and which did so much to secure a healthy growth rate and a high level of employment in the US. At the moment, there is no desire to provide any bail-outs for the institutions (or, indeed, the reckless borrowers) which now are seen to be at the epicentre of additional risk-taking. As Ben Bernanke, the chairman of the Federal Reserve, put it, "It is not the responsibility of the Federal Reserve – nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions."

Fine words and, for the most part, entirely understandable. A bail-out of the reckless, the gullible and the unscrupulous should not really be part of public policy. It creates the classic moral hazard problem, allowing people to believe that the public purse will always be opened to "reward" bad behaviour (the financial market version of this is the "Greenspan put", the idea that interest rates will always be cut to ward off financial distress, thereby encouraging people to take stupid risks). At the end of the day, though, people know that the economy, or the banking system, is "too big to fail". After all, the Savings and Loans industry was bailed out from 1989 onwards, even though its problems resulted, once again, from the behaviour of the reckless, gullible and unscrupulous.

In wartime, policymakers have to accept the death of innocents. In peacetime, society demands the protection of the innocent. Sometimes, though, it's not possible to provide that protection without bailing out the guilty. The moral hazard problem won't easily go away. After all, there will always be those asking themselves Dirty Harry's question – "Am I feeling lucky?"

Stephen King is managing director of economics at HSBC:

NOVEMBER 17th 2007    

Although the forecast below may be true for parts of the UK, and prices will fall in some places, wherever property looks like a good investment for overseas buyers the prices will hold and even rise.

House price growth to hit zero in 2008

Reuters - Friday, November 16 02:33 pm

LONDON (Reuters) - Annual house price inflation in will fall to zero next year as affordability constraints are compounded by tighter lending conditions, the Nationwide building society forecast on Friday.

If realised, this would be the weakest year for the property market in more than a decade.

"Economic tailwinds are turning into headwinds and house price inflation is expected to drop from the current rate of 9.7 percent to zero percent by this time next year," Nationwide said.

Nationwide said the main reasons for the subdued outlook are a slowing economy, tighter credit conditions, prices beyond the reach of many first-time buyers and lower price expectations.

It said interest rate cuts and a lack of supply would provide some support to the market but would not prevent a significant slowdown.

Lower buy-to-let demand is also likely to take the steam out of the market.

Nationwide's forecast is similar to that of the Council of Mortgage Lenders which is predicting house price inflation will slow to 1 percent next year.

(Reporting by Christina Fincher; Editing by Ian Jones)

DECEMBER 14th 2007
Gordon Brown is right to resist the Police Federation's insistence that the government must implement the award of the arbitration committee on Police pay. Of course the Treasury could afford it, but it could not affaord the knock-on consequences, consequences there is little doubt the PM has researched. Yes, it is uncomfortable to undermine the status of the arbitration committee and that would weaken its utility in the future. But the fact is the basis of Police pay has to be re-examined, and the arbitration committee is not the authority that decides our financial and monetary policy. It made a reccommendation which, on this particular occasion, the government has delayed for good reasons.

Menwhile there is a storm raging in the global investment markets - or should we say a black hole that threatens. Care, cooperation and steady nerves may succeed in preventing its arrival.

This article in The Independent sets out some parameters.

Cautious optimism for a new plan: The $100bn bail-out but will it make a Difference?

After the G7 central banks agreed to give unprecedented support to distressed capital markets, Stephen Foley in New York and Sean Farrell ask whether the move will help stave off global recession

Published: 14 December 2007

Five of the world's most important central banks had joined together to promise they would rescue the stricken credit markets, but investors can't decide between euphoria and more despair.

The credit markets didn't suddenly thaw, banks didn't instantly start lending to each other again, the crucial inter-bank interest rate that measures these things stayed stubbornly close to its highs. But yesterday's gloomy predictions that the interventions are failing are as premature as Wednesday's elation.

What exactly do we mean when we ask, will it work? There are two main measures. First and foremost, the central banks are trying to avoid any more banking blow-ups such as the one at Northern Rock in September. That has been a particularly acute concern as the end of the year approaches, an important moment in the accounting calendar when banks may need to top up collateral for loans and recapitalise other parts of their business.

Secondly, and more broadly, the central banks hope to thaw the frozen credit markets and bring down market interest rates. Banks and the money market funds that grease the financial system have become more reluctant to lend to each other, because they have their own requirements for the money and because they fear their rivals may not be able to pay them back. That has a cascading effect through the credit markets: businesses have found it harder and more expensive to borrow cash to fund their operations, mortgages are harder to come by, the wider economy is threatened.

On Wednesday, central bankers unveiled a raft of creative ways to encourage institutions to come to them for funds instead of relying on each other, in the hope that this will, eventually, reduce the fear that has paralysed the markets. Where normally the central banks would hand out loans at a predetermined, punitive, interest rate via what is called the "discount window", they will next week begin offering more than $100bn (£49bn) of loans by way of an auction. As well as reducing the stigma, it should also reduce the interest rate on borrowings from the central banks, and that might be enough to tempt in participants looking for a bargain.

Andy Hornby, the chief executive of HBOS, said he did not understand the market's negative reaction yesterday. "I only see upside in it. It is good to see concerted action. These are worldwide markets. All wholesale markets are by implication global."

He predicted that banks will participate in the auctions, the first of which are being held by the ECB and the Fed on Monday, with the Bank of England following on Tuesday. "There will be general demand for more," Mr Hornby said.

John Ewan, the director of the British Bankers' Association, said that other members were also cautiously optimistic about the new plan.

"Banks don't want to use the discount window because, whatever the reason they use it, they can be perceived as having trouble funding themselves. And as we know, it is a short step from the perception of Bank X being in trouble to Bank X really getting into trouble," Mr Ewan said, making a nod to the run on Northern Rock.

"The sums involved in the central banks' intervention are relatively small in comparison to the size of the losses suffered on sub-prime mortgages, which are estimated in the hundreds of billions of dollars. But central banks have left themselves room to intervene again in the coming weeks if it is necessary. More of the same would be welcome, but the members I have spoken to are happier than they were two days ago."

Jonathan Wilmot, the fixed-income researcher at Credit Suisse, said he suspected the Fed was keen to encourage arbitraging. In other words, that banks would participate in the auction in the hope of raising funds at a low level, then lending them straight back out to other institutions at what is currently a high inter-bank lending rate, known as Libor. That extra supply would then drive Libor down closer to the target interest rates that the Fed, the Bank of England and others use to manipulate their economies.

But the Libor interest rate did not crash yesterday, disappointing many who had expected that the central banks' announcement on its own would be enough to ungum the credit markets. In the eurozone, the cost to borrow for three months remained completely unchanged at 4.95 per cent, 95 basis points more than the ECB's benchmark interest rate of 4 per cent, compared with 57 basis points a month ago. The difference averaged 25 basis points in the first half of the year, before losses on securities on US sub-prime mortgages contaminated credit markets. Sterling Libor dropped a modest 12 basis points.

In a note to clients, Mr Wilmot wrote that reducing the rates at which banks lend between each other "will depend on the willingness to lend and not hoard new deposits received [from central banks]. The jury will remain out on this measure until we actually see how banks behave with this money."

The BBA's Mr Ewan concurred. "There is not likely to be a moment where we can say 'gosh, chaps, it's almost like June again'. Libor is more likely to come drifting down rather than drop suddenly."

Mr Wilmot and his colleagues at Credit Suisse yesterday also highlighted other ways that the central banks' new plan will alleviate pressure on financial institutions. By widening the types of assets that can be used as collateral to include some types of mortgage-backed credit derivatives (called collateralised debt obligations, or CDOs), the Federal Reserve will be reducing the unwanted supply of these riskier types of assets in the market.

Best of all, the face value of many CDOs is higher than they would actually fetch in the market, so handing them to the Fed as collateral for a loan is much better for a bank than selling them. At the very least, banks are delaying crystallising their losses, and may avoid a big loss all together if prices rebound in the new year.

John Lonski, an economist at the credit rating agency Moody's, is another with a "jury-is-out" viewpoint, but he suggests that credit markets are gripped by an irrationality that might not properly be shaken until the outlook for the US economy is clearer. Junk bonds are pricing in a significantly sharper rise in corporate debt defaults than seems likely, he says, and the value of mortgage-backed derivatives suggests a higher rate of defaults by borrowers than seems possible. And yet, markets continue to demand big interest rate cuts by the Fed to stimulate the whole economy.

In other words, the markets simply are not listening to central banks.

"We continue to see a high level of risk aversion in the banking sector, but it does not appear to be reflected in the observable fundamentals.

"It's a battle. The Fed clearly does not think the outlook is as dire as the financial markets believe," Mr Lonski said.

"Of course, we are looking at the deepest cutbacks in financial services sector employment since the early Nineties, so perhaps it is understandable that Wall Street has a gloomy view of the prospects for 2008."

Off-balance-sheet rescue plan

The casualties of the credit crisis are littered all around – among them, rescue plans meant to ease the crisis.

Less than two months ago, Hank Paulson, the US Treasury Secretary, was trumpeting an idea meant to prevent tens of billions of dollars of losses on the secretive off-balance-sheet vehicles created by investment banks such as Citigroup, Barclays and others.

Citigroup said it was leading a consortium of financial institutions to create an $80bn-$100bn fund that would buy up mortgage-backed debts that few other Wall Street investors now want to buy. The plan was thrashed out at meetings organised by Mr Paulson, but even his intervention could not rouse significant support.

All week, Citigroup and its two partners, Bank of America and JP Morgan Chase, have been trying to drum up money for the fund, but it is clear that it will have to be scaled back. Executives at two banks, Sumitomo Mitsui of Japan and the US-based Wachovia, played down the importance of the fund, while many others behind the scenes have turned down a chance to participate.

The aim of the fund, called the Master Liquidity Enhancement Conduit (M-LEC), is to prop up dozens of off-balance-sheet vehicles – known variously as structured investment vehicles, SIVs. SIVs raise money at low interest rates in the short-term debt markets to buy longer-term investments, mainly mortgage-related securities, which pay a higher interest rate. The value of the longer-term assets has collapsed, however, and SIVs are finding it hard to find outside investors to refinance them. The M-LEC is meant to step in as a buyer of last resort for assets that might otherwise have to be sold at fire-sale prices.

Analysts say that banks are finding other, albeit more painful, ways to resolve their leaking SIVs. HSBC has bailed out its vehicles by taking the assets on to their balance sheet.

Stephen Foley

JANUARY 8th 2008
The PM and Chancellor have been at a press conference discussing future plans and policy with particular reference to inflation. There are plans to go for three-year pay settlements in the case of public service employees, where appropriate, to bring stability. This has resulted in an interesting cross-wiring of the logic in discussions on inflation between the government, the unions and media commentators.

A rise in energy costs is taken by some as automatic, de facto inflation. I have discussed this elsewhere on this web site. A rise in energy costs can (indeed has been) the cause of rising prices; but it is not necessarily inflationary in a particular economy or context. A rise in automotive fuel costs in the UK may well mean that individuals will have to reduce their non-essential travel, whether motoring or public transport. They may have to reduce their non-essential purchases. It has already been proved that most of us not only eat too much but throw away one third of the food we buy. A rise in the cost of energy could and should reduce excessive demand and unnecessary consumption and wastful purchasing. The result will be a reduction in demand, which is anti-inflationary.

For this reason the inflationary and deflationary forces that RESULT from inflation of oil/gas/coal prices need to be taken into account. We are in for a belt-tightening period. The PM and Chancellor are explaining politely that printing money to avoid facing reality is not clever, as anyone who has studied what is happening in Zimbabwe will tell you. Since millions of UK families are heavily in debt, keeping interest rates down is vital, and that means removing inflation as one of the reasons for rate rises. I do not go along with the direct and only linking of inflation to the setting of interest rates by our Monetary Policy Committee but it has to be accepted that it is key.

Coming soon will be a decision on nuclear power generation. Those who think we should not replace our current nuclear stations, let alone build any more, should try to get their heads round some reality. Fossil energy source cost inflation is a global reality. We have outsourced most of the procuction of our non-essential purchases and even some essentials to Asia. We need to use our organisational experience and skills to create a nuclear power base worthy of our capabilities and suitable to our needs.

JAN 13th 2008
I should elaborate on Nuclear (above). In the 1980s I was for a moratorium on Nuclear Power. I believed the cost and indeed the energy expended in building, maintaining and decommissioning nuclear power stations and dealing with the acquisition and processing of fuel and dealing with waste was high enough to be a significant factor in deciding in favour of other sources of power. However, the French experience has proved that  nuclear (fission) power can produce more than it consumes, regularly and safely.
The waste disposal problem must now be clearly separated into NEW and OLD. We have to accept we made a pigs ear (under great pressure to economise) over the handling of waste in the past. Maybe some of that mixed and bulky waste should be buried deep down. New waste is a different matter. I think it should be kept in surface storage which can be completely and economically protected physically against any unauthorised or violent access. In terms of volume it will not be large. In the future it may be treatable and even usable.

JANUARY 22 2008
The Governor of the Bank of England states that he expects a slowdown in the economy as part of a necessary global adjustment. I think he also said that inflation would not necessarily fall to its target level. But here I am not sure that 'inflation' is being properly defined. In this file we have already defined it as a growing demand outsripping supply, or a collapsing supply failing to meet an existing demand. It is clear, however, that demand backed by purchasing power is about to decrease in the UK, the US and some European countries.

Demand in the expanding Asian economies that are taking over some of the role of 'workshop of the world', a title once held by the UK and the US, can admittedly cause inflation in energy and some commodity prices. It must be this inflation that the Governor is refering to. If so there is no need for the Monetary Policy Committee to raise interest rates to counter it. It is not home grown. They can continue to lower rates. A fall in the value of the Pound is of coyrse two-edged and will make imported inflation worse, but we do still have exports and it will help these. On the whole I am in favour of the Pound falling and the citizens of the UK wasting less food and favouring domestic industry, farming and suppliers a bit more.

MARCH 13th 2008
One indicatior of GLOBAL INFLATION is the price of gold in a representative basket of currencies. The US dollar has to be counted representative of course because of the size of the US economy in terms of hardware, food and global services. I haven't worked it out yet but I would say we have some real global inflation as many virtual stocks of wealth have evaporated. Hedge funds are imploding. We live in interesting times.

MARCH 17th 2008
There is no need for the Bank of England to raise interest rate to curb inflation of fuel prices It is not sterling demand for fuel that is causing the price rise, it is global demand in other currencies.  With house prices no longer contributing in their previous excessive way to inflation outside the official index, and fueland food prices beyond our control, it is wrong to seek to reduce the purchasing power of indebted British citizens in the absurd hope it will cause prices of anything to fall. We badly need more home energy production from Nuclear, clean coal, solar, wind and water with the emphasis on Nuclear, water and clean coal.

MAY 20th 2008
It is being pointed out that global inflation is being exaggerated because traders in commodity futures can mske money by causing inflation in commodity prices - a speculative bubble. There is truth in this because of the credit crunch and all the reasons that make investors flee other markets. It will be self-correcting, but it is certainly true that whereas the futures market had traditionally been a mechanism to even out troughs and peaks and give stability, when the world and his wife climbs into the futures market (via the professionals who handle their pension funds etc. etc) and the banks follow suit (on their own account and that of their clients), and the sovereign funds and the mafia and the drug dealers all get in on the act, then there is going to be a bubble effect. Oh well, we will see...

Eventually, this mess should result in an understanding that we need to rorganise the theory of taxation. Tax should be levied on energy consumption and on waste (of materials, food and all matter that has absorbed energy in its production). All other forms of taxation cold then be abandoned other than user taxes where appropriate, a simple peronal income tax and VAT. VAT should be applied directly to commodity trading to control it and to raise revenue. Of course international agreement will be required. It will never be possible to avoid some booms and busts, total stability is achieved only in death, but the present mess is not clever and does not help us to deal with the global problems we face.

JUNE 9th 2008
The penny is dropping...

International Herald Tribune
Dollar's strength seen as pivotal in global battle against inflation
Sunday, June 8, 2008

LONDON: The fate of the dollar will be pivotal for global financial markets this week as the world's two most powerful central banks battle the commodity-driven inflation that has been spurred by the dollar's long slide.

The dollar has been left on a knife-edge after a week in which the Federal Reserve and the European Central Bank appeared to compete for the prize of the toughest inflation fighter.

As a stream of global economic data sent conflicting signals on rising inflation and slowing growth, the outlook for all financial markets has rarely been hazier.

"Concerns about inflation have increased considerably among all central banks," said Dale Thomas, head of currency management at Insight Investment in Britain. Both the Fed and the ECB, he said, "have signaled they will have tighter monetary policy than people had expected."

Thomas said the desire to have a strong dollar was undermined by the fact that apart from the United States, the rest of the world is tightening policy.

The United States "wants all things without taking pain," he said.

The Fed chairman, Ben Bernanke, fired a rare warning shot on Tuesday about the inflationary threat from a weak dollar, setting off an across-the-board rally in the dollar.

Two days later, the ECB president, Jean-Claude Trichet, shocked financial markets by saying interest rates could rise next month, unleashing a wave of euro buying.

The only clear losers were government bonds, as investors expected the Fed to leave interest rates unchanged instead of cutting them further and the ECB to raise the cost of borrowing next month.

Currencies could figure prominently when Group of 8 finance ministers meet Friday in Osaka, Japan, the last in a series of high-level gatherings ahead of the annual meeting of G-8 leaders in July.

Investors will seek more clarity on monetary policies of major economies from speeches from central bank chiefs in the United States, the euro zone, Britain and Japan.

Data on housing markets, retail sales and prices in the United States and Britain could further paint a stagflationary picture of rising prices and slowing growth.

After Trichet's signal on interest rates, 2-year government borrowing rates in the euro zone surged to an eight-year high, above 10-year borrowing rates. The resulting yield curve inversion is at its widest since the introduction of the euro in 1999.

Stocks, as measured by MSCI's world equity index, benefited from a rout in bonds, drawing in funds that fled government securities, before weak U.S. jobs data sapped risk appetite on Friday.

On Thursday, the euro rallied more than 3 U.S. cents from a three-and-a-half-year low, re-igniting a rally in oil prices that had fallen earlier in the week when the dollar rose.

Thursday "was disastrous in terms of global cooperation," said Nick Parsons, head of market strategy at nabCapital.

"We had just got to the point with Bernanke talking up the dollar, with euro/dollar moving lower and oil prices $14 off their highs," Parsons said. "I do not think, despite the widening in spreads with the U.S., that euro/dollar is going to make new highs."

Before the G-8 meeting, Parsons said, "there will be a sustained effort on the part of the politicians and finance ministers to be talking down the euro/dollar."

After moves in U.S.-euro zone interest rate differentials, the financial fair value model from Barclays Capital suggests that the euro may be undervalued by as much as 1.5 percent against the dollar.

A central bank that backs its words with action will ultimately have its wish for a stronger currency granted, said Thomas, the currency strategist at Insight Investment. In this case, the ECB, which is likely to raise interest rates next month, will see a stronger euro.

"That's what happened historically and that's what will happen this time," Thomas said. "Not everyone can have a stronger currency. We are likely to test new lows in the dollar."

In addition to speeches expected this week from Bernanke and Trichet, financial markets will receive interest rate decisions from Japan and Canada.

The Bank of Japan is unlikely to raise the cost of borrowing from the current rate, 0.5 percent, the lowest among industrialized nations, until early next year.

But the Bank of Canada is expected to cut interest rates by a quarter percentage point from 3 percent before winding down its aggressive easing campaign.

Investors will also keep their eyes on the annual conference of the British Bankers' Association on Tuesday; The Bank of England governor, Mervyn King, is expected to attend.

The British financial sector suffered last week after Bradford & Bingley issued a stark warning on the mortgage market and reduced the price of its emergency fund-raising.

"We have barely scratched the surface of the deleveraging that is needed on all the banks," said Neil Dwane, chief investment officer in Europe at RCM, an equity arm of Allianz Global Investors.

"We are about to have a normal bad debt lending cycle."

A survey on British house prices is also expected this week after a series of reports suggested that the property market downturn was gaining momentum.

JULY 8th 2008
The thing to do with interest rates now, as I have said before but repeat, is TO LEAVE THEM ALONE at 5%, which is where they should be. The government needs to intervene in other ways tactically in the economy as required to fit the UK economy for survival in the global situation, while also avoiding internal disasters that would affect social cohesion. Not easy, but the current government and civil service is quite as capable as any alternative bunch of doing this. The idea that we should swap the Labour team for Tory or Liberal in the near future seems to me pointless. There is no doubt we shall see economic events which if they persist could be called recession, but classifiying the situation does not make it any better or worse. The only annoying thing is that there will be some bastards who will be making a fortune out of these events, and they are not the craftsmen, artisans, designers and builders who make the world a civilised and beautiful place. Nor will they be those investors who back the aforementioned when they identify them. They are are instead the wheelers and dealers who play with money, regardless of any criterion than the bottom line in the rolling short term.

OCTOBER 3th 2008
Although I have argued for a long time that the UK interest rate should be left alone, and that 5% is a good place to leave it unless there is a big change in circumstances, I would not throw a hissy-fit if next week it was dropped to 4.5% due to special circumstances. But my argument is still that if the circumstances are that special and this would really help and is necessary, then why not 4%?
5% is where were want to be. Interest rate change is not the answer to the systemic problem.

OCTOBER 5th 2008
While the Bank of England's independence can remain a fact as far as management is concerned, and its policy can remain in the hands of its policy committees, there is no doubt that in the present crisis careful coordination is required with the goverment in power. This is clear when we consider that even the Tory opposition has decided to coordinate its policy with that of the government. The terms of reference of the Bank's Monetary Policy Committee can therefore take account of expected and current values other than that of domestic inflation measured by sometimes arbitrarily selective criteria. Government will have to share and coordinate its plans with the MPC.

I am glad to see reality is coming home.

OCTOBER 8th 2008
BRAVO!!  A half percent interest rate coordinated internationally with Europe and the US - that's the way to do it!
I am moved. I didn't know if they were up for it*, either the drop or the essential coordination. Well done. And the rest of the package is the best that can be done for now.

*Bear in mind, when I write all the stuff on this site I never discuss matters with anyone or even meet anyone involved with any decisions, before during or after my entries, (with very few exceptions - I do sometimes accidentally meet and share a meeting of minds some time afterwards, with someone relieved to be able to do so). These files are a solitary exercise built on an autodidactic base, for a purpose that will become apparent later.

NOVEMBER 6th 2008
As noted in the Recession diary on this site over the last month, Bank of England Interest Rate had to drop further and could do because the US and Euro rates were also dropping. I expected a 1% drop today, but not the 1.5% taking it well below the Euro rate. But the MPC clearly knows what it is doing now and why. 1.24 Euro to the Pound is the rate at the close of business. I am impressed by the clarity of this decision.

News Release
Bank of England Reduces Bank Rate by 1.5 Percentage Points to 3%

6 November 2008

The Bank of England’s Monetary Policy Committee today voted to reduce the official Bank Rate paid on commercial bank reserves by 1.5 percentage points to 3%.

DECEMBER 15th 2008
Noting the descent of the Pound Sterling toward parity with the Euro, Yvette Cooper (I think it was she, or was it the other one) said the Monetary Policy Committee was "not targetting Sterling, it was targetting inflation" . The Pound would be left to its own devices to stabilise naturally over time. It had been proven in the past that spending reserves to support the Pound was money wsated.

Now that is perfectly true, but what she seems to have overlooked is that one reason for targetting inflation is to preserve the relative value of the currency. Tightening monetary policy for UK citizens, consumer, producers and investors, cannot control global inflation except in concert with all other major economies. That implies MPC monetary policy was used to target UK inflation and ensure the strength of the pound.

If the Pound falls too far, we bring about de facto price rises in the prices of all imported goods, services and comestibles. Since we use a lot of those, letting the Pound fall is felt to be inflationary for UK citizens (but see my opening para in this file). Of course it is not the cause of inflation in global goods, services or comestibles so in that sense the MPC can be said to behaving responsibly. Their job is to target the cause of inflation to prevent its future arrival.

If you have understood what I have just written you will appreciate that what is inflationary pressure for the MPC is nothing of the sort, necessarily, for UK consumers.

Our exporters can do well as the £ falls if the cost of imported raw materials is a small part of the selling price of their goods in Sterling. In this way the current situation can encourage business to use UK labour. But, let us face it, no business is going to switch its country of production of ACTUAL GOODS to follow fluctuating exchange rates when it takes a long time to establish a good workforce, premises and reputation. WE NEED SOME STABILITY as I point out every day and enshrined in my autobiographical poem on this site as my message for the decade. It may seem paradoxical that we need stability to make a great leap forward but understanding paradoxes is the secret of the future survival of  humanity. You can listen to me, or you will be listening to some noises soon that you do not like.

If the UK is to become a place where no actual hardware goods are produced but we rear our own animals and grow our own crops for food and those not employed in that sit at computers managing the global trade and finance of the rest of the world, then you can ignore my warnings. If you can construct a model of the global and national economy where that makes stable sense, let me know. You could do it, but not with current UK population consisting of people of whom the majority who know little or nothing about farming or the countryside on the one hand and can't compete mathematically or literarily with the best of the rest in the global community on the other.

FEBRUARY 15th 2011
I have felt it unnecessary to say anything since my last entry on the subject of inflation although in other parts of this web site you will see that while I have accepted the quantitative easing policy of the Bank of England I have always put great emphasis on the need for international coordination, IMF participation and future control, and serious attention to problems in the EU which have to be fixed. Now, we have some silliness again whereby a rise in prices caused by global demand and a rise in global production costs, combined with a deliberate rise in VAT and a natural rise in UK petrol price, is being classed by the single word INFLATION. The irony is that while an increase in UK interest rates would not have stopped this and an increase now will only make life tougher with little effect on the price rises, the refusal of the MPC to move off the extreme low level of interest to a 1% level where it should be is now made more difficult. The whole mechanism has become decoupled. In short there is NO manipulative solutionj to our woes and the standard of living for US citizens will now FALL and that is that. The bleatings of Milliband junior are pointless and any aggressive actions by the Bob Crowe school of industrial economics will be counterproductive.

MAY 11th 2011
The Governor or the Bank of England has pointed out the obvious: that rising fuel prices will be a significant reason for what we still call 'inflation', because the world demand, together with both long term and temporary short term restrictions on supply, is driving up up the price of oil and, as a result, gas. The decomissioning pf Japanese nuclear plants has added to the problem. It is not a UK domestic inflationary problem at source, so once again fiddling with the bank rate is irrelevant.
The predicted 'fall-back' is uncertain too. It will need an upturn in applicable energy supplies and a reduction in global demand to stabilise oil and other linked energy market prices. Other commodities come into play. Only a new type of growth can see the UK into a low-inflation regime. We are in pretty deep doo-doo. However, that may be just what is needed.
I am afraid that the Quantitative Easing, which was very necessary, is now going in the wrong direction. There is a mismatch between the supply and who has it, and the demand and who wants it. The investment into commodities per se, instead of the production of commodities let alone the greener production of commodities which is the only win-win formula, is having a very bad effect on growth, let alone green growth.
We are in danger now of making a mistake smilar to, but worse than what caused the previous bubble and crash. Just as the global market which rather perilously allowed the increasing world population to feed itself while destroying the planet and much of nature, kept some sort of peace by shuffling aid and repression in alternate waves, now the collapse of the same market has not resulted in a fall in food prices but a rise. The resulting violence causes real poverty where before there was just hard times.

JANUARY 17th 2012
How much wiser and sadder now are the economic gurus. They are realising at last that the games they were playing were workable only in a a structure that now has no adequate political context to support it. Inflation which should rise in the absence of penal interest rates is falling as the producers and retailers of goods struggle to sell their output in a world where the mass demand (required by the very productivity they lauded as the key to wealth) is not backed by purchasing power. The fatal flaw is revealed for all to see. Efficiency is based on fewer people needed to supply goods and services. In a world of ever-increasing population, what are even the existing people to do, let alone the extras? New frontiers are needed as fast as they can be found and invested in, while the exisiting environment is preserved and nurtured. But instead, our industry has been on a desperate search for cash profits which they see as the only road to survival in a dog-eat-dog world, while investors now frightened of property seek safety in gold.

The good news in all this is that the politicians and the governors of national banks, particularly those faced with sovereign debt in one place and sovereign surplus in another, are getting the message. Now they have to get it over to their electorates. Not that easy in free, democratic societies where those without responsibility can attract the ear of the public as easily as those with it, and election is regarded as as good a qualification as studying for and passing exams, and exams in an arbitrary philosophy or nationalist creed are regarded as equal to science.