Duncan Hamilton: QE2 seems to be sailing right back to where coalition started

ALAN Greenspan, the former chairman of the Federal Reserve, once said “Since I’ve become a central banker, I’ve learned to mumble with great coherence… If I seem unduly clear to you, you must have misunderstood what I said.”

Mervyn King, the Governor of the Bank of England, appears to have developed the same skill. For despite announcing a second wave of quantitative easing (QE2), we remain perplexed as to the purpose and likely impact of the £75 billion gamble.

To be clear, this particular QE2 is launched into the most troubled of economic waters. On that, the governor was crystal clear. He believes this is “undoubtedly the biggest financial crisis the world economy has ever known” and even that “the whole world is at stake”. Right then, so what’s the cunning plan?

Well, that’s where it all becomes a bit vague. The idea is that the Bank of England once again buys billions of pounds of UK government debt in order to put more money into the economy. That, of course, relies on the banks – who receive the £75bn – then lending to businesses.

Last time around, however, the banks skipped that bit – preferring to rebuild their own reserves. Amazingly, the governor explicitly admitted as much while announcing that regardless, he was determined to try exactly the same thing again. So the plan to save the world is periled on a strategy which we know doesn’t work? That’s either a fiendishly clever double-bluff or lunacy.

Equally odd was that, despite Chancellor George Osborne specifically writing to the governor to encourage him to include the private sector – in other words not just to lob money at the banks and hope for the best – yet again all the money will be exclusively spent on gilts.

Had there been concern about the long-term price of UK debt, that might have made sense. But ten-year gilts are at 2 per cent. This was surely the time to think outside the box? Moreover, this is no “big bang” solution – the £75bn was more than the markets expected but still less than half of the original £200bn QE1. Does any of that seem an adequate response to “the biggest financial crisis the world has ever known”?

The answer from the governor is interesting. It seems to be his view that unconventional measures like by-passing the banks in order to have a more direct impact on the economy is a matter for the government, not the central bank. In short, he has punted the problem straight back to the Treasury. Not, you understand, that he advocates a loosening of the fiscal straitjacket which has become the defining feature of our times. Quite the reverse – he takes the view that the fiscal restraint being shown by the coalition is an absolutely essential part of the solution. So, if I have this right, the idea is that the coalition sticks to the regime of cuts which amounts to squeezing 2 per cent of GDP every year for the next four years. At the same time, the Bank of England throws money into government bonds and hopes that, by doing so, lending and investment will miraculously appear thus stimulating growth without risking our credit rating. Brilliant, except for the minor inconvenience that we have already tried this and it didn’t work.

All of which appears to suggest that as we career towards oblivion, we have a government and a central bank unable or unwilling to present a unified and coherent strategy.

They are not alone – into the mix let me now throw the troubling downgrade of the UK banks. Oddly, it may be that the downgrade is actually good news. That’s because it reflects the market view that, post the Vickers Commission, (which moves towards splitting banks into retail and investment) any UK government would be less likely to intervene to prop up RBS, Lloyds TSB or other institution in a crisis. In other words, the risks are greater because the safety net of a taxpayer bailout is being gradually removed. Yes, folks, in the world of economics bad news can be good news.

What matters more is to see this in the context of European banking. Given that it is now widely anticipated that a whole series of “write-downs” may have to be accepted by banks which purchased government bonds from Greece, Italy and Portugal, the question then becomes what those losses would do to the capital of European banks?

The EU may look to significantly re-capitalise banks, and that includes those in the UK. The cost in the Eurozone is estimated at ¤182bn (£156bn). Given the exposure of German banks in particular, the political ramifications of raising those sums are huge. The ever provocative Robert Peston last week analysed the UK banks and raised the prospect that another taxpayer bailout of the UK banks will be necessary. I simply cannot begin to imagine the scale of public anger if that were required.

Again, we need clarity and coherence. The fragility of banks in the Eurozone must be resolved. If nations are to default, let us develop a mechanism to manage that painful process rather than pretend that it won’t happen. If banks need more capital, let us deal with that systemic reform rather than hoping the Greeks find some more money down the back of the sofa. If the fiscal union of the Eurozone requires to mesh faster, so be it.

We are out of time. Coherent mumbling is a luxury we can no longer afford.