By MoneyMorning.com.au
Taken from the Financial Times:
“The Bank of England signalled it was likely to pump billions more into the economy, after slashing its forecasts for inflation on Wednesday and saying output was likely to stagnate until next summer.”
The U.K. has an inflation rate of 5.2%.
The Bank of England’s (BoE) policy is to target an inflation rate of 2%.
It has failed.
According to the BoE’s Inflation Report:
“Under the assumption that Bank Rate moves in line with market interest rates and the size of the asset purchase programme remains at £275 billion [AUD$434 billion], inflation is judged more likely to be below than above the 2% target at the forecast horizon.”
The market has taken this to mean the BoE will print more money to buy U.K. government bonds. Because, after all, perish the thought that inflation should fall below 2%.
So why is the U.K. getting away with it, while indebted Euro nations aren’t? Because the BoE can print money… it controls the presses.
But that doesn’t mean it’s in any better shape than Greece, Italy or Spain. It just means the U.K. is defaulting through inflation rather than non-payment of debts.
Greece, Italy and Spain have to find another way…
The first step was for the European Central Bank to lower interest rates.
By cutting interest rates below the market rate, governments give themselves a free-kick. They can increase debt levels to cover the drop in tax revenues… while at the same time keep their interest costs stable.
That works for a while. Until markets start to feel there’s no or little chance of the government repaying the debt. When that happens, interest rates go up, investors get scared, and the financial and social engineers think of other whacky ideas.
Such as the proposal by the European Commission (EC) green paper titled, “Feasibility of introducing Stability Bonds”.
Here are 31 words that prove market volatility is here to stay. It’s proof nothing has changed. That the bureaucrats still don’t get it:
“Stability Bonds would provide all participating Member States with more secure access to refinancing, preventing a sudden loss of market access due to unwarranted risk aversion and/or herd behaviour among investors.”
The EC’s solution is to not just manipulate the interest rate… but the entire bond market… by pooling risk. And forcing investors to buy higher risk debt at a lower interest rate.
But as the subprime mess showed, just because “bad” debt is pooled with “good” debt, it doesn’t mean the investment is safe.
In fact, the pooling of “good” and “bad” debt has the opposite effect. It creates a higher demand because investors start to believe it’s lower risk… and so the demand increases… which encourages the “bad” debt issuers to issue more debt to meet the market demand…
This drives interest rates lower, further convincing the market these things are safe. Until investors again figure out it’s not safe.
Bottom line: we’re now into year four of the Great Recession. The bailouts that were supposed to fix the global economy are failing. But it’s a slow process.
As you’ve seen these past three years the market goes through periods of joy then despair – often within the space of a few days (sometimes within hours). This trend will carry on for at least another five years.
As policymakers keep covering up and fixing their latest mistakes, they only end up making more of them. First the joy, then the despair… market up, market down. And so it continues.
Cheers.
Kris.
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