The market gives a thumbs-up to printing money

The market gives a thumbs-up to printing money
Posted By: Edmund Conway at Feb 18, 2009 at 19:58:27 [General]

What would you expect a currency to do when a central bank admits it is about to start printing money imminently? The answer you'll find in the textbooks is pretty clear: it will fall, and fall fast. Just look at Zimbabwe.

But that's precisely the opposite of what happened this morning when the Bank of England said that within weeks it will have the printing presses roaring away. In fact, as you can see from the graph here, after the Bank announced this in its Monetary Policy Committee minutes at around 9.30, people started buying, rather than selling, sterling. Why? What on earth has happened in the topsy-turvy world of currencies that makes traders believe a good investment is a currency that is about to become all the more plentiful? Has everyone lost their senses?



The answer is intriguing, and helps underline precisely how counterintuitive is the policy challenge we face in this economic crisis. People are buying sterling not out of economic ignorance or bloody-mindedness but as a vote of confidence in the Bank of England's economic policy. In other words, they believe quantitative easing - the technical term for printing money - will, in the long run, bring the economy back to health, even if in the short run it could devalue sterling.

Meanwhile, the market is punishing the euro (against which I plotted the pound in this chart) because of the European Central Bank's neanderthal approach to monetary policy. Of all the central banks they are the most reluctant to slash interest rates and start up the presses. This could be a big mistake.

The explanation for this, by the way, goes back to the genesis of each continent's respective central bank. The ECB is the spawn of the German Bundesbank. Its history was shaped by the horrific experience of Weimar Germany's hyperinflation of the 1920s, so it is naturally inclined to fear the worst about inflation. The Federal Reserve's big bugbear, on the other hand is deflation, since that was what afflicted the US in the 1930s.

Anyway, the point is that the market believes (today anyway) that the Federal Reserve, which is already well down the road towards money-printing, and the Bank of England are right, and that the ECB is wrong. I happen to agree.

Quantitative easing is a hard sell - I know that from your comments whenever I write approvingly about it! But if handled properly I genuinely believe it could help prevent this from turning into the recession to end all recessions.

Whether you agree with me or not about that, the one thing we can surely all agree on is that, should the Bank of England pursue this course, it must, must be ready to raised interest rates and pull money back out of the economy when it looks as if deflation has really been averted.

You can count on us at the Telegraph to do our best to make sure it does.

http://blogs.telegraph.co.uk/edmund_conway/blog/2009/02/18/the_market_gives_a_thumbsup_to_printing_money