In the latest attempt to prove that nobody ever learns anything from history, the Bank Of England is practically betting the Devonshire farm that by putting the UK's economy on nitrous, it will recapture all the lost output during the recession, and that it will be able to time the stimulus exit perfectly, thus avoiding hyperinflation, or so thinks Citigroup economist Michael Saunders. We are fairly confident that the Weimar Republic also did not have hyperinflation as a policy end goal. Saunders was quoted by Bloomberg, that “Policy has been set to produce a boom to close the output gap in the next few years.”
The Bank of England’s new forecasts, published today, show that record-low interest rates and bond purchases will stoke a recovery twice as fast as those from the recessions of the early 1980s and 1990s, he said.
Alas, that is not the full story. The bank forecasts, as the charts below demonstrate, merely point out that the future economic variation around some mean will get exorbitantly high. And high vol, unless you are an options trader, is not really a good thing. Furthermore, if one removes the optimistic bias always associated with these kinds of "green shoot" smoking pamphlets, the outcome likely will be one in which the projection falls below even the worst case scenario, especially once rampant inflation finally comes to perch.
To be sure, opening the stimulus and liquidity spigot is sure to boost any economy as a one-time event. The bigger questions are i) how long can artificial stimuli be applied; ii) what happens to the new baseline level once the temporary "sugar high" is removed; iii) how does a Central Bank have any confidence that it can time the success of output gap reduction/stimulus and liquidity measure tightening, contrary to all empirical evidence. There has not been one case study in the history of monetary tightening that the Federal Reserve has not goofed without steamrolling into inflation territory. And with trillions in dollars waiting on the sidelines to be unleashed into the monetary base, and one can see why hyperinflationists are very concerned. Deflationists will, of course, counter that all such worries are offset by the tens of trillions in consumer wealth loss, and the inverted capitalization pyramid. The problem for the UK is that with its much smaller economy (compared to the US) its margin for error is even smaller than that of Ben Bernanke.
But that threat has not stopped an unjustifiably optimistic Mervyn King to mouthing off on the prospects of his recovery efforts (the cable pounding that has results on this low volume day is further proof of how realistic the UK economic "miracle" is perceived to be).
Bank of England Governor Mervyn King said in London today he has an “open mind” on whether a 200 billion-pound ($332 billion) bond-purchase plan should be expanded, signaling officials aren’t ready to withdraw stimulus even as the economy recovers. Saunders says International Monetary Fund figures indicate the so-called output gap will close by the end of 2012 if the Bank of England’s new forecasts are correct.
Back to Citigroup, who also see the flaws inherent in this approach:
“These are the strongest growth forecasts the MPC has ever published and far above consensus,” Saunders said. “The Inflation Report emphasizes the extent of the Monetary Policy Committee’s commitment to a reflationary bias.”
“If growth really is as strong as the MPC expects, then interest rates will probably rise quite markedly over the next two to three years, even if they do not rise in the next quarter or two,” Saunders said. The Bank of England’s benchmark rate is currently at 0.5 percent, the lowest since it was founded in 1694.
In the meantime to race to the bottom among the three main currencies continues unabated: the dollar pounding is conventional wisdom, yet today the GBP joins in the fray, while the JPY, courtesy of the new trade de jour which is buying Japanese CDS as Zero Hedge recently pointed out, is also stalling. Also, let's not forget that the renminbi tracks the weaker dollar lower. So on whose back is all this occurring: aside from New Zealand, which will promptly crack, somehow the global reflation trade is expected to occur courtesy of the Euro. Which begs the question: what the hell are Trichet and Merkel smoking, and just how did the rest of the developed world bribe them to doom the Eurozone to prohibitively expensive exports and stalling economic growth? Is the rise in the DAX sufficient to offset the upcoming waves of unemployment and massive housing crunch wave part 2? At this point, only the G-20 knows, although any rational human being can just as easily connect the dots.