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Printing Money Could Save the UK Economy, But it Will Crush the British Pound

Economics / Quantitative Easing Mar 11, 2009 - 11:15 AM GMT

By: FleetStreetInvest

Economics Best Financial Markets Analysis ArticleEight pence is all that stands between the pound and 1 for 1 parity with the euro.

After its short lived recovery, the pound looks to be taking the dreaded “next leg down” and is firmly back in bear market territory. I'd strongly recommend that you defend your wealth against further pound falls, it could be ugly.


Here's why…

At the tail end of last year the pound began its descent largely as a result of valuation. It was overvalued against the euro and the dollar, its main trading partners. The Bank of England also cut UK interest rates by 400 basis points (or 4%) which means investors were getting less yield on pounds held.

Today, the pound is falling once again. But this time, it's the result of a different, and altogether more worrying, cause. It appears that we have turned Japanese.

Last week the Bank of England formally announced that we've turned on the printing presses – or begun “ quantitative easing ” in economist-speak. Whatever you call it, the effect is the same. The results of this experiment are hard to predict, it has only been tried once before, in Japan . It proved an effective stop-gap for the Japanese economy, but didn't help the yen. We could see exactly the same thing this time.

Let's look at what happened first time around…

Like alchemy but in reverse

In March 2001, Japan formally began a quantitative easing program after having already reduced interest rates to zero. The trouble was, almost five years later the yen hadn't gained at all and in the interim years had actually fallen pretty hard. And all this after already enduring ten years of economic stagnation and deflationary pressure.

Unfortunately, the Bank of England is re-tracing those unsuccessful steps to try and save the UK .

Our quantitative easing (QE) describes the Bank of England's purchase of gilts, corporate bonds and other assets.

These purchases are intended to lead to an increase in deposits in the banking system, which should raise commercial bank reserves. This effectively would increase the supply of money in circulation and in deposit accounts.

It's hoped that buying gilts and corporate bonds will prove more effective than literally turning on the printing presses and handing out wheelbarrows piled high with brand new ten pound notes. The move is intended to encourage bank lending as the sellers of assets – investors, banks – will have a fatter cash cushion. This in turn is meant to bring down the lending cost in the corporate sector and thus grease the wheels of the UK economy.

Sounds great, right?

The problem is that even if quantitative easing does work – and it must be said that over the five years, Japan 's GDP did fully recover – QE is the currency equivalent of a rights issue. Let me explain...

Last week HSBC launched a rights issue to raise new funds. In other words, they issued new shares. The problem is that each new share issued effectively reduced the value of each existing share.

And it's similar with QE. It is a type of debasement – diluting value by increasing supply. Every new pound printed dilutes the value of every pound in your pocket. That spells bad news for sterling…

The case for a sterling sell-off

There are already plenty of reasons to be bearish on the pound…

UK interest rates (equivalent to a dividend yield) are near zero. UK economic growth (annual GDP) is negative and consumer and business confidence are non-existent.

But the latest move to print money is the final straw…

The advent of QE is another burden. It is little more than a blind leap of faith by our policy makers. Will it prevent a depression? Nobody knows for sure. Will it devalue the pound? Almost certainly.

No doubt other economies – the US and Europe included – are in dire straits, too. But the UK 's unique combination of low interest rates, active currency debasement, a crippling bank sector and negative growth are awful.

For the time being, the pound can resume its role as whipping boy of the international currency market. That's why I've been recommending that you protect your self from any further sterling falls .

By Theo Casey
For The Right Side
First published by Fleet Street Invest

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