How bad will things get ?

We all hope that the government’s management of the economy will take us smoothly out of the recession. It may. But it is more likely, unfortunately, that it will not.

This is a bold statement. The risks involved in the path being taken are huge, however. There were alternative approaches that appear not to have been considered – such as treating all the banks in  similar way to that applied to the Dunfermline Building Society in Scotland, But we are where we are,

Below is an assessment of the risks and a somewhat technical take on how bad things might get.

Recently the government has given us a new bit of economic jargon they created – ‘Quantitative Easing’.

This means, to you and me, printing money – the Bank of England ‘invents’ money and lends it to…errr….the government !  This use to be called ‘monetisation of debt’ when economists talked of badly run ‘banana republics’ or Mugabe’s Zimbabwe.

This monetisation consists of a £150,000,000,000 (£150bn) facility to be spent within 3 months (£75bn in the first issue). This is an absolutely desperate last resort measure which they would only be doing if some of the banks were about to go under. The government is running out of cash, and to hide this they have produced an bizzarely optimistic forecast of economic growth of 1.4% in 2010 and 3.5% in 2011, in order to appear to balance the books. They are only kidding themselves; the rest of us are a bit wiser.

Lib Dem Dr Vince Cable said he is 'broadly in support of the scheme' under the emergency circumstances, but it is nevertheless a grave and serious development which should worry us all.

What is it all about ?

The money will be spent indirectly buying toxic assets (loans that may not be paid back and therefore are severely reduced in value as 'assets') and then issuing bonds. (For the technical,  the value of the bonds will reflect assumptions about the percentage of the loans that are thought to be 'non-performing'  ie those that will never be paid back and will have to be written off, at the expense of the taxpayer).

Buying the rubbish loans from banks is clearly designed to let them off the hook. Never mind director's bonuses, this is 'rewarding failure' on a historically massive scale, beyond anything the world has ever seen.

It is not known at this stage which banks or other institutions all the loans will be bought from ultimately, so it's hard to make the vaguest guess about the REAL level of loans still sloshing around that will never be paid back, and hence the level of money that the taxpayer will ultimately have to pay for with the newly printed money.

Goldman Sachs advised the govt that it was 8%.  The IMF said that it was 12%.  On the basis of  International Monetary Fund figures, the total debt of the UK is now £1250,000,000,000 (£1.2 trillion) which is around 80% of GDP. This is breathtaking and it means debt levels are set to exceed that caused by the UK’s national fight for survival as a result of World War 2 !!!!!

On this basis the net cost of the ‘money printing’  to us taxpayers will be 12% of £150bn, or £18bn.

But there are two major glitches.

First the banks do have a 'real guess' at the percentage of all the loans that will never be paid back, but it is very hard to estimate this since they have been bought & sold and rehashed several times, so it cannot easily be known who the ultimate borrowers are - mortgagees and businesses. They are not telling however, and the govt has, deplorably, not pressed the banks to come clean and 'unravel' the loans. Instead they are just throwing money at the problem, under the threat of catastrophe made by the cynical 'overbonused' bank bosses.   

Second, the printing of money, the Chancellor says, will not cause inflation, Zimbabwe style, because there will be deflation, (falling prices, when we are used to rising prices) which will dampen any 'printing money' inflation. This is all wild speculation in a panic. There is no guarantee that there will be deflation, and more inflation is more likely. Prices are rising as the £ falls further - as it will continue to do.   In addition to the 'money printing' the UK govt is borrowing abroad. (It cannot rely on printing alone). It is paying higher and higher rates of interest for this, that will force up UK interest rates and increase inflation.

The combination of printing money, higher inflation, higher mortgage rates, falling exports, falling tax receipts, rising unemployment costs, higher interest rates, and rising international borrowing by the UK – take us into territory we have never been in before.

It is hard to say how bad things will get. They could start recovering late next year, but equally the