Almost as a sub text to all the discussion about how to solve the financial crisis there is talk of central banks printing money to increase bank liquidity.

We had this phenomenon in Britain in the heady days of financial mismanagement after World War 2. It led a Chancellor of the Exchequer, Dennis Healey, to describe the product with admirable candour as confetti money.

Of course the talk now is of responsible behaviour, of controlled amounts, and if all the central banks behaved similarly the relationship between currencies would be little changed. The effect however, even if controlled, would be the same.

In the short term the little nest egg that John Citizen has deposited somewhere would buy less. He would still have his £000 on paper but they would not be the same pounds, euros, or yen that he deposited. Their value would have been depreciated by the percentage represented by newly printed currency.

In the medium term fixed assets like houses would be revalued in terms of the depreciated currency. Values would increase on paper and debts which looked 'toxic', as the phrase is, would suddenly look less so or not at all. Debts could be discharged in depreciated currency.

This is all of a piece with a process which goes on all the time. It is called inflation by politicians and pundits. Governments everywhere make a show of struggling to control inflation as though it were some external monster which assails them. In fact it is an instrument of deliberate policy, a form of taxation.

Each year the pound in the pocket and the nest egg decline in value by a percentage. That partly explains why a house built in the 1930s for £600 which included the cost of building and a profit for the builder sold in 1950 for £3,000 and 60 years later is valued at £250,000. As much as anything it is the pound which has lost value, some of it is general property shortage and some desirable location.

The Governor of the Bank of England is tasked with keeping inflation (which is variably and possibly fraudulently assessed) at 2% or less. If he fails he is required to write an abject letter of explanation to the Chancellor of the Exchequer.

All of this is admirable if it were not a bit of a joke. The figure of 2% is not the best that can be expected in an unequal contest. It is a permitted figure, year on year, sufficiently low it is hoped, not to be noticeable. However 2% per annum over a lifetime is a considerable percentage only mitigated when interest rates are higher than the true rate of inflation.

Talk of bank liquidity is also a bit of a joke. Anybody who believes that when a bank makes a loan it actually makes available something which it has stored in its vault is seriously misinformed. It is only a credit entry in a ledger matched ideally by assets of equivalent value as collateral which the bank may seize in case of default. In normal times the loan is also insured at the borrower's expense.

It has always been a principle of banking that provided the solidity of the bank is not in question it is safe to create credit to the value of several times the assets which the bank holds. There is nothing illegal or unrecognized in this practice.

In recent times this prudent business model has been abandoned. Some respectable financial institutions have created credit to unbelievable multipliers and with dubious collateral. Banks have had an expensive fright. It is not liquidity that is their problem. They have been recapitalised at public expense and various funds are available to them. What concerns them is the uncertain value of collateral. 'Safe as houses' has ceased to have meaning and which business will be viable in a downturn of unknown depth or duration cannot be known. It is also reported that insurance of loans is not available.

Whatever the solution to our problems may be it seems certain that the future cannot depend on a bubble of uncontrolled credit. It may be that economic activity will have to be less frantic related to what is possible rather than to what is perceived to be desirable.

Perhaps government should take on the role of insurer. The commercial market is only interested in covering the unlikely or the quantifiable. Real risk is anathema. Perhaps, for a premium, government could provide reinsurance if the commercial market would cooperate.

There is supposed to be some sort of guaranteed loan scheme in operation. The continuing reluctance of banks to lend suggests that it is not effective.

Getting banks to resume responsible commercial lending is a prize worth exerting some effort and taking some risk to achieve. Without it the business community will take an avoidable beating and so will their employees.

ADDENDUM

JANUARY 19TH 2009 HM Government announced the provision for a premium of credit insurance.

JANUARY 20TH banks and building societies announced substantial cuts in interest rates charged to borrowers reflecting the removal of risk.

As a consequnce the decline in house prices will cease and be reversed. There has been virtually no market at depressed prices. With the return of buyers a market will be established which by definition means that buyers will have to offer prices that sellers will accept. Inevitably that means that prices will rise. How far and how fast remains to be seen.

As further consequences it is likely that vendors of household goods will experience an upturn and possible that an element of confidence may emerge amongst consumers generally. We shall see.

FEBRURY 4th 2009  It is reported that in the month January receding house prices increased by 1.9% after  11 consecutive months of decline. Perhaps an early indicator of recovery in the domestic economy.
      

__________________________________________________________________________________________________                           _______________________________________________________