A prescription for a sharp slowdown in world recovery
The Bank for International Settlements does not mince words. The world, including Britain, has to kick quantitative easing and near zero interest rates: they are becoming habit forming.
In raising rates we have to brace ourselves for several years of stagnation. That is the top line of the 2011 Annual Report issued by the Bank for International Settlements over the weekend.
"Many of the challenges facing us today are a direct consequence of a third consecutive year of extremely accommodative financial conditions. Near zero interest rates in the core advanced economies increasingly risk a reprise of the distortions they were originally designed to combat.
"Surging growth made emerging market economies the initial focus of concern as inflation began rising nearly two years ago. But now, with the arrival of sharper price increases for food, energy and other commodities, inflation has become a global concern.
"The logical conclusion is that, at the global level, current monetary policy settings are inconsistent with price stability."
(To see how inconsistent, have a look at this graph, of commodity prices, and wonder).
We are, in truth, in the middle of one of the most remarkable periods of policy forbearance in history. The Bank of England is supposed to keep inflation around 2%, while it is close to 5% and has been above target for more than two years. And the guy in charge gets a knighthood.
Yet the government is, in background, explicit that Mervyn King must keep his garters well and truly elastic when it comes to interest rate policy. In order for the 110bn fiscal tightening programme to avoid tanking the economy, interest rates must stay close to zero whatever happens to inflation.
Again, in private, government members speak of "QE3" - yet more money printing.
Actually this morning, Barcap's economics team have weighed in on the relatively meagre success of stimulus so far:
"The stimulus appears to have been blunted by two main factors. First, the slump in consumer confidence has created something akin to a liquidity trap. This has both magnified the effects of fiscal consolidation and made it difficult for monetary policy to gain traction.
Second, the fall in the exchange rate has had unforeseen consequences. Export sales have been relatively lacklustre, while imported inflation has been much stronger than expected. The latter has added to the squeeze on households' real incomes and exacerbated the decline in sentiment."
If we look beyond domestic policy for a rationale, perhaps the best explanation was put to me by a veteran City fund manager.
"Forget inflation targeting: the world needs inflation. Inflation is a way to erode the value of all the debts hanging over the system. Inflation wipes out the debts and the resulting currency devaluation passes on the recession to somebody else. We're not called the "first world" for nothing…"
I raised an eyebrow, and muttered the words "Plaza, Louvre" (look it up).
"I mean," said my interlocutor, "we have 350 years experience of passing on the costs of crisis to other people. That's why we're the first world. You watch - the Americans and the Brits will make the rest of the world pay."
The BIS has something to say on this also: it warns that the leverage-induced growth of yesteryear is never coming back and that the world must rapidly rebalance, finding new sources of growth:
"The sooner that advanced economies abandon the leverage-led growth that precipitated the Great Recession, the sooner they will shed the destabilising debt accumulated during the last decade and return to sustainable growth. The time for public and private consolidation is now."
But rebalancing is a competitive process and always poses the question "who shall lose?"
During the process of creating the imbalances it is obvious who lost: tour the blighted terraces of Stoke-on-Trent, or the overgrown industrial splendour of Gary, Indiana to find out. It was the industrial workforce of those advanced economies which did not operate a quasi-protectionist labour market policy.
The question now is, as we attempt to find sources of growth in the west that go beyond mass consumption and minimum wage employment, who will gain and who will lose. Do we create high-value, high-skill and high salary employment - and how do we do it at a time when everybody else is trying to do it?
These are the questions business people are grappling with - and they seem like questions arising out of the last crisis. But as the BIS points out, unless we solve them, they are simply going to be the contributors to the next crisis.
The BIS calls for a hair shirt: pay down public debt, pay down private debt, stop credit-induced growth, raise interest rates, call back all the money printed since March 2009. If followed, it is a prescription for a sharp but not short slowdown in the world recovery, in which only the fittest survive.
I imagine Sir Mervyn will ignore this advice. He and the MPC will keep interest rates low, despite the inflation target. They will do it for a variety of reasons in their heads, collectively expressed in the minutes. The banks will go on "extending and pretending" with SME loans, refusing to recognise losses and keeping businesses alive. All in the hope that high inflation plus low wage rises kick start an economic rebalancing in this country, keeping Sterling low, pulling capital in.
We will make others wear the hair shirt - and to see what kind of people.... well, I'm filing this from the departure gate for Athens.