“This is the most serious financial crisis we’ve seen, at least since the 1930s, if not ever,” Mervyn King, governor of the Bank of England, admitted last week.
He was explaining why the Bank has begun a new bout of quantitative easing (QE), worth £75 billion.
Quantitative easing is essentially a way of pumping money into the economy. The Bank buys financial assets, in this case Treasury bonds (gilts), from banks and private investors.
The former bondholders get more money in their bank accounts, which King hopes they will lend and spend. The price of gilts rises, which pushes down interest rates, making it cheaper to borrow.
This isn’t the first use of QE during the present crisis. But the fact that King has moved now is a recognition of its severity.
Alistair Darling criticised King in his memoir of his time as Labour’s last Chancellor of the Exchequer. He said King was slow to face up to the developing financial crash and too close to the Tories.
One reason for the new bout of QE is that the Conservative-Liberal coalition is committed to massively cutting public expenditure.
Tory chancellor George Osborne won’t acknowledge that it is crazy for the government to take money out of the economy during a slump.
Instead he is relying on the Bank to keep things afloat. King’s announcement came a few days after Osborne had called for more QE at the Tory party conference.
Let’s leave aside the madness of pumping money in with one hand, and removing it with the other. Will QE work? There is reason to be sceptical.
The Office for National Statistics estimates that Britain’s economy shrank by 7.1 percent between the end of 2007 and mid-2009 and has stagnated for the last year. By comparison, during the slump of the early 1930s, the economy shrank by 7.6 percent but recovered more quickly.
The severity of the present crisis reflects the nature of the preceding boom. This was based on the accumulation of debt by private households and the banks that fed the boom with cheap credit.
Both groups remain loaded down with debt.
This means that people aren’t spending. Consumption fell by 1.7 percent over the past year and is now 6.4 percent below its pre-slump peak.
But the banks form the nervous system of capitalism. They are still loaded down with debt and bad loans they made during the boom, despite being saved by bailouts three years ago.
So although QE puts more money into the banks, they are likely to hang onto to it to rebuild their finances. Hence complaints by small businesses about their inability to raise loans and Osborne’s promise to help them with “credit easing”.
The plight of the banks more generally is moving centre-stage in the crisis. The key to the eurozone debacle has been the vulnerability of European banks that had lent heavily to Greece, Italy, Ireland, Spain, and Portugal.
The efforts of eurozone governments to prevent these countries defaulting on their debts are aimed at preventing a meltdown of the banking system. But this may happen anyway.
The French and Belgian governments are trying to cobble together a second rescue for the bank Dexia, which is suffering from its holdings of eurozone government debt.
As Belgian debt campaigner Eric Toussaint rightly points out, “Dexia’s crash shows that it is the private banks that are the weak link in the debt crisis whereas governments and mainstream media highlight the public debt aspect of the crisis.”
Nor is this just a eurozone problem.
RBS, along with Commerzbank, Deutsche Bank, Société Générale and UniCredit, has been identified as vulnerable to defaults by the weaker eurozone economies. RBS, Lloyds, and ten other British banks had their credit status downgraded by rating agency Moody’s last week.
The banks are where the crisis began—and they remain at its heart.