QE2 and the ship of state

Other strange goings on at the American Federal Reserve. QE2, which most British people thought was an ocean going liner, means a second round of quantitative easing: printing money and stuffing it into the economy. The Americans have just agreed to print another $600 billion.

The question to be asked – and I think the danger of over-complication here is greater than the risk of over-simplification – is ‘Where is it?’. Where is that money? We printed it (Britain printed another £200 billion) and bought assets from the banks. What had happened is that banks were charging companies and people too much for loans because of the increased risk in hard times, so the real rate of interest, that paid by you and me, was too high. So we stuffed them full of money to bring the rates down and get the economy moving.

But we keep hearing from Mr Osborne that bank lending to companies is insufficient, so where is the money we stuffed into them to improve things?

There is a real danger that politicians follow the public mood to increase regulation over the banks and then the banks use the QE billions to prop up their own balance sheets – a second round of rescue, but from a problem caused by the regulators.

And this is not the only danger from QE. Even if it works, this money is going to have to be mopped up again or it will cause severe inflation. I think we are already seeing inflationary roots growing in Britain and we will be reliant on the skill of the central bank in picking the right moment to do it: to raise interest rates before the inflation becomes unconquerable except with more pain. With America there is the added problem that this money might well find itself flowing into China, India and Brazil causing overheating there.

QE is medicine with side effects and it fills me with dread. The first dose might have helped us. The second might be fatal.