Larry Elliott is writing about gilts this morning as he (like me) is sure there will be more quantitative easing announced this week.
Let me say straight away, that like Larry, I question the need for this: we should be stimulating the economy instead, but having made that point I also then disagree with Larry.
The fact that the Bank is even considering a further easing of policy is testimony to the profound weakness of the UK economy. For the past three years, bank rate has been 0.5% — comfortably the lowest level on record — and despite the pain being felt by savers there is no sign of it going up any time soon. The Bank has bought up some 20% of the gilts market already in an attempt to boost the money supply. Meanwhile, the Treasury has borrowed £500bn since the economy went into recession in early 2008.
In other words, net borrowing is not £500bn, it's £500bn less QE which may well be £350bn by the end of this week, as I have argued. So we have not got the debt crisis the government argues we have. We do have a deficit: we don't have a debt crisis.
And that's why Larry is wrong to say:
at some stage the Bank will need to unwind the monetary easing of the past three and a half years, selling gilts back into the financial markets. This is going to be tricky to achieve without leading to a collapse in the price of government bonds, and the more bonds the Bank has to sell the trickier it is going to be. This matters because the price of gilts goes in inverse proportion to the yield or interest rate payable on them. When the price of gilts goes down, long-term interest rates go up, so the challenge for the Bank is to unwind QE without triggering a run on gilts that would push the economy back into recession.
We'll never sell those gilts back. The IFS says we have £280bn of new gilts to sell over the next three years to fund the deficit. There is not a hope we'll add £350 billion of resale of gilts on top of that. The only likelihood is in fact of more QE: over that period there is no way the market can absorb £280 billion of new debt.
That means that the reality is that QE will lead to cancelled debt. Every single penny of the gilts repurchased will, I am sure, be cancelled. Nothing else is possible. It's just a matter of time before the lightbulb gets universally switched on to that fact that the debt repurchased under QE is no longer debt at all. There's just new cash, and given that the economy needs that cash we're not going to cancel it now, or in five years time. So let's get real about it.
And let's also remember there's nothing odd about cancelling gilts: it happens all the time. They're time limited loans. All we'd be doing by cancelling them is declaring time early. Let's not overstate the fact that this is completely possible, and more than that, it's desirable, and bar being early, totally normal. Then we can have a real economic debate.
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Here is Mervyn King talking about how selling down the gilts will be one mechanism by which they can tighten monetary policy:
But I’m still not clear. Is your position:
a) We will never ever</b reach a point at which monetary policy needs to be tightened, or,
b) If we ever reach a point at which monetary policy needs to be tightened, it can be done without reducing the size of the Bank of England balance sheet (i.e. selling gilts in the Asset Purchase Facility)
We have to sell £280 billion of gilts in the next three years to pay for the deficit
There is no way monetary policy will need more tightening than that….
It’s fantasy to think otherwise
And no, I never do see the day that reverses
OK, so what about 5, 6 years time, 10 years time? Will the base rate still be at 0.5%? The APF gilt portfolio will still be there.
If Labour win in 2015 and go on a massive deficit spending spree, will the base rate still stay at 0.5% forever?
It is of course possible that monetary policy will not be tightened for a long time, but to predict unequivocally that monetary policy will never need to be tightened is frankly bizarre.
From a publication out later this week:
When the Bank of England wanted to bail out the bust banking system in August 1914 — bust due to Britain’s declaration of war on Germany and its allies, while British banks were holding vast amounts of their bills of trade — the Bank of England purchased them from the banks and forgot about them. It works every time and does not cost anything — and thus also does not require the painful spending cuts that Britain has had to endure due to the government’s far more expensive involvement in helping the banks.
That’s what QE is too – bailing out bus banks
And there never, ever will be obligation or reason to repay
Shall we deal with the real world, not your fantasy? It helps
“When the Bank of England wanted to bail out the bust banking system in August 1914 — bust due to Britain’s declaration of war on Germany and its allies, while British banks were holding vast amounts of their bills of trade — the Bank of England purchased them from the banks and forgot about them. It works every time and does not cost anything — and thus also does not require the painful spending cuts that Britain has had to endure due to the government’s far more expensive involvement in helping the banks.”
Or how about the largely forgotten “Bradbury Notes”? These were notes produced by the government to help bail out the banks as they were going bust?
It is referred to in the Excellent Grip of Death by Mike Rowbotham:
When war broke out in 1914, the British economy was threatened by a familiar crisis. People started to exchange their bank notes and withdraw their deposits in gold. By the start of the war the Bank of England held just £9 million in gold reserves, yet there were total recorded bank deposits amounting to some £240 million. Struck by a similar situation, many continental stock exchanges had crashed or closed, and both Lloyd George and the commercial banks feared a run on the Bank of England, a run which they could not contain. There then followed a quite remarkable series of events. In May of 1914, Lloyd George, as Chancellor of the Exchequer, declared the suspension of gold payments. He then extended the bank holiday by three days, during which the stock market was also to be closed. The Bank and Lloyd George then held discussions on how the crisis could be overcome. It was decided that the Government should create its own money. When the commercial banks opened again a few days later, those who asked for gokd were given, in exchange for their old bank notes, new Treasury notes, a new legal tender. These Treasury notes came to be known as “Bradburies”, after Sir John Bradbury, Secretary to the Treasury, whose signature appeared on them, The total issue was £3.2 million and the creation of this money hekped the government fund the initial stages of the war effort.
However, funding of the war was not the intention of the notes, As Christopher Hollis records: “the issue (of notes) was made with the goodwill of the bankers and indeed at their plea and intercession. Had that new money not been issued, the private banking houses of Great Britain would have been compelled to default to their creditors in a weks time. Once the government had successfully alleviated the initial crisis to the banking system, and the Bank of England in particular, by the issue if these Treasury notes, the Bank of England “insisted” forcibly that the state must upon no account issue any more money on this interest free basis.”
It goes to show, once capital is n trouble, what extraordinary lengths the state will go to to prop it up! Bailing out banks is obviously nothing new!
Maybe of interest
http://www.davidmcwilliams.ie/2012/02/06/the-champagne-is-flowing-again?utm_source=Website+Subscribers&utm_campaign=f0289ceb84-06022012&utm_medium=email
Good article
Richard
Light bulbs definitely do need to go on in respect of sovereign debt.
The fact is, it’s not dated debt, but dated credit.
Most gilts are essentially dated preference shares issued by UK Plc: Consols (the interesting and archaic little rump of Consolidated Stock) are almost exactly analogous to 2.5% redeemable preference shares in UK Plc.
Not that I’m an advocate of the completely toxic Plc form.
Stock – as it existed for 500 years before private banks hijacked public credit – is essentially wholesale fiat money (which is based upon taxation) sold forward at a discount.
Ron Paul – who is completely off the wall on many subjects – is precisely right when he advocates that the $1.6 trillion in debt held by the Fed after being bought with QE should be written off.
To do so is – as you are essentially pointing out above – no different to burning redundant bank notes.
What people are missing is that for 500 years our National Debt was to all intents and purposes a National Equity, and it can be again.
For the last 300 years we have suffered an aberration: the banking system is not, and never has been, a necessary intermediary between citizens.
We need banking: but we don’t need banks.
Your point about burning bank notes is wholly relevant
Interesting point re debt cancellation, but given this QE process devalues the £.
My question is how do we manage any resulting import cost push inflation and the current economic inactivity/unemployment causing a potential inflationary depression and further QE.
It also illustrates why full reserve banking should be looked again.The banks should be then restructured so they can intermediate,compete add value and or not, without systemic risk or being able to socialize the speculative bets (on trends) that go wrong on taxpayers or other creditors exposed such as non speculating customers.
.
Where is this inflation?
There is a risk of deflation, but not inflation
Shall we deal with the reality, not the speculation?
Your right the risk of deflation debt destruction is ever present in the immediate sense.
Specifically the reality is of rising prices of imports- Gas prices,Petrol/Oil,food public transport and taxes like VAT/ council tax although hopefully imports may partially reverse if world demand falls. The cost of an annuities (up),housing costs (up).
I think both are happening to different costs and assets at the same time, whether officially measured or not by the indices. Globalization/outsourcing/immigration have pushed labour costs down but not the above items imho at least not yet.
@sm
QE does precisely nothing to devalue the pound, since it is only the exchange of one form of £ denominated credit asset (an undated interest free bill of credit) for another (a dated interest-bearing bill of credit).
If QE were used to acquire foreign assets, THEN the pound would be devalued.
That is precisely why the Swiss National Bank’s threat to print Swiss Francs and simply buy € assets with them blew speculative buyers of CHF out of the water and enabled the SNB to ease the pressure on their currency which was destroying what was left of their industry.
The fact is that while financial assets may be inflated by QE, retail price inflation is – everywhere and always – a fiscal phenomenon.
ie QE has to get out into the real world to cause inflation, and at the moment most of us are insolvent, illiquid or both.
I believe your statements are actually agreeing that QE has and does enable effective devaluation.
As i understand it QE has enabled the UK to purchase its own debt.This debt to the extent it WAS owned by foreigners who have moved funds elsewhere it will have increased the direct supply of sterling available.
It has also enabled HMG to continue deficit spending and in a open trading country with an overall trade deficit this will depress the fx rate, as some of it directly/indirectly leaks into imports.
(eg EU companies winning HMG contracts for train sets)
Unless i am mistaken the fx markets discount new QE annoucements almost immediately against currencies which are not following similar strategies. (Your example the CHF, Norwegian Krone or say Gold or even the Big Mac Index). The threat of the Swiss bank to effectively print money purchase foreign fiat paper proves the point, as does the fx market reaction to QE rightly or wrongly..
I understand the BofE pension inflation outlook and actions offer a another clue.
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6646330/Bank-of-England-staff-pension-fund-shuns-Gilts.html
QE is leaking into the real world.
The gas companies are not insolvent or illiquid and prices are higher despite demand falls and increased world production. eg the US no longer imports significant gas and is looking to export.
My worry is that changes can be dramatic once the horses are stirred into bolting. Lets hope you are right, but i fear you are not.
Every premise of what you write sees contrary to facts
What drives your desire to believe what is obviously not true?
The reality is QE had nothing to do with the devaluation we had
And there is not a hint of inflation, at all
I wonder what the basis of your logic is in that case?
Or why no doubt you’re happy with the private banks creating cash but not the government – whose right it solely is
QE is expected to cause inflation and devalue the pound. If you don’t believe me, I suggest you read some of the BoE publication on QE.
“Inflation expectations might be expected to increase in
response to the monetary stimulus associated with QE.”
The BoE impact assessment of QE found that it Sterling depreciated by 4% due to QE.
“Sterling’s reaction was more in line with what might have been
expected. Uncovered interest parity would predict a
depreciation in response to lower domestic interest rates.
Summing over the immediate reactions to the six QE news
announcements, the sterling ERI did indeed depreciate by
around 4%.”
That is their view
They also thought the economy sound in 2008
[…] Richard Murphy is basically right to say that this means that government debt is lower than official figures show, if we consider the […]
I have no particular problem with QE to create money to facilitate the economy for the public good. I even think a ‘small element’ (close to full reserve banking) of private creation of debt money should be allowed where risk and reward stay contained and the directors have an element of future liability, perhaps unlimited.I would support full reserve banking with similar safeguards on the authorities.They can then control the money supply directly and with more accuracy – for better or worse.
I am sorry to report that the items that i named above still cost me more in pounds,maybe i dont buy the things falling in value,, the only deflation(decrease in prices) i have experienced is in assets and income. Maybe it will reverse when i cant afford it and stop/reduce eating or using gas- that would be an inflation caused depression of demand?
Is there a more effective explanation for the effective devaluation since QE started? Why are the Bundesbank so against QE?
I dont expect the QE to be reversed for years, the banks have to move to Basel 3 , more capital with a higher reserve requirement, i expect lending to be constrained until the banks have this capital. I do expect living standards to fall, by the effects of deflation/inflation on different assets.The bondholders of banks imho are being bailed at the expense of future inflation/taxpayers.
This is slightly off the topic, but still on the question of government borrowings. Our Liberal-National Party opposition in Australia (our version of the chaps currently in your government) are trumpeting the claim that because government borrowings are so high, there is a ‘crowd-out’ effect and so our banks have to charge higher interest rates. Is there any truth to this or just more baloney from the neo-liberal forces?
Just baloney
There has never been any evidence of this anywhere
Corporations are awash in cash – and governments are raising it at next to nothing
The pricing is due to risk, not crowding out