Philip Hammond sprung a surprise by announcing a new era in the relationship between the government and the Bank of England last night. The details are here. The Guardian, and many others, comment on the story in a way that is not apparently related to the documentation published, saying:
The Bank of England will be allowed to provide more than £500bn in lending to the economy without seeking the Treasury's permission, in a move that reinforces the strength of the UK financial system as Britain prepares to leave the EU.
Announcing the plan at the annual Mansion House dinner for bankers in the City of London on Thursday, Philip Hammond, the chancellor, said the changes would help to improve the resilience of the central bank. It would also help with its “ability to meet its monetary and financial policy objectives in the future”, he said.
Hammond said the government would give the Bank £1.2bn, a sum that would underwrite the £500bn lending pot, but the move would not impact public borrowing because the money would remain in the public sector.
I have scanned all three documents published by the government and Philip Hammond's speech, and the source for this story is not apparent, so it must have come from an independent briefing. The new arrangements that the documents refer to are also less than transparent in some respects, and so anything I say here is, I stress, provisional. Some initial thoughts do, however, emerge.
First, the supposed aim of these reforms is to make the Bank of England more like a bank. It has an enhanced capital base, can retain more of its profits, and has more operational freedom. That said, this appears to be a charade almost certainly designed to get around government accounting requirements. It would seem to me as if the increase in risk that the Bank is meant to bear and the supposed right it has to retain profit within certain boundaries is all an attempt to shift the Bank of England's operations off the central government balance sheet post-Brexit. That may just be the cynic at play, but I doubt it.
Second, no bank should be running a £500 billion loan book with any risk within on a capital base of £1.2 billion, meaning that the chance that this money is going to be released into the productive seems very low indeed. I think the intention is instead to bolster the balance sheets of commercial banks if they suffer significant risk post-Brexit. No other interpretation appears possible to me.
Third, there are signs that the Treasury and the Bank of England think that things will be extremely difficult post-Brexit. There are provisions in the new arrangements for 'collateral haircuts'. In other words, if this new lending is asset-backed, as is likely, then the Bank is anticipating falls in asset prices.
Fourth, it would seem as if the Bank is being given more opportunity to decide when, and if, quantitative easing will be unwound. The interest rate at which it may consider beginning this process has been reduced from 2% to 1.5%. In my opinion that suggests it is very unlikely that this will happen any time soon.
Fifth, the coincidence between £435 billion of QE funding and a new £500 billion lending pot backed by £1.2 billion of new capital suggest to me that the new lending is almost entirely dependent upon realisation of QE bonds now held by the Bank. In other words, all that is being said is that if there is substantial demand for bonds post Brexit as the saving community head for safety during the course of an economic crisis then the Bank will be allowed to sell its bonds held under the QE programme to meet that demand and will then be allowed to lend back the proceeds into the commercial banking system to make good the liquidity crisis that would otherwise arise.
I stress, this is a first reaction to a quite complex set of new measures which superficially, and as reported on all the media, make no sense at all. Unpacked as I present the above they do, however, have a coherent logic, albeit that the logic in question very clearly suggests that the Treasury and Bank of England are in practice planning for a hard Brexit and a consequent credit crisis for which they are creating the possibility of emergency liquidity funding for commercial banks.
If I am right then I also offer three other ideas. The first is that the Treasury so lacks confidence in the government that it is outsourcing the saving of the economy. Second, this is dangerous: the Bank will, no doubt, deliver another emergency package that will favour the City and those who are associated with it. Thirdly, democracy is imperilled once again.
My summary is you should worry: the Treasury clearly is. And they may be right to do so, even if it looks to me as if they are delivering the wrong solution.
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It’s the shock doctrine on steroids. The right-wing Brexit clique in the elite are creating the shock of hard Brexit that they intend to take advantage of but they don’t even feel they have to wait till the effects of the shock take effect before they implement their self enriching and divisive policies.
They’re setting up their policies in advance and delegating their excecution to a pseudo-independent BoE in order to put them beyond democratic intervention and thus to shield the Conservative Government from any popular blowback that isn’t immediately suppressed by the right-wing media under the guise of perverted jingoistic patriotism and supposed treachery against the 52% majority for Brexit.
10/10 for evil Machiavellian plotting guys! Welcome to the largest secrecy jurisdiction on Earth everyone else.
Adam Sawyer says:
“They’re setting up their policies in advance and delegating their execution to a pseudo-independent BoE in order to put them beyond democratic intervention and thus to shield the Conservative Government ………”
Or in other words (?)….. this is an extension of the distance between government and the economic levers (as established by Gordon Brown’s move to give the BofE a spurious independence) so when the government f**ks up, they can blame somebody else for the mess (?)
Sounds plausible to me. Another step towards abnegation of responsibility.
Indicates to me that some banks have bet and overstuffed themselves with very low yielding bonds that take a hammering when rates go from 1.5 to 3% a 50% loss. No one left to buy other than gullible politicians using state money. Expect bonuses all round despite the losses. Unjust. Q Who will be hit most as the door shuts ?
I suspect that it’s just a funding for lending type scheme. Of course, banks don’t need funds in order to lend, so it’s actually an interest rate swap.
BoE credits reserves to the bank, and creates a corresponding asset for itself due from the bank. The interest rate on the asset can be set at a rate different from the reserves, which allows BoE to reward the bank if it meets certain lending targets. In the past it was set at a fixed rate for a couple of years, with additional payments being made to reward lending.
Unwrap it all, and BoE just pays a fee to the banks to reward good behaviour.
I admit to being confused by this, from the Grauniad; “Hammond said the government would give the Bank £1.2bn, a sum that would underwrite the £500bn lending pot,” because isn’t money creation by the BofE where the government gets its money from anyway, effectively by command? This is surely theatre then, to impress the rubes, in which case we should be wondering about the reasoning behind it.
I think I have it; “As part of the changes, the Bank of England will see the emergency funding programme launched straight after the Brexit vote, known as the term funding scheme — which provides banks with cheap finance during times of stress — become part of the Bank of England’s balance sheet rather than the Treasury’s.” I suspect this means the government will be declaring everything to be fine and dandy post-Brexit and showing us the govt books to back that up, hoping against (faint) hope we won’t remember how they’ve cooked them. The disasters will all be on the BofE’s balance sheet, which we know no-one looks at or else they’d all be asking where these hundreds of billions are coming from which are routinely appearing in the asset purchase facility.
And by shifting the claim on profits I think they will try to de-consolidate the bank to achieve that goal
Bill Kruse, in his ‘confusion’ has a point though, in principle.
As in – why on earth should the government be giving the BoE £1.2bn. Its like sending beer to the brewery.
I know that’s a bit abstract, but still…
It’s all a game of pretence
And the aim I am sure is to pretend that the Bank stands independent of the government so that QE no longer looks like QE….
It’s very hard for BoE to provide funds for the banking system as a whole, since it is already fully funded.
If BoE pushes in £1,000 it comes straight out the other end, either as reserves at BoE or gilts at HMT. When you pour water into a full bucket, an equal amount spills.
So term funding is a way to re-allocate reserves from banks with an excess to those running short (but not the banking system as a whole) , and can be used to subsidise banks through the rate charged.
It’s similar to ECBs LTRO operations, which recycled reserves from banks in the core € zone to those in the periphery. But the UK does not have a periphery in its monetary system.
The UK cannot have a run on its entire monetary system, unless you talk of cash withdrawals.
I agree all that
Which is why as I think I said, this is all a charade
The “reply” buttons are confusing me, but to Richard Murphy’s assertion:-
“Which is why as I think I said, this is all a charade.”
I agree totally. It was like BoE offering liquidity (in the form of reserves prior to the Referendum). Perhaps it was useful in calming the sheep, perhaps Project Fear. But since banks are drowning in reserves because of QE, and the UK monetary system as a whole can’t suffer a run except for cash, totally unnecessary. Which is why so little was drawn.
With £490bn odd of reserves, there’s about £13,000 cash available for any individual of working age. And there’s another £1,200bn of gilts which can be converted to reserves….
After that, things get interesting.
We currently get by on “only” £70bn of cash….
Private bank solvency is the issue. Not liquidity, although liquidity can defer or be used to obviate the consequences of solvency. And I’m not against this as long as the providers of capital to the private banks are thrown under a bus.
BoE prints currency, but that is a senior liability not equity. So I’d imagine that HM Treasury (or the Treasury Solicitor, which is the state office that owns BoE) will sell BoE £1.2bn of gilts or similar in exchange for some additional shares. The number of shares doesn’t really matter since, there being only one shareholder, there is no dilution.
Some papers will be signed and some buttons pushed.
But behind the smokescreen power will shift and the next bank bail out is being prepared
Well its a funny old, somewhat confusing way of preparing the next bank bail out but then again I suppose that the obfuscation is deliberate.
It is deliberate, I am sure
Ps the additional capital might be a down-payment for the unwind of QE (or if it is not unwound, the impact of negative carry should the Bank Rate rise). Get it in early before people link the two and start chattering about it.
BoE doesn’t really need capital.
Precisely Kim,
It doesn’t need capital and that’s the part of this that stands out like a sore thumb.
A bit of a head scratcher so we need to wait on the details.
The banking system is already awash with reserves because that’s what QE did as it exchanged long dated assets for reserves.
And it certainly does not encourage bank lending
http://neweconomicperspectives.org/2009/06/dont-fear-rise-in-feds-reserve-balances.html
They’ll need to start balance sheet reduction at some point which just means letting the current gilts expire instead of buying them.
All in all at the moment it just sounds like a bribe to keep the commercial banks onside during the Brexit negotiations as they do think increasing the reserves encourage lending.
What you call balance sheet reduction I call sucking cash out of the economy to restrict the scale of economic activity, because that is what will happen
Why do you want to do that?
That’s the wrong way to look at it Richard. Don’t ignore the interest income channels or you end up looking at it from the wrong way round.
Ask Warren he’ll explain it to you.
QE was sucking cash out of the system as it sucked the interest income out of the economy. Interest income is a fiscal stimulas. Increasing interest rates increases those payments. Raising rates supports the economy via the interest income channels, and the higher the debt to gdp ratio the larger the effect.
Paying interest is like basic income for people who already have $’s.
Reducing the balance sheet does not suck income out of the economy. The Fed’s shrinking its balance sheet but Treasury is expanding it balance sheet at the same time.
https://www.youtube.com/watch?v=xaFY0K-Sv1Y
That’s why both Japan and the EU who are still doing QE are suffering from deflation. QE is not a fiscal stimulas
Warren explains it here
http://moslereconomics.com/2014/10/13/there-is-no-right-time-for-the-fed-to-raise-rates/
Take a look at it you need tog et this right. Why I explained how increasing interest rates don’t fight inflation they cause it and they don’t make a currency stronger they weaken it.
I have never said QE is a fiscal stimulus. It is a monetary operation.
People’s QE is a fiscal stimulus and is quite different
“What you call balance sheet reduction I call sucking cash out of the economy to restrict the scale of economic activity, because that is what will happen
Why do you want to do that?”
Doesn’t it depend whereabouts in the economy you suck the cash from. ? It’s exactly what’s needed in the asset markets. Not what this change of policy will achieve of course. Quite the contrary I suspect.
If only we could target the withdrawal that accurately
Just more smoke & mirrors. It would be naive to expect anything else from such an administration. Energy should be directed towards building & delivering the progressive, sustainable alternative. Everything else is just tinkering with a failed socio-economic model.
Like Adam above I think this is that this is an attempt by the government to reinforce the fiction of the independence of the Bank of England and to potentially offload any s..t that might be coming its way if Brexit does go pear shaped . Given the impotence of the Bank of England’s monetary policy I think this is a reasonable assumption. I noted also that Andy Haldane has got on board with the attempt to force rates up. Maybe he’s getting his ducks in a row for the top job in a year’s time ?
Still at least some post Brexit planning then….
Interesting analysis.
But would People’s QE be easier?
Yes
For a start it would be completely honest about what it is doing
Second, it would be aimed at the productive economy and not another bank bail out
Bank of England now provides funds for the bailouts (whether big ones or fiddly ones) rather than HM Treasury.
Bit of a “so what”, I think? Like Philip Hammond reducing the personal allowance continuously for higher rate taxpayers, to avoid everyone talking about a 50% rate. Some clever SPAD’s idea …….
[…] By Richard Murphy. Cross posted from Tax Research UK […]
[…] Par Richard Murphy. Croix publié de Tax Research UK […]
Sorry for being ignorant, but did I understand this correctly?
The BoE is hoping to sell the bonds it currently holds from the aftermath of QE and release that money into the economy if needed to support the commercial banks after Brexit? or;
Is this just another form of QE where they will create 500bn. worth of electronic money and buy even more bonds to stipulate the economy.
Thanks!
Z.
Excellent question
In effect it will be QE2 by recycling the same assets in a new way to inject more money into banks
At least that appears to be the plan
If things are worse than they expect they’ll simply be back to more QE
Thank you!
“In effect it will be QE2 by recycling the same assets in a new way to inject more money into banks..”
Assets which the private sector couldn’t get rid of fast enough ten years ago because much of it is garbage (?)
This is patches on patches. It’s the Micros**t economy – what we did last time didn’t work so let’s do some more of it.
Banks liabilities are an unjust burden to the public – Exchange of emails with the Bank of England: https://leconomistamascherato.blogspot.com/2018/06/banks-liabilities-are-unjust-burden-to.html
The m9eny is made by double entry
Dr Customer loans (an asset in he bank’s book)
Cr Customer account (so they can spend it)
Where and how does your credit appear?
Might you do the double entry for me? And leave a loan intact, of course.
Is this not developing into a similar scenario to that detailed in Naomi Klein’s The Shock Doctrine?
Yes
No Richard you didn’t.
But you said balance sheet reduction is deflationary and sucks money out of the economy.
It isn’t and never was and I was explaining why. QE is deflationary and balance sheet reduction is the opposite of QE.
Balance sheet reduction is a fiscal stimulas – Like I say ask Warren.
Regards…
We’re going to have to disagree
Balance sheet expansion created new money, and it did deliver a limited fiscal expansion. Much less than it might have done, but it did.
Remove those funds and like it or not, I guarantee it will be deflationary
And I don’t care what Warren says: to suggest it would not is quite absurd
I freely admit this is all too convoluted for me to understand. And Carney says we could be talking about £750 billion! On behalf of those equally baffled could I ask someone to explain in a few simple sentences who gets the benefits of this and who gets the risk and liabilities?
Is it again just a way of giving the banks loads of dosh and giving us all the risks and liabilities?
In effect the government is handing over up to £500 billion to the Bank of England to use to bail out banks if, as is likely, there is a financial crisis as a result of Brexit. And by giving the power in advance to the Bank of England they are trying to say the failure will have nothing to do with them and the support will simply be a technical issue that has not required government intervention, but simple intervention by a technical body.
Richard, you seem sure that this jiggery pokery is to offset anticipated Brexit damage.
I’m not arguing, but isn’t the excrement going to hit the extractor anyway ? The next round chaos could start anywhere. Trump is winding up the pressure across the board, with the FED behind him. The Eurozone is utterly dysfunctional. Is Brexit really going to frighten the international money market’s horses ?
Alan McGowan says:
“…….And Carney says we could be talking about £750 billion! …..”
I don’t even know whether £750 billion is a lot any longer. Increasingly the initial letter preceding ‘-illion’ seems to mean very little.
I’m with George W Bush here…. How many noughts are there in a Brazilian he is reputed to have asked. (Has to be apocryphal. Doesn’t it ?)
I wonder if Hammond reads history …
— This link is to a short article related to the author’s then new book — Saving the city. The actions of the Bank of England and the treasury were covered up until recently — they practised QE in saving the banks, and funding the purchase of British War bonds.
http://www.lbma.org.uk/assets/blog/alchemist_articles/Alch73Roberts.pdf
Well worth reading
When Italy and Germany tried the same thing 20 years later- i.e. to create State Notes – they were battled over with WWII. J.F.Kennedy tried it also in 1963… and we know what happened… In Italy the late PM Aldo Moro who printed state bills in the 1970 (500 lire notes as “biglietti di Stato a corso legalle”) was killed apparently by a terrorist group named Red Brigades…
Some Tories have been spreading the idea that if a Labour Government came into office there would be an immediate run on the pound. To bolster themselves against such a position after Brexit it would appear they are fireproofing themselves by allowing the Bank of England to pump QE into the financial sector.
Laughably they condemn Labour when they did it, whilst repeating exactly the same operation to as usual save their own skins.
What this does highlight though and should be thrown back at them, in an impending crisis they use borrowing to solve a financial crisis, but ignore the requirement to properly fund our public services. The other small point is of course they don’t have to borrow under QE at all and can just issue the money to serve what ever is in the interests of the country and people. But hey, they would never admit that there is such a thing as a money tree and they use it against the interests of the people they were elected to serve.
Thank you Richard for highlighting this as the media would prefer the Tories slipped this neatly under the carpet.
Your political analysis is entirely correct, I think