It is less than a week since Mark Carney announced that the Bank of England Monetary Policy Committee had decided to restart the QE programme with an intention to buy £60 billion of government debt (gilts) and £10 billion of high quality corporate bonds.
The aim of QE is twofold. One is to inject cash into the economy, but since the BoE is also providing £100 billion of funding for lending to banks for this purpose in parallel to these purchases that is not the case on this occasion.
The second is to increase demand for the assets purchased, and so push up their price meaning that if they carry a fixed interest rate, as both gilts and high quality corporate bonds do, then the real rate of return on them falls. This is then supposed to force those in search of a return to lend to riskier organisations (by definition in the private sector) which will supposedly increase the supply of funds for investment.
There is a real problem with the theory behind this type of QE as it is currently operated. First, it ignores the fact that gains are part of a return to an investor and so pushing up the price of an asset when there is the chance that more QE might still come just encourages many investors to stick with the gilts they have got. This is not irrational: as the FT has explained today (and all FT suggestions hereafter refer to this one link) the rate of return on some longer dated gilts has been 32% this year it is unsurprising as a result that when over the last few days the BoE has ventured into the market to buy just over £1 billion of gilts it has been really hard for it to find willing sellers, and that despite prices reaching record highs.
As the FT also points out though this is not just because of an anticipation of gains on the part of the holders of the debt. Those holders are in the main financial institutions. And before anyone jumps up and down that means life assurance companies and pension funds, and the reason why they hold bonds is quite simple. These organisations know that they have to be able to pay out reliably to their policy holders over long periods into the future and just about the only thing that guarantees their ability to do just that is the return on government bonds, or gilts. In effect then they can only sell these if they can replace them with more government bonds. But that is nigh on impossible for two reasons.
The first is that given that they do not want foreign exchange exposure (especially post Brexit) the only supplier of the bonds they need is the government but right now the government will over the next year be buying bank in net terms about as many new bonds as it issues. So for pension funds the supply of bonds that they must have to meet policy holder needs is drying up. So they can't sell to the BoE, whatever the price.
The second reason is that this is not just a UK problem: even if they could hedge the currency risk the European Central Bank is, because of its QE programme, dramatically reducing the available supply of EU based government bonds as well.
So there is a massive conundrum. The BoE wants to buy gilts to force the current owners to take more risk but the current owners of those gilts do not want risk based investments because they need to be sure, for the sake of society at large, that they can meet their obligations to their policyholders and that means they want to keep their gilts. In fact, not only keep them but potentially buy more of them because the supply of pensioners is rising: the baby boomers who are now in retirement are fuelling the demand for gilts and nothing in the market - from commercial debt onwards - suits their needs.
So, this QE programme is pretty much doomed to fail unless something really fundamental happens. That something really fundamental that is required is more government borrowing to create more gilts to meet demand.
How to do that? It's quite simple really: the government has to decide to invest in new infrastructure, training, R&D, a green new deal, and so on and pay for this with borrowing via gilts, which is precisely what the market Is demanding that it do.
And by happy coincidence the growth that will be delivered by the investment programme will fuel growth in tax receipts, reduce beenfit spend and by the multiplier effect stimulate growth in the commercial sector with further knock on advantages. That, however, will mean that the current deficit which has been fuelling gilt creation at present will fall, requiring even more borrowing for investment for the purpose of meeting the need for gilts.
It's a pretty virtuous circle. And if at any point a problem arises then QE could step back in - which is how People's QE was always intended to work.
It's so obvious that it's hard to understand what is holding the investment programme back. Might Philip Hammond explain why he hasn't already announced it? Because to keep the BoE, the gilt markets and pension funds as well as the economy as a whole on track he needs to do so, very soon. It's only dogma that is stopping this and perversely the markets are saying very loudly and very clearly that they want that dogma out aside.