As the FT noted recently, about twenty per cent of the world's government debt is now owned by the central banks of the governments who issued the debt in question. And, with the global financial crisis now a decade old, the question that private sector commentators say is hanging over those central bankers is how they are going to 'normalise' this situation. By that they mean, how is that debt going to be sold back into the market?
The answer is it is not.
Let me put this in a UK context, but it stands as well for everyone else. In 2008 UK debt reached £600 billion. Now, QE excluded, it is £1.75 trillion. The debt has nearly tripled. More than £700 billion of that increase has been since 2010. And since 2009 £435 billion of this debt has been repurchased by the Bank of England, which (as I get bored of pointing out) means the total is not now about 90% of GDP but is actually something less than 70% because a government cannot owe itself money and the U.K. Government owns the Bank of England, which is not an independent entity as a result either in practice or in law.
'Normalising' this debt would require that the Bank of England sell it back to private sector markets. Now, I readily admit that I argue there is a need for more government debt in the UK but there are three ways of supplying it.
One is for the government to continue to run deficits. Don't worry: it will, for many years to come. This source of supply is guaranteed.
Second, there is a green or people's QE programme that could issue debt to fund new infrastructure spending. This would inject new money into the economy, build sustainable infrastructure, create jobs, support the value of the pound, be environmentally robust, deliver new housing and update much of our creaking economy and so revive our fortunes. In the process it would create a return to service debt. That could deliver the required new bonds.
Or third the government could just sell bonds back into the market, reduce bank liquidity, reduce funds available for investment in the private sector, help precipitate a credit crisis and seek to pull the economy down. That's the 'normalisation' route. Of course it need not do this. As has been shown here, QE has not actually boosted money supply so by itself it has created no economic risk, including of inflation.
Those are the choices then. Well, actually, the first is not a choice: deficits are going to continue. So there are only two choices. One is get the economy going again. The other is seek to crash it, not to put too fine a point on it.
Bankers seem to want option two.
It's time for central banks and governments to make clear that 'normalisation' is not going to happen. The debt government purchased using QE has been cancelled. The money QE injected into the economy is there to stay, because it is needed. And there will be new debt issues to create economic activity. It will be up to markets to decide to buy them or not, but it doesn't really matter. They can be QEd if the markets refuse to play ball.
And that's where we get to the real nub of this. 'Normalisation' would put money markets back into a position of power over government. That's what they want. QE destroyed that power. That may be the best argument against 'normalisation' of all.
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In the Bank of England Staff Blog, ‘Bank Underground’, Nick Butt, Rohan Churm & Michael McMahon published “Did Quantitative Easing boost bank lending?” (17th July, 2015). In it they argued that: “There is a body of evidence to suggest that QE is an effective means to boosting asset prices, aggregate demand and inflation, but it’s far less clear whether it improves the flow of credit to the economy. In theory, increases in deposit funding caused by such purchases might lead banks to increase lending. In this post we explore how this might occur. But we find no evidence that this happened in the UK.”
Their conclusion, based on empirical testing for a ‘Bank Lending Channel’ (BLC) “using balance sheet and market operations data that are available to researchers at the Bank of England”, rather than the speculative theorising or ill use of statistics that seems to me too often to plague economics, was that: “we find no evidence to suggest that QE boosted bank lending in the UK through a bank lending channel, possibly because the high churn in deposits meant they were not viewed as a stable funding source by banks. In the process, we dispel the myth that money created by QE lay idly on banks’ balance sheets. Instead deposits and reserves moved more rapidly around the banking system, consistent with the portfolio rebalancing channel of QE.”
On 4th November, 2013 the FT.com reported a Jacksonhole paper on QE by Arvind Krishnamurthy and Annette Vissing-Jorgensen on what I take to be at least in part an examination of the Portfolio Re-balancing Channel (PRC), suggesting that the Fed’s US Treasury purchases significantly raised Treasury bond prices, but had limited effects on private sector bond yields, and offered few economic benefits. If I understand this correctly (churn may have been an issue in the US Treasury example too, but now I am speculating?), the evidence suggests that QE – if dependent on the PRC – is unlikely to work. QE is effectively only going to work if the credit created is used on programmes to “inject new money into the economy, build sustainable infrastructure, create jobs, support the value of the pound, be environmentally robust, deliver new housing and update much of our creaking economy and so revive our fortunes”, as you suggested. QED?
Yes
I agree with them
But since M4 has not risen I see not a shred of evidence supporting unwinding it either
I think while the stated aim of QE was boosting lending, really, SFAICS, it was to get toxic ‘assets’ off bank balance sheets (all those mortgage-backed securities etc.) and swap them for good money. Portfolio Rebalancing might be one polite way of putting this, stopping the banks from facing the insolvencies they legally should have admitted to and saving the banking system in the process would be another. The economy was saved, or economies were saved if we include America, but the problem it then invited to get its feet under the table was moral hazard, where banks behave badly ad infinitum to the cost and detriment of the rest of us and are well aware they’ll perpetually be allowed to get away with it. And here we are 🙂 Bankers uber alles, then, no more hiding it. As a culture, modern man has effectively worked for them for the last few centuries, since money became the product of the banks post the setting up of the BofE, but while till recently that’s generally not been understood now it’s becoming obvious; we exist to serve. As for unwinding QE, It may well be Carney is muttering about this because he’s trying to reinforce the idea there’s only so much money in the world and the banks are its gatekeepers so we’d all better be nice to them. I suppose he has to do what he can, not least to justify his position, but it’s a bit late in the day for that I’d say myself 🙂 I don’t know that central banks can be relied upon to take the side of people or the government against banks in general. Bit of a whole other subject there though!
In fairness, that was not what was done with QE in the UK
It has been elsewhere, I accept
I don’t appear to be alone in thinking it was done here too, “In QE, a UK bank’s bonded assets are swapped for a BoE cheque that is paper cash (just as a Bank of England banknote is a bearer’s cheque) but to be held on deposit as part of the UK bank’s liquid deposits (reserves) at the BoE. That way the central bank has direct liabilities (deposits) to balance-off against its bought-in assets (3 year collateral). ” It makes more sense in context at http://monetaryandfiscal.blogspot.co.uk/2009/03/what-is-iq-of-qe-cooee.html which was written back in those days. I’m sure you’ll understand more of it than I do but it seems to my relatively uneducated understanding the author a) grasps his subject and b) agrees QE was used for asset swapping. I’ve always thought this to have been the case, actually, I don’t know why more people didn’t and don’t.
That’s not QE though
That’s what’s accepted as part of central reserves management
QE swapped government debt for cash
The cash was in part then returned as central reserves
All that I admit: but QE did not involve mortgage backed securities in this country
I’m not sure I agree with what you have written, Richard.
QE was never designed to directly boost M4. It boosts M0/M1 money supply. It’s stated aim though was to lower long term interest rates – indirectly boosting M4 by making borrowing cheaper, not by an artificial increase of the money supply of the size of QE.
Regardless, the chart you link to shows M4 hasn’t increased, but that doesn’t take into account what would have happened if QE had not been in place. You can’t argue that QE hasn’t affected M4 because the chart is flat – when more than likely without QE M4 would have contracted significantly. It wasn’t called a credit crunch for nothing.
I would also be very careful in saying that QE has created “no economic risk”. Central bankers around the world are doing a lot of work on the risks associated with QE and zero interest rate policies. All pointing to the answers that there are significant long term risks involved. Certainly the ECB and FED have spent a lot of time on this.
This paragraph of yours truly alarms me though:
“It’s time for central banks and governments to make clear that ‘normalisation’ is not going to happen. The debt government purchased using QE has been cancelled. The money QE injected into the economy is there to stay, because it is needed. And there will be new debt issues to create economic activity. It will be up to markets to decide to buy them or not, but it doesn’t really matter. They can be QEd if the markets refuse to play ball.”
Currently, with good economic growth in the UK and US, and growth picking up in Europe and even Japan, QE is going to start being unwound. There is no doubt this is going to happen. The FED and ECB are likely to announce their plans as early as next month.
QE debt is not cancelled. QE is an asset swap – a sterilized financial transaction. It takes debt and swaps it for cash, lowering long term interest rates. The Central banks end up with bonds on their balance sheets against a cash liability, but no debt is cancelled. It does not create any new value in an economy. The UK government isn’t 435bn richer because of QE, if you want to put it that way. Suggesting debt can just be QE’d away is a step into pure monetarism. Money printing in the most basic sense.
Suggesting that a government can just issue debt as it sees fit, and then print money to buy it’s own debt back if the markets don’t buy it and then expect no economic repercussions is pure fantasy. Money printing on any scale would most certainly cause serious economic damage, and has done so every time it has been tried.
Let’s say the markets didn’t play ball? Can you not see any consequences of a government printing money to fund it’s spending?
See this morning’s long blog on this issue
I have read what you have written with care and it is, with respect, nonsense that all revolves around the comment “Suggesting debt can just be QE’d away is a step into pure monetarism. Money printing in the most basic sense.”
Of course it is that
We have a choice. We give this power to bankers who abuse it for profit
Or we give it to government who use it for people.
There are consequences, definitely. But all your mumbo jumbo says is that you don’;t like the idea of government or people exercising power, even when you nite it did mainatin liquidity at low interest rates – both of which kep the economy going when nothing else would.
Douglas Kent, I disagree that printing money has caused problems every time it’s been tried; can you explain the serious economic damage done by Germany’s printing of the Rentenmark, for example? Or the serious economic damage done in what’s come to be known as the Worgl experiment?
Here’s Randy Wray saying pumping the commercial banks full of QE reserves isn’t reflationary:-
http://multiplier-effect.org/flash-past-qe2-wouldnt-save-sinking-ship/
Thanks
if not now, when? recall the policy was promised as a temporary directive to calm markets…not indefinite support to help re-inflate asset bubbles… in any case interest rate rises when led by the US Fed will have a destabilising effect on markets (particularly EMs) and this cannot be masked or postponed indefinitely…
I’ve answered that question
Never
What is the reason to unwind?
And if rates rise what’s the reason to compound that cost with a wholesale destruction of money?
This is an interesting discussion but I am not sure I fully understand the issues as presented. QE has been ex-post a crisis. What I am not sure about is the way the system actually operates; especially under stress. For example I am still not clear how BofE Standing Operational Facilities (SOF) work. The BofE describes SOF as having two roles; one an arbitrage role to stabilise Bank Rate. The other, however is described in the following terms by the BofE (I have mentioned this before in a comment some time ago): “The second role is to provide a means for Sterling Monetary Framework participants to manage unexpected (frictional) payment shocks which may arise due to technical problems in their own systems or in the market-wide payments and settlement infrastructure.” Perhaps someone would care to parse carefully precisely what that means.
The rules for the SMF are in the ‘Red Book’, which may be found on the Bank website, (follow SMF).
On collateral the Bank says this: “The Bank’s capacity to risk manage collateral is constantly evolving with a focus on collateral held by SMF participants in the course of providing financial services to the UK economy. The Bank forms its own independent view of the risk in the collateral taken.” (Red Book, p.7, para.44). This gives the Bank fairly wide scope on ‘collateral’, I would have thought. At the same time I could not find very much in the Red Book on the Operational Standing Deposit Facility, which – unlike the Operational Standing Lending Facility – is uncollaterised. Nor am I clear how far these collateral rules would impinge on other aspects of the Bank forming an opinion on collateral using other measures; like QE for example. Perhaps I am barking up the wrong tree.
This facility simply means the Bank provides cover to ensure overnight payments are always settled
It requires reserves backed by collateral to be held to cover that risk
You may be right, but I do not think this quite answers the implications of everything that may arise under the Bank’s chosen expression, ‘unexpected (frictional) payment shocks’. Let me paint a brief scenario. I would have thought it was under normal overnight payments conditions that crises unfold. Supposing the standard regulatory rules have failed (2007-8?). I speculate that for a bank that has been lending long on bad risks and borrowing short, but somehow unnoticed by regulators, it may first come to attention in just this set of circumstances. I may be wrong, but if I am why does the bank need a facility provision for 0% borrowing with no collateral at all (when the Red Book mentions ‘collateral’ no less than 92 times)? Why is this relevant to wider matters? Perhaps we can see here something of the underlying intellectual culture of the central bank.
I am not wholly sure I follow your question
The change is in attitude post 2007
Before then overnight was assumed to always effectively be payable because it always had been
Then banks realised they could go bust and would not lend to each other
Repo covered part of the risk but not all: clearing through the BoE was uncovered and so collateral and an increase in reserves was required
That was the change in culture and it is down to 2007
[…] Let’s put this in context: Rupert Harrison was George Osborne’s Chief of Staff for  most of the time he was Chancellor whilst Nick Macpherson was Permanent Secretary to the Treasury during that period. These two know each other, well. And they are disagreeing over the unwinding of QE, which I discussed yesterday. […]
I think the situation should be ‘normalised’…… but the new normal should be that Central Banks DO buy and sell government bonds. CBs have long operated in the markets to do this as part of steering market rates towards policy rates, the only difference in the last few years is that this has occurred in much longer maturity bonds in the hope that by guiding longer term rates lower investment will be stimulated.
The problem here is that ‘you can’t push on string’. People do not suddenly wake up and say, wow, rates are really low let’s go and build a factory and create some jobs. (If they do anything they buy-to-let, buy stocks etc.).
The missing ingredient is government that needs to borrow a lot more (at very low rates) and spend it directly in the the economy – preferably on something useful like health, education and infrastructure.
I agree that small scale operations have always happened
Most of all I agree your last suggestion