I have this letter in the Guardian this morning:
Two comments on my letter concerning the use of People's Quantitative Easing to buy out PFI (27 September) in your paper on 28 September require a response.
Martin Wheatcroft says that the Bank of England reserve deposits of our clearing banks, which is where most QE funds are now located, have interest paid on them, meaning that People's QE is not costless, and that cost could rise, considerably. He makes three mistakes. First, interest is only paid by Bank of England discretion. It could withdraw or limit it. Second, he quotes nominal and not inflation-adjusted interest rates, and it is adjusted rates that matter overall for People's QE because they indicate the real cost. Third, he assumes UK interest rates will rise without QE being unwound, and that is exceptionally unlikely. His scenario will not come to pass: if rates were as high as he suggests there would be no QE-generated funds in the Bank of England on which interest would be due.
Tim Worstall also makes a mistake. He says big business does not use gilts for cash management. That's true if nominal ownership of long-term funds is taken into account. But that's because big business only makes use of these gilts overnight, when the massive “repo” market, which places the cash of these companies on deposit while the world sleeps, makes extensive use of, and is entirely dependent upon, the availability of government-backed gilts to make that market work.
My critics are making use of highly selective and unrealistic evidence. I stand by my arguments.
Professor Richard Murphy
Professor of practice in international political economy, City, University of London; Director, Tax Research UK
I think a few points of elaboration are worthwhile. First, with regard to Martin Wheatcroft, it is indisputable that the reserve deposits of our clearing banks held at the Bank of England have risen since QE, by almost the amount of QE. There is good reason for that: it is these reserves that are effectively used to guarantee that these banks clear funds against each other each night without the Bank of England taking risk during that process, which it had prior to 2008. Do they need to be in this amount? Maybe not. But whilst they are and whilst the Bank has been paying what has been, in effect, negative interest rates on the sums in question, that interest has been paid. But banks, including the BoE can withdraw interest payments and that is possible on these reserves. If the cost became positive in a real sense I am sure that would happen.
Wheatcroft does anyway ignore the fact that there is no chance of real interest rates of 5%: such rates only reflect persistent higher inflation rates, as he also ignores the fact that unless QE was loosened considerably rates are unlikely to rise much, and if QE was loosened considerably then at least part of these reserves would disappear with the redeemed QE and no interest would be due as a result. I am afraid his attempt at point scoring showed a failure to think matters through properly.
As for Worstall, I am a little surprised by his comment. He should know how the repo market works and that this involves the technical sale by banks of gilts overnight and their repurchase with what appears to be interest credited in the morning, in this way providing the large customers making use of this facility for their cash piles with the deposit guarantee that they crave and which the government will not itself supply. The gilts remain legally in the possession of the banks and many of them will be in nominee names and some will be borrowed (this being a feature of euro repos now, I believe) but the fact that nominal ownership does not reflect beneficial ownership of use of an asset was something I thought he would be familiar with. Apparently not.
I am grateful to the Guardian for the right to reply.
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And I am grateful that you are here at all.
Well done and thank you.
I’m confused – you seem to flit between ‘QE will be unwound’ and ‘QE won’t be unwound’ depending on what supports the particular position of the day.
I have no doubt QE will not be unwound
But if the rates that were suggested by Martin Wheatcroft were to happen QE would have to be
I think that unlikely so the rates won’t happen
Was that so hard to follow?
And for the record, I have said QE used to counter a run on gilts could be unwound
You know how it is, when the facts change you change your mind? That’s what I do
The facts haven’t changed, just the latest position you are trying to justify!
And they are planning to unwind QE in the US and the UK.
Steve Groves.
“And they are planning to unwind QE in the US and the UK.”
Yep.
And Elon Musk is planning a manned space station on Mars. Which do you think will happen first?
Nice one, Andy.
You appear to totally misunderstand how ‘repo’ works and which parties are borrowing / lending gilts!
So you’re saying gilts have no part in it?
And you;’re saying they’re not sold and repurchased under contract
Really?
No, I’m claiming that your comments about which party is lending and which party is borrowing doesn’t stick up to your previous claims about the gilt market!
Then respectfully it seems to be you who does not understand
Your time here is over
Richard, that was a clear and useful expositition. You explain that repo:
which is easy to understand.
You continue
which is more difficult for the non-specialist. Is what appears to be interest in fact interest or is it something else like a fee ?
And then conclude
which is puzzling for the untutored in these matters. I can see that the banks now have the gilts but where does the cash end up?
The bank sells the asset to the bank. It gets the cash
The next morning it repurchases the asset at a slightly higher price. That’s the interest
The company gets the money back to use during the day
Then it buys gilts from the bank again overnight
And sells them back the next morning
During he day a company needs cash to manage cash flow
Overnight it does not
But there is no guarantee on large cash deposits so instead it buys a gilt – which is an asset with recourse rather than one without
That’s why gilts are needed by the banking system
The gilts are likely to never be registered in the name of the company buying them overnight. They may even be lent to the market by a pension fund for this use – meaning the bank my not seem to be the owner either (multiple claims on one asset are a real risk in this market). But this is the way large companies who do not trust banks with their money seek security
If the private company owns the gilts and is lending them to a bank then they are receiving cash. Which doesn’t make this process a ‘home for cash’ as you previously claimed. It means they would ctually have more cash for which they need to find a home!
The private company buys them from the bank
And sells them back at a higher price next morning
That’s what I said
That’s how repo works
Private companies almost never use the repo market to place cash. Primarily because it earns them little or no net interest. The interest they receive from lending cash is offset by the interest effectively paid by borrowing the bond. Corporates really aren’t large users of government bond markets or the repo market.
Corporates try not to sit on large cash piles. Investors hate it, so cash is.typically invested in the business or paid out to shareholders. Why would you sit on large amounts of cash yielding very little when your company should really be making a much larger return on investment?
Wow
You”re clearly in a parallel universe
Corporates are bit part players in government bond markets at best. Nor do most of them use repo to place cash. It is not efficient, both in return and credit terms.
I assume you have seen stories about vast cash piles corporates are hoarding away, and that is what you are referring to. Again, you seem to be only looking at one part of the story. Companies want to maximise returns, so investing in the lowest returning assets out there is a low priority.
But why not go and look at the annual reports of say, Apple or Microsoft, two of the companies reported to have the largest piles, and see how much is invested in government bonds?
Recent reports suggest a great deal is indeed invested by them in bonds
And sectoral balance accounting suggests that also has to be true
Go have a look
Guy, are you actually stupid or do you just like arguing for the sake of it?
“Companies want to maximise returns, so investing in the lowest returning assets out there is a low priority.” Some however like tyro investor Warren Buffet prefer to play a long game which is possibly why he’s got more than usual of Berkshire Hathaway languishing in cash at present. (Unless I am misinformed – we don’t talk regularly these days, he seems to be coping without my mentorship)
Richard,
Thank you for trying to help. You wrote:
I am still confused, alas, but no doubt at a more sophisticated level.
As is very obvious that includes an error: they happen; the article originally included a ‘to’ that should have been a ‘by’
The bank sells the asset to the customer – the company
I apologise for writing in haste
Minor errors happen
As much as I am loathe to be cynical, I do recall expert advice which once suggested that one of the classic troll tactics is to sidetrack an on-line conversation on a peripheral point with the intent of de-railing the forum through determined and repeated distraction.
I’m not saying that has happened here but it does look like a distinct possibility.
The theory is sound
It happens