I have been asked to explain how quantitative easing works, given how important it is within our economy and managing the coronavirus crisis right now. What follows is part of a larger piece of work that is in development, and is a bit technical in nature, but I hope it is of use to those who are looking for a bigger understanding of this issue. When I can find time I will do another Mythbuster to explain the economic consequences of this:
What is quantitative easing?
The Bank of England says that quantitative easing (QE) is[1]:
Quantitative easing is a tool that central banks, like us, can use to inject money directly into the economy.
Money is either physical, like banknotes, or digital, like the money in your bank account. Quantitative easing involves us creating digital money. We then use it to buy things like government debt in the form of bonds. You may also hear it called ‘QE' or ‘asset purchase' — these are the same thing.
The aim of QE is simple: by creating this ‘new' money, we aim to boost spending and investment in the economy.
There is nothing wrong with this simplistic explanation, but to make sure that it is properly understood, and that its consequences can be explained, it is important to break the QE process down into its relevant stages.
Accounting for quantitative easing
Quantitative easing is a process that involves the following operations:
- The Bank of England set up a new company, called Bank of England Asset Purchase Facility Fund Limited[2] (the ‘APF') to manage this process. It had to do so because all money creation involves the making of loans, and the Bank of England cannot lend money to itself, and so had to lend it to this other company instead.
- The Bank of England lent money to the APF to provide it with the funds that it required to acquire government bonds, as well as a limited quantity of corporate bonds, under the QE programme. Those loans have now reached about £745 billion in total[3].
- As is normal with regard to bank loans of any sort, new money was created as a consequence of this loan. The Bank of England acknowledge this in the statement noted previously. They explained this process in the Spring 2014 edition of their Quarterly Bulletin[4].
- The vast majority of the money created in this way was used by the APF to buy government gilts from the financial institutions that owned them. These included banks, building societies, pension funds and life insurance companies as well as some overseas and private owners of these assets. The gilts in question were bought in an auction process. As a result, current market prices were paid at the time of the reacquisition of these gilts by the government. The price paid may not have been the price at which the gilts were originally issued by the government[5].
- Once bought by the APF the reacquired gilts have sat on its balance sheet as assets. To date none have ever been sold back to the financial markets although some have been redeemed by HM Treasury at the end of their lives. In that case the proceeds have been reinvested in the purchase of replacement gilts acquired in exactly the same way as other reacquired gilts, as already noted. The objective has always been to keep the same value of gilts in ownership.
- The loan from the Bank of England to fund the purchase of the reacquire gilts is a liability on the APF balance sheet.
- That same loan is, of course, an asset on the balance sheet of the Bank of England, and the two sums do balance each other out.
- This netting off is not, however, shown in the accounts of the Bank of England because although the APF is nominally owned by the Bank of England all its profits and losses are under written by the Treasury in an agreement dating back to 2009 when the QE programme began[6]. As such it is under the effective control of the Treasury. The consequence of this Treasury control is that although it would appear that the APF is owned by the Bank of England, the substance of the transactions undertaken is that the Treasury has reacquired debt that it has issued to the financial markets in the form of gilts, and has done so with a loan from the Bank of England.
- Although the nature of this transaction would imply that the reacquired gilts are cancelled, because it is immediately apparent that the Treasury cannot owe itself money, the legal form in which the gilts were created, and the nature of the loan structure used for their repurchase has meant that legally the gilts have not been cancelled as a consequence of their repurchase. Whilst the economic substance of what has happened is that the gilt is cancelled, the legal form of their continued existence has been maintained.
- As a consequence of this continued legal existence of the reacquired gilts, technically the Treasury has to still pay itself interest on these gilts as those interest payments fall due for payment, and as a matter of fact, these payments have been made.
- Politically it has suited the government's narrative to maintain this pretence that interest is owing on these gilts. As a consequence of this pretence, successive governments have been able to claim that the cost of government debt servicing has been more onerous than has actually been the case, and have claimed that this has prevented it from undertaking other forms of spending. This claim has been disingenuous. In practice, the income received by the APF as a result of the payment of this interest belongs to the Treasury as a consequence of the management agreement reached between it and the Bank of England, previously noted. The result has been that the income in question has been returned to HM Treasury, as a matter of fact. The accounts of the APF make this clear. The refund has not, however, been used to cancel the interest charge recorded in the government's own accounts: it does, instead, appear to be shown as part of the ‘other income' of the government. In accounting terms this might be called a misrepresentation. The two sums should be offset to present a true and fair view of the interest cost that the government actually incurs. The only possible explanation for this misrepresentation has been that it has suited government purposes to make it.
- Because the accounts of the Bank of England do not include a consolidation of the APF the Bank of England's accounts do not reflect the APF asset holding, and do instead show the loan account balance owing by the APF, which is actually effectively payable by HM Treasury as a consequence of the Treasury's agreement to indemnify the Bank of England with regards to the Bank's operation of the APF.
- However, the UK government does prepare accounts on what is called a Whole of Government basis. In these accounts the gilts owned by the APF are shown as cancelling the liability owing by the Treasury with regard to those same gilts Because, as a matter of fact, no one outside the government is owed any money with regards to these gilts once they have been re-acquired this presentation does show an overall true and fair view of the position of the government with regard to the gilts in question. Because of the accounting requirement that the economic substance of a transaction must take precedence over the legal form in which it is undertaken the correct presentation of the liabilities of the government with regard to these debts is shown in the Whole of Government accounts as a consequence, with the gilts in question being shown to be cancelled. The political preference of the government to show that the debt still exists is overruled by the accounting requirements that a true and fair view be presented by its accounts.
- The fact some separate accounts e.g. those of the APF, still show transactions being undertaken with regard to these gilts, does not alter this economic substance that the transactions in question net out on consolidation for the government as a whole, and as such have no real economic substance to them, clearly indicating that the gilts in question are effectively cancelled.
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[1] https://www.bankofengland.co.uk/monetary-policy/quantitative-easing
[2] https://beta.companieshouse.gov.uk/company/06806063
[3] https://www.bankofengland.co.uk/monetary-policy/quantitative-easing
[4] https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/quarterly-bulletin-2014-q1.pdf
[5] There is nothing surprising about this change in the price of gilts after their issue. As official interest rates have been reduced to almost nothing[5] over the period during which the quantitative easing programme has been in operation, and whilst the amount of interest actually paid on government bonds in issue remains a constant (which on all but index linked bonds it does, over the lifetime of a gilt, which can be for a period of up to fifty years), the price of bonds increases in the open market to equate the price of a bond already in issue with the current equivalent interest rate return expected upon it as if it had been issued now, taking into account the time expected to pass until redemption of the bond takes place. There is nothing untoward about this: this is how fixed interest bond markets work.
[6] https://webarchive.nationalarchives.gov.uk/20091204191052/http:/www.hm-treasury.gov.uk/d/chxletter_boe050309.pdf
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Really interesting. If only the entire populace could be educated on this (and the EU).
In a nutshell politically motivated “smoke and mirrors” is being used to deny all the citizens of the UK an equitable Integrated Supply and Demand Policy. This is corruption pure and simple!
https://larspsyll.wordpress.com/2020/10/21/what-is-effective-demand-2/
Always very well explained a bit away over my head though,here is another one for you Richard,I always hear people say we are the fifth richest country in the world but with massive debts and more to come how can this be,at my age it wont bother me but my G/children and their family is the ones who will suffer not the friends of the Tories making a killing at the moment.
This debt will never be repaid…
Yet we still have the government, the media and most worryingly of all ,the opposition still using the term “borrow” to explain how we are now having to spend more than we tax in take.
In any understanding of the word “borrow”, what we have now is not borrowing.
Precisely
But established economists are taking me on on twitter this morning to say otherwise
Do established economists have any credibility left now?. I much refer the informed opinions who live and work in the real world,
Great article Richard, really interesting.
It seems obvious to me that even if you call it “borrowing” the money they are “borrowing” back originally came from the government (effectively) in the first place. For it to be any other way, there would have to be a finite supply of money.
What I find strange is that people are able to simultaneously believe in an expanding supply of money, but also hold the belief that the government needs to borrow the money it itself has created.
I feel like it’s people propping up a nonsense understanding, because should this come crashing down, it would unravel their whole political belief system.
A lot of what you describe is correct, but you have made some important omissions and at the end you start to get things wrong.
Firstly it is worth saying in full what the BoE say about how QE works in the link you gave.
“How does quantitative easing work?
Large-scale purchases of government bonds lower the interest rates or ‘yields’ on those bonds (the investopedia website explains more about bond yields). This pushes down on the interest rates offered on loans (eg mortgages or business loans) because rates on government bonds tend to affect other interest rates in the economy.
So QE works by making it cheaper for households and businesses to borrow money — encouraging spending.
In addition, QE can stimulate the economy by boosting a wide range of financial asset prices.”
So they say it works by lowering interest rates, not just by printing money.
In points 4/5 you miss out the implication for buying Gilts in the open market. Gilts are issued and redeem at par, but not purchased by the APF at par. This is important to note for the later points you make, where you only consider the interest (coupon) payments of the Gils, but not their mark to market value.
You start to go wrong at point 9. The economic substance is that the Gilts are NOT cancelled, because of the above.
Point 10 is essentially correct – the interest payments (coupons ) on the Gilts are effectively cancelled, but you fail to mention that instead of coupon payments the BoE now has to pay interest on the reserves it has created.
Point 11 is just wrong. The government and BoE’s narrative is that QE has reduced debt servicing costs. They specifically mention this several times, even if they account for it slightly differently.
Point 12 is true, but you miss a major issue here. HMT indemnifies the APF, and all profits and losses are passed back to HMT from the APF. There have been significant mark to market gains from the bonds held by the APF and these have already been passed back to HMT, as well as losses in a couple of years. These values have been generated by the mark to market value of the Gilts held changing with interest rates (bond yields, specifically) and not the coupon payments from the bonds.
This means those bonds are still in existence and still carry risk. Should interest rates rise, the APF and therefore HMT would suffer losses on the bonds it holds.
Point 13 isn’t quite true either. As I mentioned, the BoE is still paying interest on the reserves used to buy the APF gilts. Which is a cost. You also fail to notice that even if a Gilt issued by government is owned by government, it can still lose money on it. For example, the 10y bought at market for 150 will redeem at 100, and the government could lose money on that redemption. This shouldn’t be that surprising – asset values change over time.
The point about accounting you make, saying that the Gilts are shown to be cancelled, is also not true. They make specific mention in the whole of government accounts that the APF gilts are represented by the reserves used to buy them, because the APF is at arms length, and there is a risk on the APF balance sheet because of those bonds. It might be an accounting technicality, but doesn’t mean those bonds are cancelled.
Point 14 is also incorrect I’m afraid. It the bonds were truly cancelled, you would see no mark to market gains and losses being passed between HMT and the APF. The fact that the APF and therefore HMT can both profit and lose money from the bonds it holds means those bonds are not cancelled. The interest payments from bond coupons net out, but the mark to market gains and losses don’t.
As I said, this is part of a much bigger piece and did not cover all issues
The bigger piece covers much of what you say, but is not finished. I am also assured by those who have tried to areas it that dealing with all these issues is mind boggling
But let me address some issues
a) I know gilts are not bought back at par. They are cancelled at par: the premium is properly accounted for as prepaid interest over the life of the cancelled giilt: the one remaining accounting function it has when considering substance and not form
b) The BoE does not have to pay interest in the reserve account balances – it chooses to – at base rate right now
c) You offer no reason why 11 is wrong
d) MtM is a red herring – and it is not paid to the Treasury (not that it need be anyway, as it is already in the APF which is part of the Treasury) and that is because there is no means to make payment. And there is not a penny of risk – because whatever risk the APF has is equal and opposite gain to the Treasury – so you are wrong. Please do consolidated accounting/ The Treasury cannot lose on these bonds: it is impossible unless they chose to sell them – and they have no need to do so. Please don’t think mark to market accounting reflects reality – it assumes a sale that will never take place
e) Gilts redeem at par. As I note – the premium is an asset representing interest prepaid. There is no loss.
f) The claim the APF is at arm’s length is a sham – fraudulent even. It is a function of the TREaasury. Of course it is not at arm’s length. Please don’t but their lies.
g) There is no market gain or loss between HMT and the APF: they would always net to zero if both sides accounted in the same way. You are wrong.
In answer to your points:
a) This is not correct. The bond premium will change as interest rates change – which is why you see bond mark to markets change. This is another reason you can’t simply cancel bonds in the manner which you suggest.
b) The fact that it chooses to means that it is still paying interest on those reserves. If it didn’t pay interest, as you claim it could choose to, there would be serious implications and the BoE would lose the ability to maintain short term interest rates – which it does by paying interest on deposits primarily.
c) For example: https://obr.uk/forecasts-in-depth/tax-by-tax-spend-by-spend/debt-interest-central-government-net/
OBR, government and BoE all acknowledge that QE has reduced debt servicing costs through lower rates and netting off with APF.
d) MtM is not a red herring, and the APF accounts show that net MtM changes are paid to treasury, or any losses covered by treasury. They specifically split out the interest received from the market to market changes in the bonds. You can see this on page 12 of the following APF accounts.
https://www.bankofengland.co.uk/-/media/boe/files/asset-purchase-facility/2020/annual-report-2020.pdf
The APF gained £14.5bn from interest, £32.5bn from MtM changes on the Gilts they hold. They pay interest to the BoE of £3.5bn and the remaining £43.5bn is paid back to HMT.
When you say HMT can’t lose on these bonds you are also unfortunately also wrong. They issue a bond at par, and are now short interest rates. Market yields move lower and they buy the bond at 150. The coupons cancel out, as you suggest, but they have still paid 150 for an asset which will redeem at 100. That will be true irrespective if the bond is never re-sold to the market – the loss will be locked in.
e) A premium on a bond price is due to the present value of the coupons and bullet being higher than when issued, because interest rates are lower. There is no prepayment on Gilts.
f) The APF is at arm’s length for very specific reasons. I am surprised you don’t know this. This also explains your confusion regarding the whole of government accounts. The accounts of the APF and WGA are not prepared on the same accounting basis, so you can’t just consolidate them in the manner you suggest.
Let us first start with the APF. You would agree I hope that an entity with more liabilities than assets would be bankrupt. The APF liability is the loan from the BoE, which is essentially a fixed amount with a floating interest rate cost.
Their assets are the Gilts they purchased. The Gilts change in MtM value. If they decrease in value the APF would be bankrupt, and would need money from elsewhere to remain a going concern. If the bonds rise in value they show a profit.
The APF accounts are done on an MtM basis for accuracy and efficiency, not least because bonds purchased at market prices would have to be written down immediately (for the reasons above) if moved to a different accounting basis comparable to WGA, even though their value would not have changed on an MtM basis.
The government doesn’t MtM their borrowings. Primarily for simplicity. It would be hard to keep track of things politically if the national debt changed all the time due to moves in interest rates, so the government presents it’s Gilt borrowings in purely nominal terms plus a debt service cost. The true value of the £2trn of government debt is much higher than £2trn at the moment – were government to buy it all back today.
So it is not a sham that the APF is at arms length. It can suffer losses and make gains, which otherwise would not be accounted for in WGA – and I would hope you agree that net gains or losses should be.
g) See above. Bonds will show profits and losses depending on the path of interest rates, which makes the purchae price (and time) important. Even if you account for the APF and HMT in exactly the same manner, if you issue a bond at 100 and buy it back at 150 you will likely have lost money.
If anything, the structure in place means HMT doesn’t have to crystallize losses upfront and can ammortise them over the life of the bond – though those losses don’t disappear. As it turns out, there have been profits to date on QE operations, but accounting for it in this manner means that losses are also possible, should interest rates rise.
I think you are looking at things purely on a static basis and assuming fixed coupon bonds also have a fixed value, which leads you to your mistake.
a) You are wrong: only the premium at the time of reacquisition matters: that is fixed. After that there is no risk because the Treasury owns both sides of the arrangement. Until you get your head around that your comementary is worthless
b) Wrong: the short term rate would be zero
c) Rates have reduced servicing cost
d) I know the APF accounts inside out: you fail to read them as being internal accounts of the Trteasury which is what they actually are, and so the double entry is wholly within the Treasury. The Treasury cannot lose on the assets it now owns: they are not longer traded and will be held to redemption. The premium is porep[aid interest not now due. That’s it.
e) As far as the Treasury is concerned the premium is a prepayment of interest that cancels income repayable to it buy the APF. Try doing the double entry any other way.
f) Of course I am aware that there is a fraudulent reason for claiming the APF is not part of the Treasury – but it is a fraud nonetheless, to pretend that there are gilts in existence when there are not. It is scandalous that the APF is not consolidated: an accounting scandal of massive magnitude. Stop exonerating it. ~And the APF can make neither profit nor loss: by definition. Again, stop telling untruths.
And please don’t post your false arguments again
a) If you sell something for a given price, and then buy it back for a higher price you have still lost the difference. I hope that much at least is not controversial.
I also hope that we agree that a fixed coupon bond will always have the same coupons, and bullet maturity repayment.
That does not mean the vale of that bond is fixed though. It will depend on the market level of bond yields when bought or sold.
So if, as in my example, HMT issues a bond with a 5% coupon when rates are at 5% that bond will trade at 100. If interest rates move lower to 0%, that bond will trade at 150. This is actually roughly where he current 4.75% coupon 10y bond is trading in price terms currently.
So if you sell the bond for 100, then buy it back for 150, you have lost 50. The coupons cancel each other out, as you suggest, but you have still lost money on the bond.
b) Why would it? The first thing you would see if all excess reserves being placed into other return seeking assets – which would promote instability in markets as asset prices would be linked closely to the availability of money market liquidity. Any excess liquidity would then go seeking any place to be parked, even at negative yields. The more liquidity, the lower rates would go unless the BoE stepped in and put a floor in place. Which is exactly why they do it.
This is exactly what happened in the Euro via the ECB, before the ECB introduced a 2 tier deposit rate to stop this phenomenon.
c) I’m not sure what you mean by ” rates have reduced servicing cost”. For sure, debt servicing costs have reduced as interest rates have moved lower and QE interest rate costs are at the BoE base rate rather than long bond yields.
But I thought your point was that that government and the BoE aren’t acknowledging this reduction in debt service costs, when they vry clearly are doing so.
d) At this point I think you are making things up. The APF clearly states where it’s profit and loss comes from. It also clearly states that any profits are returned to HMT, and and losses are made whole by the HMT indemnity guarantee.
The fact that there are profits and losses, from MtM changes in the Gilt prices, means that things are not as you claim they are. As I have shown, with example, HMT can make a loss on assets it now owns.
e) Bonds do not prepay interest. There is no cashflow at any other point other than coupon dates.
There is such a thing as present value, which is different. Which is why bond prices change.
For example, the 5% bond with a yield of 0% and price of 150 does not mean any prepayment has occurred. You still get your 5% coupons, but the increase in price is solely due to the current level of interest rates. The present value of 5% coupons is worth more over the 10 years when discounted at 0% than at 5%. This is basic financial mathematics.
If yields move back to 5%, the bond will once again be worth 100. By suggesting prepayment (which is just hopelessly wrong, I’m afraid) you would also mean then that the opposite is true.
If you are sure that what you are saying is true, I am sure you can also provide a link to prove that this is how HMT account for this.
f) I’m not sure where the fraud is coming from. You could consolidate everything but that would not give you the answer you are looking for – as I pointed out in my example. It is also very clear from the accounts that the APF can and does make a profit or loss.
If the APF was consolidated into the WGA directly and you cancelled the bonds owned by the APF, you would have to account for any losses upfront, as well as write down the value of the APF holdings from MtM fair value to nominal book prices – which would be about £100bn on the MtM for the year to Feb 2020.
Doing it the way they have is the most efficient way to manage the situation – even if it doesn’t meet your standards. It is a much smarter way to account.
Any way you look at it though, and however you consolidate the accounts buying Gilts back at higher prices than they we issued at is still going to mean HMT has lost money. You can acknowledge it upfront, as you see to want to do with consolidated accounts or you can amortize the cost as HMT has done, but you can’t escape this very basic fact.
This is pretty simple stuff in concept – you only need to understand bond valuation and pricing and some common accounting principles to get there. I’m sort of surprised you haven’t managed to.
I have already explained why you are wrong on this
And the Treasury did not lose on repurchasing these gilts
It saved paying future interest to third parties – and that was what the premium represented
Hence, prepaid interest
It really is not hard
And now your posts will be deleted, because I bet bored after a while with people who can’t understand macro issues
It is becoming apparent you don’t understand how bonds are priced or function.
HMT will lose money in the example I gave you. The value of those coupons are already priced on a present value basis, so buying them back doesn’t achieve anything in terms of “savings”.
Do you think that the owner of such a bond will accept less for a bond than it is actually worth which is what you are suggesting? Because that is the only way HMT could make a saving.
If bond yields have gone down since the date of issue, then the price of the bond will have risen. This is because the coupons are worth more, when discounted back by lower rates. The difference will be the present value of 10 years worth of 5% coupons.
So HMT repurchasing the bond will not save them anything. They will report a loss upfront. There is no prepaid interest, there is only present value, and what you are saying is simply totally wrong.
You are in effect saying that if you sell something and then buy it back again at a higher price, you don’t lose money. It literally is that ridiculous.
Do I really gave to explain this?
First, I know exactly how this bond is priced. So I did not read your example.
The treasury bought a bond at a premium. Rationally that is the discounted value of the future income stream payable with the discount rate being the difference between issued and prevailing rates to equate these over bond life.
You claim the treasury makes a loss on purchase, which rather bizarrely means you think the bond is legally cancelled; it could not do so otherwise. Thanks for that. Argument over.
I say in substance it is cancelled. The premium is prepaid interest to be unwound over the remaining life of the gilt previously contractually arranged, and still paid but with this cancelling the income on return to the treasury, so stating interest cost at originally contracted price.
Simple really.
And right.
You need an accountant to get these things right.
On consideration, it might be worth illustrating the point with an example. I will simplify but hopefully it should get the point across
Before the great financial crisis, 10y bond yields are at 5% and HMT issues a £100m 10y bond with a 5% coupon. I hope we can all agree that this bond will issue at par – 100. HMT receives £100m from the sale of the bond.
The GFC happens and markets price interest rate lower – to 2.5%. our bond now has a value of 125, the extra 25 coming from the present value of 5% coupons and bullet repayment at a lower discount rate of 2.5%.
The BoE starts QE and the APF buys the bonds from the market, at market prices, so pays £125m for the £100m face value.
We could account for it several ways.
If we take your consolidation and cancel method, HMT suffers a loss of £25m. That’s it. The bond can be torn up but the loss is crystallized.
Using a pure MtM method, on both sides (WGA and APF) you would see the APF with an asset (bond) worth £125m and liability (borrowing from BoE) of £125m, so not net profit and loss. The WGA would show a liability of £125m (repurchased bond) vs an asset of £100m (cash from original sale of bond). So still a net loss of £25m.
However, when you look at the hybrid method of accounting, where APF is MtM and WGA not, you see an advantage emerge. The APF once again has no net asset/liability value as above, but the WGA accounts change. It has assets of £100m still (from the sale of the bond) but because it accounts for bonds on WGA at nominal levels, it has liabilities of £100m as well.
As I mention in my other post, another major reason for the WGA being prepared in the manner they are is to eliminate the fluctuation of Gilt prices on the value of government debt outstanding – effectively simplifying the situation.
Where does the £25m loss go? Higher debt service costs for the 10y years. This offers obvious advantages for a government as it doesn’t have to account for upfront losses, and can ammortise the cost of this loss over the next 10 years. The loss is still very real though – HMT has simply repurchased the bond it issued at a higher price.
There is another advantage to the accounting method used, which is at arms length. Let us now say that economically things get even worse and 10y rates go to 0%. The £100m of bonds issued are now worth £150m.
If you those bonds were cancelled when bought at £125m, that £25m loss is locked in.
If you do it the way things are currently done, you get a distinct advantage. The APF now has an asset of £150m and liabilities of only £125m. The £25m profit can be passed back to HMT.
HMT itself now shows assets of £125m (£100 from sale of bond, £25m from APF) and liabilities marked to book of £100m, but the ammortised cost of repurchasing the bond is still £25 over the life (because they have locked in a sale at 5% and repurchase at 2.5%). HMT has made it’s money back – as well as front-loading the £25m to today and spreading it’s cost over 10 years. This is a massive benefit from HMT’s viewpoint, which would not be possible if the bonds were cancelled.
Of course, there is a downside to doing things the way they are. If interest rates move higher you can reverse the example above, the APF loses money and you now front-load those losses. Which is one reason why it is so tricky to exit QE.
So, in short, QE could cancel bonds, but there would be a cost associated with doing so – and quite a substantial one. In not doing so, there are significant advantages but the bonds and their risk still exist. Either way, you are still left with a cost to government and QE not being free.
Tell me how the gain is passed back to the Treasury?
With what is the payment made?
You will not be able to answer that, which is the mark to market gain is not paid….there is no means to settle it
I’ll deal with this one first as it is quicker.
We can tell from the accounts that the MtM gains ARE DEFINITELY passed back to HMT. The accounts specifically separate out the interest payments and MtM value gained, and the amount passed back to HMT is the sum of these less the costs.
How this is done is not specified in the accounts, but I would guess that this is done through a combination of repo, adjustments to the loan account and from the cash raised as bonds mature (which a significant amount do each year).
You could do it all through repo, but ultimately the exact mechanism is not that important – as long as we know that it is, which we can see from the APF and WGA accounts.
No – it’s just left on account because there are no means to settle it
The accounts make that very clear
You really need to learn to read and understand accounts
https://www.bankofengland.co.uk/-/media/boe/files/asset-purchase-facility/2020/annual-report-2020.pdf
See note 2c) page 17.
“a process for partial settlement of the indemnity between the Company and HMT was established”
The accounts make that very clear.
You really need to learn to read and understand accounts.
And the MtM gain is the balance near enough owing to HMT
Odd that….
Of course the realised issues were settled
I asked you how an unrealised gain could be settled and you have not answered
That’s because they can’t be
Because by definition they’re paper entries
And if the a/c with HMT is to balance (as it must) then they have the other side of the risk
It really does follow like night does day
https://www.gov.uk/government/news/changes-to-cash-management-operations
The MtM gain IS the balance owing to HMT. They don’t transfer all of it, for prudential reasons, but some of that value is transferred.
It is pretty easy to settle unrealized gains. As I said, you can use repo, cash from redemption or adjust the loan account to manage it. The APF uses a derivative to do exactly the same thing it turns out.
Just because it is a paper entry doesn’t men it isn’t real and cash doesn’t change hands – it’s called a margin account. You don’t book profits and losses only when something is held to maturity.
It hasn’t been paid
Stop the BS
That was your last post
Way out of my depth with this particular ding-dong.
Only thing to say is that it all seems a bit academic if the bonds are never sold back into the bond markets anyway.
Is it ever likely that they will be? Can’t see why they would be?
They never will be
Pragmatically
Or even academically …
Yeah.
My stamp collection is only worth something at the point that it is sold.
If the gilts are never going to be sold, where is the Treasury liability?
It was due on buying them
It was newly created money
Keith does not understand money….
Given that the BoE has been paying interest on reserves since March 2009 I hardly think it now needs to use QE to control the level of interest rates!
Thank you Richard for going to the trouble of delving into these financial processes regarding QE. Over the years I have taken most financial services exams and this aspect has never been covered in this way.
The word which comes to mind is obfuscation!
When you mention QE into the economy, I take it to mean at the top end of the economy. The gilt owners are not people living in housing estates. I’d imagine very little reaches the bottom.
It eneters the babking system
A lot stays within finance
So to clear my head
can I summarise your points7 to 14
The UK Govt. deliberately ( ? ) muddies the water by pretending that the gilts are not cancelled
However in the Govts. consolidated accounts ( ? ) ” the whole of the Govts.basis ” the gilts are indeed shown as cancelled. ( ignoring the interest element )
Wonder what the trolls will make of that !
Jonathan Portes says I am wrong because there is a new liability – the new money
I do not deny this
He says all money is a liability
That’s an interesting claim…
Along with his claim that they are equal and opposites
I’ve seen this argument before, seems a rather academic one to me. Yes there is money(reserves) created here but what kind of liability is national currency? It’s not like you can ask for it to be redeemed in anything else. Take a £5 note to the BoE for redemption and they will give you another £5 (or maybe 5 x £1 coins). It’s not a liability in any real sense of the word.
Beside national currency is a very useful thing to have, we can’t run an economy without it so its not like its a problem. Money creation is a be duty of any Sovereign power.
You get it…..
Excellent summary which I’m sharing with friends who have an interest in esoteric matters like this. Re point 11 in your summary, am I right in thinking that the smoke and mirrors effect of interest paid on such gilts also works it way into the GERS figures as part of mysterious “accounting adjustments” charge?
Very likely
You have to look at all of this from a psychological viewpoint. Why would the establishment, which is dominated by the rich and their gofers, want to set up a phoney debt obligation or obligations and the answer is they hate uncertainty. The drive or desire to be rich helps remove uncertainty the degree of which is often the product of insecure parenting.
In order to obtain or maintain par value in money creation practice has clarified there has to be reflux and this mainly involves taxation. The concept of equitability held by the less rich and particularly the poor, however, means pressure to place the larger burden of taxation on the rich.
Whilst the rich may acknowledge that as far as government money creation is concerned not all has to be refluxed there is still the threat that a significant amount still has to be refluxed.
We should be very much aware what better than to set up phoney debt obligations than insist a country needs a national bank! Historically UK governments used to use tally sticks to create money without a national bank. The pressure to fight wars and the consequent taxation and inflationary effects from this eventually resulted in a privately funded Bank of England to control in theory the government’s money creation being set up in 1694. It was believed forcing the government to take out loans (gilts) would spread the cost of these wars in to the future.
As always, a clear and correct description….. but I fear that few readers will make as far as paragraph 14.
“QE allows the Government to spend without borrowing” – this is what EVERYONE in this country should understand.
The BoE could allow the government to spend without borrowing by just granting it an “overdraft” (Ways and Means account) but, for various reasons, chooses to buy gilts.
It could buy gilts direct from the government (with money it has created) but, for various reasons chooses to buy gilts in the open market.
The BoE buys gilts from banks and other financial institutions who then take the cash and errr…… buy gilts from the government at auction.
Whichever way you look at it, QE allows the government to spend without taking money in from anyone.
Of course, one then has to explain the limits of this ability (inflation etc.) but that is a full MMT story. QE is simple.
Spot on
I should out it as simply as that
But my point is – in reality QE does result in the BoE replacing gilts with money – and its choice that they pay interest on this
Agreed, the BoE has only recently started paying interest on its reserves. I believe it was after the 2008 crash as a way of giving the banks yet another subsidy in hard times…poor souls. So historically this is not a normal situation for our central bank. If interbank markets are working normally, which they should be now after all the extra reserves pumped into the system this year, why do they still pay interest on reserves banks hold at the BoE? You would think the BoE would want to be encouraging the banks to lend more right now, there is even talk of negative interest rates, which I think the BoE will never do.
Before 2008 it also made much more extensive use of the Ways and Means Account – its overdraft at the BoE
There is always more than one way of skinning a cat. It is interesting the govt. has decided to go down the QE route rather than the Ways and means one. Could it be easier to obscure what is going on? The amounts involved are eye watering ( as they need to be). To have the new money created sitting opposite gilts looks better than an a straight up overdraft from certain points of view I suppose, but it’s really only aesthetic.. Ways and means never covered these kinds of figures in the past either, its like having an overdraft as opposed to a taking out a mortgage.
It was EU law
But that was also applicable before 2008 and so the argument is hard to follow…
Yes of course, I forgot about that. The EU fiscal pact rules have also been generally ignored/eased by the EU since their creation . Can’t see the EU ever wanting to get into a bun fight over this with the UK ,they have had enough trouble to cope with within the EZ as it is. Besides we will have now left the EU and they are allowing leeway on the rules to national govts right now to get out of the mess.
There is also the suspicion that this will also allow the BoE to keep pretending that it cannot on its own resources sustain gov spending by the Treasury(via Ways and Means) as this risks awkward questions about where the BoE is getting its reserves from we can’t have people seeing that money can be created out of thin air!
Far better to have everyone see and that the BoE needs an actual asset (gilts)to justify all this money creation. Even though the Treasury just issues gilts to give the BoE to hold in return. I guess a written “official” promise is better than a looser verbal one saying we will pay it back when we can…our credit is good. So this is a kind of a fig leaf to cover the BoE’s /Treasury’s modesty.
Net effect being the same of course.
https://positivemoney.org/2020/04/the-ultimate-magic-money-tree-has-been-unveiled-dont-let-the-government-tell-you-otherwise/
..and buying gilts from banks and other financial institutions has the knock-on effect of generating handsome fees for intermediaries, which keeps everyone in the Square Mile happy.
Mr Parry,
You twice use the phrase “for various reasons”. I think understanding is best served by the “various reasons” being fully spelled out. I submit this response reaches beyond process to purpose.
Clive Party.
Love your simple explanation.
It answers my basic questions/misunderstandings.
Thanks for explaining QE Richard.
I think my brain is going to explode!!!!
I’ve got so much stuff to get my head round!!!!
Better that, than sitting in the dark though!!!!
We need to bear in mind a few things here.
Firstly, David Graeber argues in his book “Debt: The first 5000 Years” the marketplace was established by governments needing to service their enormous armies and navies.
Secondly, governments like the UK would issue credit money in the form of tally sticks without a central bank.
Thirdly, with the marketplace coming into existence the private sector needed a medium of exchange. Silver was taken to the government mints to create coins. The government kept some as their fee for coining.
Fourthly, to control the government the rich pushed to set up the privately owned Bank of England. The government stopped charging for creating coins at the Royal Mint. The BoE gained control over the issue of banknotes.
See pages 1 and 2 of Chrisine Desan’s book on the evolution of money. The English were the forerunners in the evolution of money over the last 300 odd years:-
https://books.google.com/books?id=kMwCoQEACAAJ&pg=PA1&source=gbs_toc_r&cad=4#v=onepage&q&f=false
The English appear to have developed ideas which originated at the Hague. Downing, our man at the Hague, came back from there with ideas for a CB but only managed to get what became the Treasury up and running. The Houblons, one of whom had been out there at the same time as Downing, actually managed to get the CB going, probably because unlike Downing they applied to do so at a time of war when monarchs were traditionally scratching for readies. I gather to improve his chances Downing put considerable effort into trying to get a war going between England and the Low Countries, this against the specific written orders of his king. He failed, and was rewarded only with a spell in the Tower for his efforts. There were also the Land Bank gang and the South Sea Bubble mob, and Philip Burmalachi, all of whom seem to have been inspired by the Dutch Finance model.
What better way to make sure the people don’t get what they want from their government than making sure the government has to have its own bank. Banks are all about creating debt. “Oh look the government’s already in debt can’t afford to do what you oiks want!”
Indeed
Ultimately you have to wonder why mankind developed an economic system that enforces repayment of money spent defending against a natural disaster. What baffles me more is why so few people question this basic premise.
Consider state education as grooming and you’ll get it. If you want to bamboozle a population and keep them bamboozled, state education is your friend. It helps to keep them busy in their waking hours too, don’t want them having time on their hands, they might start asking questions and developing their own ideas.
@ Scott Hutchinson
People afraid of debt! When you attach “money” debt to the use of real resources then you’re obligated to others because all the might of laws neutrally and remorselessly reinforce that obligation. There is no court of arbitration to declare that given your changed circumstances forcing repayment of the debt would be morally wrong. Home repossession by the banks in the aftermath of the 2008 GFC is a classic example!
Trying to follow Keith.s line
Why would the Govt. inject money into the economy at a potential huge loss to itself –our selves ?
Am I missing something in this expensive coupon exchange ?
Who wins ?
He is making up the loss….
A very clear explanation of a very complicated process. The BTL arguments as usual also very helpful. Thank you Richard. Keep up the excellent work. Nil carborundum ……..
Is there a flow diagram that shows the working of the UK economy, with QE, borrowing, tax, council tax and border flows? Perhaps such a diagram would be too complex to be useful?
I do not know of one….
[…] Read here […]
A note about tally sticks.
A bit off-topic, perhaps, but tally sticks have been referred to in these discussions as if these had been a means of financing government without taxation. This is not so. As described by Robert Ashton in “The Crown and the Money Market 1603-1640” (OUP 1960), the Crown farmed out to consortia of private individuals collection of certain taxes and customs revenues hypothecated for specific purposes. These consortia were required to deliver up revenue to the Exchequer only to the extent that they had guaranteed those revenues in bidding for the farming rights. Any surplus tax legitimately collected by them over and above this amount belonged to them.
The tallies issued by government departments in payment for goods and services were, in effect, cheques drawn on the farmers of those taxes which had been hypothecated for the supply of those goods and services, which the farmers of those taxes were obliged to honour from the cash they were holding in revenues from those taxes. If they weren’t currently holding any cash, the tally holders had to wait until they were. Tax farmers then periodically submitted redeemed tallies in lieu of cash in settlement of their obligations to the Exchequer.
Tallies were thus acceptable in payment not because they served to redeem recipients from their personal liabilities to taxation (as MMT accounts imply) but because they served as negotiable claims on tax revenues intended for the Exchequer.
Furthermore, the issue of tallies did not, as implied, preclude the need for debt. The Crown also borrowed heavily from private citizens, and most of the plethora of finance bills enacted in the seventeenth century specified the amounts to be borrowed from willing lenders and established new customs tariffs, or extended existing ones, to generate the revenue to service these debts.
Thank you
I am no expert in this area
Do others have a view?