Headline on the BBC: Bank to pump £75bn into economy.
Wrong. As the article explains "the Bank will not expand the supply of money by making new banknotes. Instead, it will buy assets - such as government securities (gilts) and corporate bonds."
1. Let's assume the BoE buys gilts in the open market. If you own a gilt and you need 'money', what you do is, er, sell it in the open market. What they envisage is a situation where one branch of government, the BoE, gives people bits of paper with numbers on them (bank notes) in exchange for bits of paper issued by another branch of government, HM Treasury. Please do not overlook that banks notes and coins are non-interest bearing government securities repayable on demand. A bank note or a coin is an interest-free loan to the government, but it is still government borrowing. Once the deal is struck, the two branches of government can meet up and tear up their bits of paper and, to the outside world and in real life, nothing has happened. Apart from the paper basket being unusually full. So that achieves the square root of nothing.
2. As an aside, let it be noted that such a strategy does increase the amount of 'money' sloshing around if the BoE overpays. As it happens, the price of ten-year gilts jumped by three full points today, i.e. the markets' first assumption (which may or may not be correct) is that the BoE will overpay by nearly three per cent.
3. Let's assume the BoE buy corporate bonds (IOU's issued by businesses) in the open market. Exactly the same principle applies; if you own a corporate bond and need 'money', what you do is sell it in the open market, simples. So buying corporate bonds only increases money supply if the BoE, a branch of the government, does what governments always do and overpays (which is quite likely, see point 2), which gives a modest windfall gain for the holder of that corporate bond - but only to the extent of the overpayment. So if the BoE spends £75 billion on corporate bonds, overpaying by 5%, it has increased money supply by a mere £4 billion, which is the amount of money that the UK government spends every two days anyway.
4. The BoE like to describe this as 'buying corporate bonds', which is a fancy way of saying 'lending businesses money'. So we're back to the old issue - if it's a good, creditworthy business, why can't it borrow from commercial banks or issue new corporate bonds to the general public? If it can't do either of those, obviously it's not a very good credit risk, so why should the government force the general public, i.e. the taxpayer, to lend to it indirectly? Ergo, the BoE will be lending our money to businesses on more favourable terms than they could otherwise obtain i.e. wasting taxpayers' money, a bit like the PFI disaster.
5. When they talk of 'pumping in £75 bn', seventy-five billion of what, exactly, and into what? All that happens if you increase the money supply is that price inflation cancels it out again, it achieves nothing. Or more relevantly, if you slow down the speed at which the credit bubble is bursting, you reduce the deflation rate slightly, which achieves nothing either, of course.
6. As an aside, there are two ways of getting excess credit/debts out of the system. The hard core free-market liberal way is bankruptcies, debt-for-equity swaps and the like; and the softie/large government way is printing money and having high inflation. I prefer the former way, of course, but really they are both questions of degree - the moral difference is that with the first, the stupid, reckless and gullible are punished particularly harshly, and with the second, the losses are spread out a bit more evenly, so that even the cunning, the cautious and the innocent lose out to some extent.
OK, I hope that explains what is wrong with the headline. See if you can spot all the other deliberate errors, one-sided transactions and downright lies in the rest of it, or indeed elsewhere on the world wide interweb or MSM.
Not satisfied
59 minutes ago
23 comments:
I'm by no means an expert (as has been shown in numerous other disagreements about banks increasing the money supply in the pyramid of loans ) but I understood that banks were obliged to buy gilts when they were issuing extravagant amounts of credit in order to thus slow down the money supply.The banks are obliged to pay for the gilts in cash or electronically in a way which reduces their balances.
When the Guv buys them back ,they pay electronically in a way which does not reduce the Guv's balances (because they don't really have any) but which supplies the banks with very easily realisable
reserves , ready to start the credit cycle.Not locked-up for specified periods in gilts which therefore cannot be lent out.
Thus new money starts appearing which the Guv has not borrowed.
If the Guv buys the gilts in bank notes,these are not a form of borrowing.If bank notes were ever presented for redemption, the Bank would simply hand you the same notes back.
Feel very uneasy for being in line with orthodox opinion on this one.Unnerving.Although it is a strange orthoxy which confesses indeed boasts that the Guv can increase the money supply without borrowing or taxing.
Sort of on topic. I am just reading an article in Autosport (!) about the history of Honda's failure in F1 which takes in a team called BAR funded by BAT which eventually morphed into Honda F1 team. I quote:
"The team had spent too much and BAT had no option but to bail it out converting loans to shares and diluting the investment of the original partners."
If it's good enough for F1, it's good enough for the banks.
Bravo, a fine post.
However, there is one further point.
Either A) as you say QE achieves the square root of fuck all, a la Japan.
or B) Massive hyperinflation as we all lose in in a nightmare of panic and paranoia.
I am hoping for a)
Dave, don't confuse the asset side with the liability side! The government gave/lent money to the banks (a liability from the banks' point of view) and forced them to invest in gilts (an asset from the banks' point of view). This is a self cancelling transaction - imagine you are a bank and I am the government, and I allow you to give me an IOU on the precondition that you 'invest' the proceeds of your IOU into an IOU that I have issued.
So far, so pointless.
You decide that owning a long-term IOU from me (a gilt) is a mug's game and demand cash. So you give me back the original IOU that I issued and swap it for notes and coins (another form of IOU that I can issue), or indeed their electronic equivalent (yet another form of IOU that I can issue).
Sorry, still pointless.
If the government's aim is to get rid of credit/debt burden by inflating it away, then so be it, at least that has identifiable winners and losers. But shoving IOUs and bits of paper back and forth achieves slightly less than nothing, apart from earning Tony Blair's new employers £700 million.
L, I haven't summoned the energy yet to look at Ford's debt-for-equity-swap of the week, the details are fascinating.
CU, I am also hoping for a), we'll see.
Methinks there is an void in your analysis Mr W.
What does the Bank of England pay for things with? (OK, "with what does the BoE pay for things?") You and I and Lloyds and Barclays have to pay with money sitting in our account. We cannot just magic money into our account, it has to have come from somewhere first.
If we buy a corporate bond we pay for it with money that is already sloshing round the system. No increase in the total amount sloshing results from such a purchase.
By contrast the Bank of England can just award itself £75billon by declaring "as from now we have an extra £75billion". Who can argue with it, who can say "show me the cash", who can suggest that it is any less real money than any other money? Answer: no one.
The BoE can then use that money to pay for anything it wants and thereby inject it into the economy when previously it did not exist at all.
Compare the BoE's position when buying a corporate bond to the position of you and I doing the same thing. We can only spend money that is already out there, the BoE can spend money that has never before seen the light of day.
Of course they need a way to inject that money into the economy and buying bonds is thought preferable to giving 5 new crisp £20 notes with every purchase of Daz at Tesco, but it amounts to the same thing. They borrow nothing, they just hand out money that did not exist before.
TFB, yes of course the BoE can print 'money', i.e. issue large amounts of IOUs. But you overlook that this adds to the stock of government debt - so factor in Ricardian Equivalence and price inflation and tell me where that has got us.
This is all getting a little confusing.
Mind you, if the economy stabilises towards the end of 2009, Brown will hail the success of this plan and the polls will start to swing back to Labour.
MW
Your explanation of the bookkeeping effects of "printing" money is spot on - for every debit in the BoE's books (ie promises to pay by banks and others who can't actually pay) is matched by a credit (ie either an increase in the BoE's capital - owned by HMG - or in BoE's liabilities - owed to HMG).
All this isn't necessarily inflationary (as CU writes citing the Japanese experience). But what happens when the "assets" on the BoE balance sheet turn out to be crap? Can the BoE just write them off against HMG's capital/loans?
To answer my own question: it appears easier and chaeper to write off the crap assets in the institutions where they presently rest and for those institutions either to be re-capitalised by (alas) the taxpayer or (depositors being guaranteed by HMG) let them collapse according to English or Scottish legal practice. This would have the moral advantage that the "guilty" institutions receive condign punishment and would put paid to the endless chanting of "it's the bankers wot dunnit" and concentrate the rest of the public's ire where it also should be (with politicians and regulators).
In all the flim-flam isn't this the underlying reality of what QE is being used to effect and, moreover, accords with your recommendations re Northern Rock about 18 months ago? I can see why the PM would not want to do it the easy way - it might look as if he's "doing nothing".
U, I completely agree with your third paragraph, it really is as simple as that.
Not sure about your last paragraph. QE is just the wishy-washy big government way of spreading the losses around as widely as possible, rather than our preferred option which is leave the crap where it is, and work out who's lost out afterwards.
Letting the banks go bust is best. Someone will turn up to buy the good bits. Tescos. They have just announced an expansion of employment in the FS division and that they will be launching a full service bank. It's in the FT today.
Let's say I'm running a pension fund, and I'm holding a lot of gilts.
That's because I not only want to, I need to; in fact I have a legal obligation to hold a certain fraction of the fund in safe assets like gilts.
But let's say that one day I realise that in fact I'm holding rather too many gilts. So what do I do?
a) Wait for the Bank of England to set up a programme of buying gilts, when I will be enormously grateful that at last I can dispose of my excess holdings.
b) Sell my excess holdings in the gilts market, immediately.
Let's say that I do b).
Now along comes the Bank of England, and offers to buy some of the gilts I'm still holding.
Why should I take up that offer? I've already adjusted the fund's portfolio, and I wasn't intending to sell any more gilts just yet.
The answer can only be - because the Bank of England is making me such a good offer that I'd be a fool to refuse it.
But, nevertheless, I may refuse it, because by announcing that it intends to buy up a large chunk of the existing gilts it has pushed up the prices in the market, so maybe I could do just as well by selling in the market, and at my own convenience ...
Meanwhile, even as the Bank of England is begging pension fund managers to sell some of the existing gilts, which they actually want and need in their funds, and which the Bank would pay for with newly created money, so the Treasury's Debt Management Office will continue to issue new gilts to roll over the government's debts and fund its budget deficit, exactly as before, and crediting the receipts to the government's account at the Bank of England.
Wouldn't it be more straightforward if the Bank of England just credited the newly created money to the government's account?
Here's a quote from Gladstone in 1891, which suddenly takes on a new meaning now that Parliament has apparently agreed that the Chancellor can order the creation of as much new money as he pleases:
"The finance of the country is ultimately associated with the liberties of the country. It is a powerful leverage by which the English liberty has been gradually acquired. If the House of Commons by any possibility loses the power of control of the grants of public money, depend upon it, your very liberty will be worth very little in comparison."
MW
My opinion - very badly expressed - was in agreement with your second para. In other words, no one really knows how this is going to play out but, for the time being, throwing money about a la QE is seen as "doing something". It might conclude per my 3rd para or not: nobody knows. More worryingly though, it seems to me that Brown, Darling and (possibly) King neither know nor care.
I was addressing your point 3 Mr W.
It is not only if the BoE overpays that the money supply increases.
If the company selling the bond sells it to me, I can only pay for it using money already in the system, so the money supply stays the same. If the BoE buys it, it uses "new" money and necessarily increases the amount in supply, even if it pays a fair price.
If it overpays, then it introduces even more.
But it is not the case that the money supply only increases where the BoE overpays.
Or so it seems to my addled brain.
TFB, take a step back and accept that 'the government' is merely a very large business that has income (taxes) and expenditure.
As we know, any large business can 'print money' by issuing shares or bonds, which may turn out to be more or less than face value, once the dust has settled. Indeed, any individual can 'print money' by paying with an IOU at the corner shop, all of which sooner or later has to be redeemed. Or an individual could subscribe for a new corporate bond issue with a personal IOU.
The more corporate bonds a company issues or the more IOUs you pay with at the corner shop serve to a) reduce the value of corporate bonds or personal IOUs you have previously handed out; and/or b) increase that company's or your personal indebtedness.
None of these activities increases 'the money supply'. The technical term is 'shoving round bits of paper with numbers written on them'.
To cut a long story short, QE might achieve a) price inflation and/or b) an increase in government liabilities (i.e. future tax liabilities) but little else.
I think it more accurate to say there is an increase in the money supply but there is no increase in wealth simply because more money is in the system.
Wealth is stuff, the same amount of stuff is around until more stuff is produced. Adding more money does not (of itself) create more stuff and, therefore, does not (of itself) create more wealth. All it does is add more of the things by which we measure wealth, thereby diluting the amount of stuff you can get for each measuring unit.
A pound of toffees remains a pound of toffees even if you change the measuring unit and say a pound now consists of 20 ounces rather than 16. "Whoopee", say the beguiled, I now have 20 ounces of toffees where before I had 16; but they still have the same amount of toffee.
The point I made in my earlier comment remains true. The BoE doesn't have to pay over the odds to increase the amount of money/pounds in circulation, because it is paying with pounds that were not previously in circulation and it takes no old pounds out.
I think the Bank of England must be prepared to pay over the odds, because it has to induce the present holders of the existing gilts to sell them, even though in many cases they would then use the cash to buy new gilts to replace the ones they had sold.
Why should they bother to do that, unless they thought that they could profit from the process because the Bank was being exceptionally generous in the prices it was offering?
Many of the present gilts will be high coupon, compared to the new issues, which has rather complicated ramifications - too complicated to work out quickly.
But a cynic might say that the essential purpose of this scheme is political, rather than economic.
Until now the government has been funding its deficit mainly by selling gilts, but as it needs to sell more and more gilts demand wll start to dry up.
Therefore the cunning plan is that while one arm, the Debt Management Office, will continue to offer new gilts for sale as before, another arm, the Bank of England, will buy up existing gilts, so ensuring that there'll always be sufficient demand for the new gilts.
Why else should Darling specify in his letter to King:
http://www.hm-treasury.gov.uk/d/chxletter_boe050309.pdf
that two thirds of the purchases made under the Asset Purchase Facility using "Central Bank Money" should be UK government debt, while the remaining third should be "private sector assets"?
And why else does he write that:
"There will be no change to the financing remit for 2008-09. In 2009-10, the Government will continue its policy of meeting its net cash requirement (plus maturing debt and any net finance required for the foreign exchange reserves) through the issuance of debt, which includes gilt sales, National Savings products, Treasury bills and other short-term cash management instruments."
and
"However, the Government will not change its issuance strategy as a result of asset transactions undertaken by the Bank of England for monetary policy purposes."
The net effect will be that much of the new money created by the Bank of England, ostensibly "to get the economy moving again", will indirectly find its way into the government's coffers, enabling them to maintain or increase public expenditure at a time of falling tax revenues.
I'll leave it to others to speculate about the possible electoral implications of that.
So far this novel funding mechanism appears to be incomplete, because the Bank of England will continue to hold the gilts it buys, while new gilts will continue to be issued, so public debt will continue to increase.
The final component, which as far as I know has not yet been put in place, would be the free transfer of the gilts from the Bank of England back to their issuer, the Debt Management Office, where they would be cancelled and thus removed them from the public debt.
I have tried to understand this, and the implications of it. I'm afraid I am at a loss. It smells to me like they are debasing the currency. It looks like a modern equivalent of coin clipping. I am certain in my gut it will lead to rampant inflation.
I intend to keep my money in the ISAs despite the pathetic interest rate because I am convinced that we about to get hyperinflation, which will only be squeezed out by another bout of 80's style high interest rates, so the bastards are not getting to tax me on it.
And beyond that I think it may be wise to clear any debts, and buy any toys that prudence kept me from buying as I saved up. The toys are about to get dearer, and the money spent paying off debts can be replaced by higher valued monopoly money I am going to be paid when wages chase the inflation rate.
I am afraid for our economy in the hands of these people.
Reading the Sunday papers has made ne realise that the description I gave above of the Guv grabbing banks' reserves during upswings of lending is out of date.
It appears that Thatcher put a stop to it.(Is she some kind of Manchurian Candidate?)
This shows what happens when you rely on the likes of Major Douglas for information about the banking system , though I will still adhere to his Social Credit idea of the National Dividend ,an unearned income for all worked out by computing the difference between people's aggregate earnings and how much much they would need to earn to keep industry working at full capacity.
Asked if people would n't play golf all day,he replied " They only would if they wanted to".
Two points that seem to be getting missed. The accounting involved in the 'creation' of £75bn and the impact (big picture - what is it we're trying to achieve)
From an accounting perspective, the creation of £75bn is a result of DR cash CR Long Term Liabilities/Reserves (which aren't exactly accurate anyway), thus £75bn is created in 'new money'. Under the Maastricht treaty, you can't just print money without having the reserves to cover it/or without creating a liability (IOU ROW).
The purchase of assets/issue of new gilts has it's own double entry.
True this creation, doesn't increase wealth (it's eroded through inflation), but the logic is this £75bn will multiply.
Giving it to pension funds, won't have this effect, and like you ultimately point out, will have little impact.
One positive is that it will drive down the price of money in the short term, by increasing debt prices/reducing yields. When LIBOR+3 was at 6%+ they should have adopted this approach.
In this instance, I would like to have seen HMG tell Europe/shareholders Northern Rock would no longer be managed at arms length and would be wholly owned by the UK, then the £75bn is passed onto them to hand out in new mortgages.
Why? Because the only way we will get through this, is by bottoming out asset prices. Either by deflating the economy to 100, or inflating, calling that 100 and starting again...or a bit of both. Can't help feeling this is a missed opportunity
RB, that's all good stuff ... apart from the last two paragraphs.
1. Why should the government print money to prop up house prices? The govt can already decide house prices at a whim by e.g. liberalising planning laws, increasing or decreasing Council Tax, but do high house prices make us, as a society, any richer?
2. I'm all in favour of allowing asset prices to bottom out ASAP, that would be the opposite of giving NR to lend out willy nilly in a falling market, so the last para contradicts the penultimate one (and I don't really agree with either).
Not sure it's contradictory, but on review I could have worded what I meant better. I'll try and explain my logic
First step, is that the government gives £75bn to NR specifically for mortgages. Accepting anything up to say 110% (take away the fear a little of the 'negative equity'), providing it meets a set criteria of say 3x income.
Now, I'm not saying demand is huge for mortgages, but it definitely exists and it's not being satisfied, which is driving prices down further. Currently supply outstrips demand, thus prices are falling (or at least demand that can be financially backed up). Creating a supply of money will allow people to follow through on that demand. Then the domino effect would start to take hold. As people see that asset prices are bottoming (the rate of decline, drops and starts to flatten), thus the opportunists return to the market (buy to let).
If the economy is going to inflate, through debt devaluation measures, asset prices will follow. It seems to be a fear from some people in this post, so a house that costs £110k might just cost double in 5 years if those 'fears' are founded.
As for bottoming out the equity markets...I don't have a clue. The knock on effects of the property market (in terms of confidence) may encourage people to spend, particularly in times of high inflation. The government buying shares will just monetarise gains/losses.
To answer your first question, do they make us richer? No. That's why the impact of a recession now, was always going to have less impact than the 30's although the figures might look worse. Simply because, our gains, on the whole were unrealised. My whole logic on being rich is that growth isn't really growth, unless you're taking it from someone. If we based everything in the world, you'd have to take to give to someone else. Everything else is essentially inflation. Perception is everything in the ups and downs though
RB, if you look at this chart, roughly at what price level would you expect house prices to bottom out?
Nice analysis Mark. Ceteris paribus, we'd be looking at a calling a bottom after more than a 33% decline. I'm not sure the analysis takes account of the currency bubble that's been allowed to form however.
We can either burst the bubble (which isn't going to happen, as china want to keep their investments in the US at par), in which case your analysis seems to be consistent with how I would look to chart it. Real growth using kind of medium-term measures - it's an interesting read.
I think a devaluation of the dollar however, won't happen and thus my logic is based on almost rebasing our expectation (by forcing a bottom). Calling today 100 (even though it contains an element of inflation) and taking the hit I guess in currency.
It leads me to think (which I've never given it much thought) of what happens when the dollar bubble bursts? I base that question around the fact that they're in deficit, and China's funding it (Chimerica as Niall Ferguson called it) at an unsustainable price. Logically, the US should be more poor, but they become more rich, because of excess investment in the dollar, because it's seen as a base currency. Maybe I'm missing something - I tend to think sporadically
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