In which we establish that all the propaganda and obfuscation surrounding Quantitative Easing in the UK appears to have worked, and people fail to grasp the blindingly obvious (see e.g. exchange of comments between me and CityUnslicker).
The basic rule is that 'You cannot owe money to yourself', you can only owe it to, or be owed it by somebody else. To give a simple example:
i. You pop out for a packet of cigarettes and realise that you forgot your wallet, so you give the shopkeeper an IOU on which you declare "I [name of address, signature] promise to pay the bearer on demand the sum of £6". You smoke the cigarettes and, were you to draw up a personal balance sheet the next day, among your liabilities you would include that £6.
ii. Let's imagine that the shopkeeper owes his paper boy £6, he knows that the paper boy lives next door to you and knows you well, so he gives the paper boy the IOU, which entitles him to collect £6 from you. You no longer owe the shopkeeper £6, you now owe it to the boy next door.
iii. You happen to be a plumber and are called to fix a leak in neighbour's house, for which you charge £30. The neighbour only has £24 in cash, so he takes the £6 IOU off his son (for board and lodging) and gives you that as well.
iv. You then go home with the IOU in your wallet. That piece of paper has gone full circle and ceases to have any value. It makes no difference to you whether you keep it, chuck it on the fire or tear it up and throw it in the bin. Your debt with the shopkeeper is settled and you have been paid in full for the plumbing job.
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Let's apply this logic to Quantitative Easing:
v. Over the years, UK commercial banks had built up holdings of £200 billion in UK government bonds, issued by HM Treasury. That is an asset from the point of view of the banks and a liability from the point of view of HM Treasury.
vi. During the QE program, another branch of HM Treasury, the Bank of England 'bought back' these £200 billion in bonds from the banks, and in exchange the banks were given electronic balances with the BoE. The banks made a modest profit on the deal, because the BoE overpaid slightly, but that is the end of the matter for the banks - instead of having assets of £200 billion in UK government bonds, they had assets of £200 billion being cash on deposit with the BoE.
vii. Again, to take a simple analogy, it makes little difference to an individual investor whether he has £1,000 in UK coins and notes under the mattress; or whether he has £1,000 in a National Savings & Investments account; or £1,000 in UK gilts. Coins and notes; NS&I and gilts are all assets from the investor's point of view; and all are liabilities from the UK government's point of view.
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viii. The interesting bit, and the bit which people either can't or don't want to understand, is what the position is between the BoE and HM Treasury.
ix. The BoE website helpfully explains:
In January 2009, under a remit from the Chancellor of the Exchequer, the Bank established a subsidiary company, the Bank of England Asset Purchase Facility Fund (BEAPFF)... In March 2009 the remit was extended to allow the MPC to use the Asset Purchase Facility to make purchases of assets (now including gilt-edged securities) in pursuit of its monetary policy aims.
The accounts of the Fund are not consolidated with those of the Bank. But the Fund is financed by loans from the Bank and those loans are included in “other assets” in the chart above. They account for the bulk of the increase in “other assets” since March 2009.
As it happens, we know that 99% of the QE program consisted of buying up UK government bonds (see link at xiii. below), not mortgage-backed crap like in the USA.
x. The BoE's balance sheet as at 4 March 2009 shows 'other assets' (bottom right hand corner) of £23 billion. Under its liabilities it shows 'reserve balances' of £31 billion, which is money that the commercial banks have on deposit with the BoE (second from the top on the left hand side).
xi. The BoE's balance sheet of one year later, 3 March 2010 shows 'other assets' (bottom right) of £214 billion and 'reserve balances' of £154 billion.
xii. So over a year, the BoE's BEAPFF spent about £191 billion on buying up gilts (£214 billion minus £23 billion) and of that money, about £123 billion (£154 billion minus £31 billion) ended up being deposited by the commercial banks straight back with the BoE. It's a mystery to me where the other £68 billion went (£191 billion minus £123 billion), but that's for another time. Apart from the missing £68 billion, this confirms what I said at vi. above.
xiii. Right, so the BoE's PFF (part of HM Treasury) now has £191 billion of UK government bonds in a safe somewhere. The BEAPFF's balance sheet as at February 2010 ties in nicely with all this. It shows that it is financed by a £200 billion loan from the BoE (Note 11) and that it holds £193 billion in UK government bonds (aka 'gilts') (Note 9). The other branch of HM Treasury which originally issued those bonds still records that £191 billion (or £193 billion or whatever the real figure is) as a liability in its own books, but it's not really.
xiv. Simple logic and basic accounting says that 'You can't owe yourself money' and exactly the same goes for a government department. So, as I commented over at CU's, it doesn't make any difference what happens to the bonds in the BoE's safe. It makes not the slightest difference to anybody outside the government whether they shred them, bin them, burn them, or wait until the maturity date and take them down the corridor to the redemptions department.
xv. if the government adds up its own assets and liabilities, it could (if it so wished) continue to treat that £191 billion as a liability of one department and an asset of another department, but it always nets off to nothing. The main thing is that the £154 billion shown as 'reserve balances' on the BoE balance sheet (which is real money owed to real third parties, the commercial banks, glossing over the fact that they are part-nationalised) is included under 'liabilities'.
xvi. To summarise, the whole thing was smoke and mirrors. QE in the UK was not 'printing money' (although it was run in such a way as to make a couple of billion easy profit for the commercial banks), it did not increase government borrowing (or reduce it) and as far as the outside world, all it did was to shorten the average time to maturity of UK government debt - instead of the commercial banks etc holding £191 billion in government bonds, due and payable in five or ten years' time on which they were earning 3% interest, they now hold a similar amount in 'reserve balances' at the BoE on which they are earning 0.5% interest, which in theory they could (but in practice they won't) withdraw tomorrow.
xvii. Also worth mentioning is the basic idea that one man's financial asset is another man's financial liability. So if you have a £10 note in your pocket, you have an asset. The BoE, which issued that note has a corresponding liability, which is why it shows 'notes in circulation' of £50 or £55 billion as a liability in its own balance sheet (depending on which one you look at).
