No, this is not "creative accounting".

Simple question: if you remortgage at a lower interest rate, does your annual cost go down?

A: of course if does. So by definition, your annual surplus goes up (or your annual net loss goes down).

It is the same with QE. The government refinanced £350 bn of interest-bearing debt by replacing it with £350 bn* of QE money which costs it 0.5% interest.

If the government's interest costs go down**, then that reduces the deficit.

* Let us assume, for simplicity, that the £350 bn old debt was not bought redeemed at a premium i.e. £350 bn nominal of high interest debt was bought back for £375 bn or something.

** There is a good argument and plenty of evidence to show that governments don't need to pay interest at all, separate topic. But 0.5% is pretty close to zero.

It is a mystery to me why 'financial journalists' find this so difficult to understand and pretend it is more complicated than it is.

From yesterday's Evening Standard:

The Chancellor is also going to get a handy leg-up from Robert Chote’s watchdog on the public finances over the next few years — cutting his borrowing bill with the wave of a magic wand.

How so? It all comes about through the change in the OBR’s assumption about the Bank of England’s Asset Purchase Facility (APF), the vehicle in which Threadneedle Street holds the £375 billion of government bonds it bought under its money-printing programme.

"Osborne will paint this as fiscal rectitude, when he’s being rewarded for economic failure." [says] Russell Lynch.

Explaining the mechanics of this without needing to put a wet towel over your head is difficult, but here’s the gist of it.

All those bonds bought by the Bank under quantitative easing (QE) rack up “coupon” or interest payments from the Government — say of between 2% and 2.5% — most of which is now transferred back to the Treasury, after the Chancellor changed the rules a couple of years back***. But the Bank bought the bonds with the newly created QE money on which it pays interest set at Bank rate, which is just 0.5%.

Broadly, the difference between the two rates is now returned to the Treasury. The details of these arcane transactions have been relegated to supplemental fiscal tables in recent publications and this transfer —which looks like very (ahem) “creative” accounting — gets much less attention. But it has a big impact. For example, this financial year, the APF is forecast to generate £14.1 billion in coupon payments less £2 billion in interest paid out on the QE cash — £12.1 billion.

The "creative accounting" is pretending that the original bonds still exist and making two sub-departments of HM Treasury pay interest to each other, but such is life.

*** Not clear how the rules would ever have been any different. Governments pay interest on their bonds. The holder of the bonds receive the interest. If the UK government holds German bonds, the German government pays the UK government interest. If the UK government holds UK government bonds, it pays itself interest i.e. nothing happens.

Economic Myths: Negative interest rates put money into the economy

From the BBC:

Bank of England deputy governor Paul Tucker has said negative interest rates should be considered. A negative interest rate would mean the central bank charges banks to hold their money and could encourage them to lend out more of their funds.

Firstly, how much of the banks' "money" does the Bank of England hold?

As at the balance sheet published on page 54 of their 29 February 2012 annual report it was £218 billion. The £286 billion shown on that balance sheet is the net value of the UK gilts the BoE repurchased under QE, to muddy the waters a bit, you then have to refer to page 5 the Bank of England Asset Purchase Facility Fund Limited's 29 February 2012 Annual Report to reconcile the missing figures. This figure seems to reconcile with the commercial banks' accounts say. Barclays 2012 accounts say that have £86 billion deposited with central banks, Lloyds 2012 accounts say they have £80 billion. I can't be bothered adding up and reconciling the rest.

What is not clear is how much that £218 billion actually belongs to the banks and how much is held by banks on behalf of gilt investors (mainly pension funds and annuity providers) who chose to cash in under QE. By all accounts, this is the bulk of it.

Those gilt investors have to invest in gilts or similar, those are the rules. So the bulk of that money has to stay where it is.

We also know:
- the BoE is currently paying 0.5% interest on those £218 billion deposits (or whatever larger figure it is now).
- the government invented a whizz bang new scheme last year to prop up banks and house prices, called the Funding for Lending Scheme, whereby, basically, commercial banks get up to £80 billion in low-interest loans.
- the interest rate charged on FLS loans, politely referred to as "fee" is only 0.5% per annum (flat fee 0.25% plus variable fee 0.25%) as long as the borrowing bank does its bit for house prices (see last page of this)
- if a commercial bank is naughty and takes the FLS money but just uses it to replace more expensive sources of funding (which is what they have done and why savings interest rates have plummeted), there's no penalty, it's only if a bank is extra naughty and reduces its total lending by 5% that the interest rate charged rises gradually to a savage... 1.75% per annum.

We conclude that there is a temptation there for banks to be naughty. Even if those public spirited bankers nobly resist this temptation, it's 0.5% in either direction. As a result of QE, the BoE is paying commercial banks 0.5% on money they deposit with (i.e. lend to) the BoE. As a result of FLS, the BoE is charging commercial banks 0.5% for money it lends to them.

So if it were true that the banks can merrily withdraw the £218 billion which they have deposited with (lent to) the BoE, there would be no need for the FLS, would there? Or alternatively, we can deduct the £80 billion FLS loans in one direction from the £218 QE deposits in the other direction and call it £138 billion, which we know all belongs to gilt investors, not the banks.

The FLS only makes sense (even in their warped world view) if banks can lend out money and earn more than 0.5% in interest. But if banks could earn more than 0.5%, they would have withdrawn the £218 billion anyway, wouldn't they?
----------------------------------------
Conclusion: the banks do not have any money with the BoE to withdraw and lend to the real economy anyway, whatever the base rate is, positive, zero or negative.

And even if they did, then so what?

Let's imagine that the BoE prints up £218 billion in new notes, dumps them in the safe and rings up the commercial banks and tells them to come and get it, and to the extent that they leave it in the safe, they will be charged 0.5%? The first thing they'd do is go and collect that money and transport it back into their own safes (assuming their physical storage costs are less than 0.5%).

How does that do the economy any good, unless you are in the safe-manufacturing or security business?

Even if the banks lend it out, it will not and cannot go into actual lending for investment into productive assets, because productive assets finance themselves. The income which people can generate in one year from putting productive assets to use is, broadly speaking, the same as the cost/value of those assets. That doesn't mean that the return on capital is 100% per annum, because the bulk of the income goes to the human beings who operate them, but there is plenty of cash there to pay the interest.

If you want to buy a new car but don't have the cash, you don't need a bank. The motor companies are all happy to let you have one under an HP or finance lease, you pay a small deposit, monthly instalments for three years and then you can normally buy the car for fairly cheap at the end, which is worth doing unless you know it has been driven by a complete idiot for the last three years.

The car manufacturer is not actually too fussed whether he sells a million cars a year for £30,000 cash, or whether he sells them on three-year HP deals, in the long run, the number of cars he makes and the amount of cash he collects each year levels out at the same.

Summa summarum, FLS and negative interest rates are all just part of the "They own land, give them money" programme.

QE & FLS: Rubbing our noses in it

From City AM:

Under QE the Bank prints money to buy government debt, to push down interest rates. This is meant to stimulate the economy, but it also drives up inflation. In addition, QE has been criticised as it reduces the value of the annuity retirees can buy with their pension pots, attracting the ire of the older generation.(1)

Weale yesterday defended the policy, arguing that young people have been particularly badly hit by the downturn(2) and so need support from the central bank.(3) In particular he noted that almost 10 per cent of young men have been unemployed for more than six months, compared with just over three per cent for men aged 31 to 64.

As a result he feels hitting the old with QE has been justified because it helps the young.(4)

1) The first paragraph is a fair summary, apart from the bit about QE being intended to "stimulate the economy", there is absolutely no reason to assume that it will achieve anything of the sort, like just about everything else the UK government has been doing for the last five years, it's about propping up banks and house prices.

2) Yes, just about everything the government is doing - propping up rents and house prices, taking away benefits, hiking tuition fees, increasing taxes on labour which destroys jobs and makes it disproportionately harder to get a job in the first place, massive deficit spending etc - is designed to fob off as much of the burden onto the young and future generations, so the end result is hardly surprising.

3) The central bank is part of the government, if it wanted to "support" the young , it would be doing pretty much the opposite of what it is actually doing (see long list in 2).

4) Woah! False choice there! This is not a question of sharing a dwindling cake between the under-40s and the over-65s, what's happening here is that the usual suspects are f-ing over both groups simultaneously, the only winners here are the bankers, insurance companies and landowners.

Just to illustrate the point, also from City AM:

MORTGAGE lending climbed to an 11-month high in October, according to data out yesterday, as the Funding for Lending Scheme (FLS) entered its third full month of activity...

Mark Harris, boss of SPF Private Clients, a mortgage broker, said he expected the mortgage market to ease further and further over the coming year. "This bodes well for next year – as lenders saturate the low loan-to-value (LTV) market with a plethora of rock-bottom rates, they will be forced to turn to the higher LTV bracket," he predicted.

The FLS is out of the same stable as QE, it's about reducing interest rates for the benefit of the already wealthy and the Baby Boomers. Apart from the fact that easy credit and high house prices are what got us into this mess in the first place, the only people to benefit from FLS are people who are selling land (because they can sell them for higher prices) and people with a lot of equity who can double on their mortgages and expand their BTL empires.

More QE insanity

From The Daily Mail:

The Chancellor has bagged a £35bn windfall that will reduce public borrowing by reclaiming the surplus cash sitting in the Bank of England's £375bn quantitative easing programme.

The change in policy will cut both the public debt and budget deficit, flattering the public finance figures when the Office for Budget Responsibility updates its outlook at the Chancellor’s Autumn statement next month.

Critics immediately accused George Osborne of fiddling the books, but the Treasury insisted that the move will draw Britain into line with the US and Japan, which also have big QE programmes.

Under the current arrangement, the interest paid on the gilts bought through QE is held by the Bank – effectively transferring the funds from one part of the state to another. As long as the funds remain at the Bank, though, the Treasury has to raise extra borrowing in the market.

Once past the idiot headline and opening paragraph, as the article says, this transaction nets off to nothing and "spending" this extra £35 billion merely means that the government has to borrow another £35 billion from elsewhere (assuming constant government spending - that is the real problem, not how it is financed).

It's like the underlying bonds themselves, they are a nullity, a nothing, an accounting fiction, a point which I'm relieved to say, seventy per cent of respondents understand. Those bonds are no longer real debts, what are real are the replacement debts of £375 billion which the government issued in exchange.

George Osborne might as well argue that the government can save itself £35 billion by cancelling the interest payments on the QE bonds now held by the Bank of England, that would be just as moronic. Describing somebody who points this out as a "critic" shows how desperate they are, these "critics" are merely stating blindingly obvious facts (even though many people oppose QE because they think it increases deficits - it does nothing of the sort, it is merely a way of financing or re-financing government deficit spending, whether past, present or future).

Via HPWatcher at HPC.

Another QE myth which needs to be debunked

Hpwatcher at HPC repeats a common myth, often perpetrated by the likes of The Telegraph:

The B of E has bought £32bn of the last £34bn debt issued. Hardly anybody else wants it so the government must print money to buy it or the yields would soar to reflect the risk.

When challenged, he insisted that his statement (about the £32 billion and £34 billion) was factually correct (which it probably is) but his next sentence is quite simply untrue. I responded thusly:

HPW, you say that this is because "Hardly anybody else wants it so the government must print money to buy it or the yields would soar to reflect the risk."

This is quite simply not true, the UK government could quite happily issue 3 or 5 or 10 years bonds, and people would happily buy them.

The current yields on existing 10 year UK gilts are below two per cent. It is just that the UK government prefers to borrow very short term (by taking 'overnight' deposits from commercial banks) on which it only pays about 0.5%, and the yield curve being what it is, commercial banks are just as happy with 0.5% overnight as they would be with just under two per cent for ten years fixed*. There is a lot of behind the scenes pressure on them to do so, and the bankers are happy to take a modest cut by buying new gilts on Tuesday and selling them back on Thursday.

* As Richard W pointed out a week ago, from the taxpayer's point of view this is a very risky strategy:

[QE] makes a difference because long-term debt would be turned into short-term debt. The UK debt stock has one of the highest average maturities in the world. I think it is something like around 13 years. A high average maturity is good although it cost slightly more.

His point being that now would be an excellent time for the UK government to do the opposite of QE, which would be to replace short term debt with very long term debt. If it can borrow at maturities up to thirty years for just over three per cent, then why not lock in as much of that as possible? On £1 trillion total outstanding government debt, our interest bill would be a modest £30 billion a year fixed for thirty years (with average annual redemptions of a similar amount). It is surely more likely than not that even overnight rates will be higher than three per cent for a large part of the next thirty years.

More complete and utter bollocks on QE

From The Telegraph:

Economics truly is a dismal science.(1) Take the apparently ludicrous scheme under-pinning the economy: one branch of the state (the Treasury) is borrowing money from another branch of the state (the Bank of England) and everybody in the City is cheering madly, despite the dangerous circularity of the exercise.(2)

To the uninitiated, this will sound like blatant accounting fraud (3) but I’ve just described quantitative easing (QE), the perfectly legitimate wonder drug that was meant to cure the economy (4) but to which George Osborne is now hopelessly addicted...(5)

Feel free to read the rest if you like if it's the sort of stuff which will reinforce your own prejudices, but I find that it always helps to know what you are talking about before your start speculating as to what the consequences of something are.

1) No it's not, it's fascinating. And because we have so much history from so many countries to compare and contrast, we can pretty much say with certainty was the consequences of any particular economic policy will be, because the chances are, somebody somewhere has already tried it.

2) The government cannot borrow money from itself. It can pretend to do so, but it can't. Those cash flows (or lack thereof) and accounting entries between two departments of the government can be completely ignored, and all we need to look at is cash flows and accounting entries between the government and everybody else.

3) It's only fraud if you are gullible enough to believe in it, which he clearly is and does, therefore he is guilty of perpetuating the "fraud" rather than debunking it.

4) It's the public sector deficits which are supposed to "cure the economy" with all this chit-chat about 'the multiplier effect' and so on. This is also complete and utter bollocks, but a different topic to QE. Those deficits have to be 'financed' somehow, the government finances them by simply spending more than it raises in taxes. The balancing figure has to be accounted for somewhere, whether as a) unpaid invoices or late collected tax payments, b) freshly printed bank notes, c) electronic balances with the Bank of England or d) longer term government bonds.

When QE started, what the government did was replace a large chunk of (d) with a large chunk of (c), it did not materially affect the total amount of government debt outstanding. What it did was to replace long term borrowing with short term borrowing, thus reducing the overall average interest rate it pays (but generating handsome fees for bankers involved in the paper shuffling).

If his first paragraph is correct and taken in isolation, then the government is issuing (d) to itself in exchange for (c) which it has also issued to itself, this is a complete nothing of a transaction.

5) Osborne is addicted to QE because he and his mates like deficit spending, which is easier when interest rates are low; he likes low interest rates because it helps prop up house prices (and the author of the article is so stupid that he once claimed that low interest rates "increase the wealth of homeowners" (or words to that effect); and of course because the bankers can cream off their handsome fees and commissions from keeping the plates spinning.