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.
Thursday, 1 November 2012
Another QE myth which needs to be debunked
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14 comments:
The last part is what I assumed that the government would be doing! Surely the new gilts that are being issued (and then being bought back) are very long term ones?
Maybe not!
I thought I understood this malarkey but now I'm not so sure!
BE
BE, if gilts (of whatever maturity) are issued Tuesday and bought back on Thursday, then the dates on the bits of paper are nigh irrelevant. Cancelled is cancelled.
The point is that by Thursday afternoon, the government (in whatever guise) has borrowed an extra £x billion short term from commercial banks (although the ultimate lender is the banks' depositors) and in exchange, the commercial banks get a credit to their reserve account with the BoE.
Nope, still can't quite get my head around it. Is my sneaking suspicion that I should get my savings out of cash reasonable?
BE
BE, it's simple. Ignore the transactions which cancel themselves out and look at the net, which is a) the govt is running a deficit (which we knew) and b) the government is borrowing very short term to fund that deficit. All deficit spending means borrowing, they are two sides of the same coin.
As to your savings, that's c) a separate topic and d) I don't give investment advice but e) paying off your mortgage is usually the best bet.
I'm sorry but you are wrong. The effect of QE is to reduce interest rates. Thats the whole point of it! The State needs to raise the £120bn extra over what it gets in tax revenue from somewhere. Do you honestly believe the commercial markets would have lent £500bn over the last 3 years to the UK government at 3% for 30 years, in the absence of the BoE hoovering up all the issued gilts with printed money?
Of course they wouldn't. At some point between 2008 and now, in the absence of QE, the bond market would have blown up, we would have hit a funding crisis just like Greece, Spain, Ireland, Portugal el at. After all our debt position is worse than several of those, and they have suffering rising bond yields. Whats so wonderful about the UK that we wouldn't suffer the same consequences?
QE may or may not be inflationary in the long run. It most definitely does depress long term interest rates. Ask anyone who has had to buy an annuity recently.
S, nobody's disputing that the intention of QE was to depress interest rates (opinions are divided as to whether that was achieved - I think it did have the desired effect, for instance).
But as at today's date, people are prepared to lend the UK govt for thirty years @ 3% interest and overnight @ 0.5% interest.
Clearly, if they had to refinance the overnight stuff with thirty year gilts, the average interest rate paid would go up.
1. One argument says that this would push up thirty year interest rates (more supply, same demand).
2. The counter-argument is that current thirty-year gilt holders are bearing all the inflation etc risk and that the overnight people rank ahead of them. If the overnight people ended up in the same boat as the thirty-year people (so would want higher rates) but the thirty-year people would no longer be bearing the whole risk (so might be prepared to accept lower interest rates).
3. If our situation were that precarious (we are not in a currency zone, which helps), then why haven't thirty year interest rates sky-rocketed?
The reason they haven't skyrocketed is that the BoE has been buying gilts in the market (£325bn of them so far), thereby raising the price and lowering the yield. They buy gilts of all maturities not just the short dated ones. Any gilt holder knows that if the price starts to fall the BoE will step in start buying again, so the price is guaranteed to stay high. Its a self fulfilling prophecy. The BoE can buy as many gilts as it wants via its magic printing press, the gilt holders know this, so prices stay high without need for overwhelming QE purchases. If the BoE said 'No more QE' then yields would start to inch up, and at some point when reality hit that they meant it, all hell would break loose, and yields would go through the roof, just as they have done in the Eurozone.
Whats so hard to see about all that?
S:
"Any gilt holder knows that if the price starts to fall the BoE will step in start buying again, so the price is guaranteed to stay high. Its a self fulfilling prophecy."
Yes, there is a lot of psychology at work. But it's still a bit of a gamble if you are willing to hold a thirty year gilt.
And you are missing half the equation as usual.
1. Let us agree that when government debts go up, the overall average interest rate they have to pay goes up.
2. And let's agree that long term interest rates are usually (as at present) a couple of per cent higher than short term ones.
I hope that you realise when the BoE buys back gilts it does not reduce UK public sector debt by one penny?
So factor 1. is not in play, doing buy backs does not reduce total public sector debt (neither does it increase it, if truth be told), so interest rates at the long end stay much the same.
There is a short term jump when QE is announced, but that only lasts a couple or hours or a couple of days and then we are back to normal.
As to factor 2, if the BoE says it will only pay 0.5% on overnight borrowing/deposits, then that sets the baseline (if they can get away with it) - the long term rates are merely short term rates plus a couple of per cent. It's the 0.5% which matters (if they can no longer get away with it, then thirty year rates will go up anyway, won't they?)
Finally, you cannot compare us to the other PIIGS, because although our public sector finances are just as f-ed as theirs are, we have the luxury of being able to 'print' money indefinitely, and they can't because they are in the Eurozone.
It's the same with Japan, they have been QEing like maniacs for a decade or more and Jap govt interest rates are resolutely low.
So can we gather from that that you favour QE3, Mark?
JH, woah!
I do not favour QE, not one little bit. I'm just trying to explain what it is and what it does (not much, apart from pushing down interest rates - and even that is disputed).
So the evidence says that countries with their own currencies who indulge in QE can have long term low interest rates (UK/USA/Japan) but counties without their own currencies that don't use QE can run into rising debt interest rates(Ireland/Spain/Italy/Greece/ Portugal etc).
I'd say that pretty much confirms that QE reduces interest rates.
S, yes, that would appear to be the case, unless somebody can prove otherwise. But that's about it, there is a marginal downward pressure on interest rates, which is great for you landowners and awful for tenants and savers.
I think it is much better to consider bond issuance not as a borrowing operation but as a tool to build or drain reserves in order to hit the interest rate target. The government doesn't need to borrow it's own currency from the non-government sector in order to spend.
good explanation here:
http://www.creditwritedowns.com/2011/03/how-quantitative-easing-really-works.html
QP, I read as far as this bit...
"... as bond market liquidity dried up, the Fed stepped in and purchased a panoply of assets... "
... and thought to myself that he is One Of Them. Bollocks to all that. QE is just swapping bits of paper for bits of paper, in the most literal sense.
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