Sunday 23 January 2011

Quantitative Easing: You cannot owe money to yourself

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.
-----------------------------------
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.
-----------------------------------
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).

52 comments:

Span Ows said...

...OK, so, the paper boy was the killer?

Mark Wadsworth said...

SO, the paper boy is entirely innocent. It makes no difference whether the shopkeeper gives him £6 coins and notes to pay his B&L to his Dad, or whether the shopkeeper pays him with the IOU and he pays his Dad with that.

Sackerson said...

Mark, I risk provoking scorn here but please be kind: when the BoE created £200 bn to buy equivalent amount in bonds, this increased the money supply, didn't it, even if the money is not circulating in the general economy.

And when the bonds mature the Treasury has to pay over £200 bn, so this increase hasn't been sterilised - we now have £200bn at the BoE plus £200 bn held (maybe reinvested elsewhere) by the banks.

Or have I missed something? Not thinking clearly, maybe - it's Sunday afternoon.

Steven_L said...

So looking ahead, what is the £140bn reserved for?

Will the gvt direct the banks to invest this in loans to favoured infrastrucrtire project or lend it as AAA rated 'green investment bank' bonds during the latter half of this parliament?

Methinks that's the plan, then allow them to count the AAA bonds as tier 1 capital.

£140bn of investment can buy a lot of votes in marginals.

TheFatBigot said...

I think you are omitting a link in the chain, Mr W.

Prior to QE the Treasury owes £200b to the bondholders. During QE it repays that debt. At that stage we have to ask: "with what does it repay the debt?"

When the bonds were first issued the Treasury received £200b, but that was pissed up the wall years ago to fund diversity outreach coordinators. In order to buy-back the bonds it must find £200b from somewhere.

Does it use £200b it has in a biscuit tin under the bed? No. It turns on the virtual printing press and makes a new £200b. That's what the electronic balances are - they are money that did not previously exist.

Your packet of fags IOU analogy illustrates a closed system in which the same amount of money is always circulating. The IOU represents £6 that already exists in the system. If the shopkeeper presented the smoker with his IOU and demanded repayment, it could only be redeemed from existing assets, the smoker could not mint six new £1 coins he could only use coins already in existence.

The position with the Treasury/BoE is not a closed system. They do not dip into the emergency fund in a tea caddy on the mantelpiece in order to buy-back the gilts, the do the electronic equivalent of minting 200b new £1 coins.

That the banks then deposit those coins in the BoE's safe is neither here nor there, a new £200b has been created that did not exist in the system before.

Mark Wadsworth said...

S, "when the BoE created £200 bn to buy equivalent amount in bonds, this increased the money supply, didn't it,"

No, because the £200 billion went straight back on deposit with the BoE. That money is not sloshing around in the economy or causing inflation. And the banks aren't going to withdraw that money and spend it or lend it because they need to keep something to one side to repay the SLS and CGS and so on.

"when the bonds mature the Treasury has to pay over £200 bn, so this increase hasn't been sterilised"

Again no. Imagine the scene in five years time when the bonds mature. The BoE guys take the gilts from the safe and walk up the corridor to the Debt Management Office and ask for them to be repaid. Why would the DMo bother repaying them? And even if they did, the BoE would hand the proceeds straight back to the DMO. It is pure paper shuffling in a literal sense.

"we now have £200bn at the BoE plus £200 bn held (maybe reinvested elsewhere) by the banks."

Are you talking assets or liabilities?

a. Commercial banks used to have £200 bn gilt (assets) and now have £200 billion deposits at BoR (assets), so no real change there.

b. The BoE has new paper assets £200 billion (which it didn't use to have) but these are not real assets, and also £200 billion real liabilities (reserve balances) which it didn't use to have.

c But the £200 billion real liabilities that the DMO used to have (gilts held by commercial banks) are now purely paper liabilities, as it 'owes' this money to another branch of HM Treasury (i.e. the BoE).

d. So it all nets off to absolutely nothing. If we ignore intra-HM Treasury paper shuffling in a literal sense (see above), the government has converted longer term liabilities (gilts) to shorter term liabilities (reserve balances).

TheFatBigot said...

"The BoE has new paper assets £200 billion (which it didn't use to have) but these are not real assets, and also £200 billion real liabilities (reserve balances) which it didn't use to have.

c But the £200 billion real liabilities that the DMO used to have (gilts held by commercial banks) are now purely paper liabilities, as it 'owes' this money to another branch of HM Treasury (i.e. the BoE).

d. So it all nets off to absolutely nothing."

Yes, but that's not the full picture. Before the exercise started the Treasury owed the banks £200b on the bonds but had no corresponding asset; now they have assets to match the liabilities. Those assets are the "printed" money.

Mark Wadsworth said...

TFB, one last try and then I will give up and admit that the MSM and the politicians have managed to brainwash even relatively intelligent people.

You say: "They do not dip into the emergency fund in a tea caddy on the mantelpiece in order to buy-back the gilts, the do the electronic equivalent of minting 200b new £1 coins. "

OK, let's forget about bonds and reserve balances and imagine that there were just coins and notes in existence (which are of course assets to you and me, but liabilities to the government).

What happens to the money supply if the government decides to buy back £5 notes for £5 in coins? It ends up with loads of fivers in the safe. Does it make any difference to the outside world whether it keeps those £5 notes in the safe or whether it burns them?

(Clues: 'nothing happens to the money supply' and 'no of course it doesn't').

Mark Wadsworth said...

TFB: "Before the exercise started the Treasury owed the banks £200b on the bonds but had no corresponding asset; now they have assets to match the liabilities. Those assets are the "printed" money."

No no no no no. Please apply the example with the IOU. If you issue an IOU and it ends up back in your wallet, is it an asset or a liability? Answer = it is neither.

Or to paraphrase your words (only making it factually correct this time):

"Before the exercise started the Treasury owed the banks £200b on the bonds but had no corresponding asset; now the Treasury has liabilities of £400 billion (£200 billion bonds and £200 billion reserve balances) and assets of £200 billion (£200 billion bonds). The Treasury's net asset position has not changed.

And the bonds cancel themselves out (in the same way as if you hold an IOU which you made out to buy some cigarettes) so really the Treasury still owes the banks £200 billion on the reserve balances and has no corresponding asset."

Anonymous said...

Mark, if you were correct then it would mean that the government has discovered a way to spend 25% more than it takes in in tax revenue for ever more. For the first time in history! Why not spend 100% more using this paper shuffling method? Or is their a limit?

The government sells the bonds to get notes that it can spend in the real economy, this creates inflation. If they keep on with the buying the bonds themselves they risk undermining all faith in their paper money system itself, risking repudiation of it.

I can't understand why you have got yourself into such an intellectual cul de sac over this. Maybe you need to look at what happened in Zimbabwe, they just did exactly the same thing.

Mark Wadsworth said...

Anon, I am correct and I am talking specifically about QE.

The fact that the UK government is borrowing like topsy and spending £160 billion more a year than it takes in tax revenues is an entirely separate issue. Governments can do this even without QE, as the current Lib-Con government is showing.

And yes, this reckless spending does worry me, and it probably does lead to inflation, but it has NOTHING TO DO WITH QE.

Deniro said...

The process of Treasury bonds being purchased by the BOE and then appearing on the BOE balance sheet is consequential, the treasury pays the capital and interest due, over time, to the BOE.
The purpose of the QE exercise is to increase the commercial and investment bank reserves at the BOE, which is then available for lending. The banks involved are called the Gilt Edge Market Makers. To decrease the money supply, the process is reversed and the GEMS are invited to buy Gilts from the BOE, thus decreasing the money supply.

Anonymous said...

Hi MarkW,

1. I suspect a good chunck of the £68bn are now in foreign central bank deposit at BoE (some a result of trade deficit, some results of carry trade) - unfortuantely BoE does not break this down. Some of those may have been used to repay the loan they owed to BoE.

2. QE is of course swapping 0.5% interest bearing m0 for gilts.

However, the money printing and screw the tax payers bit come in when:
(a) Banks sell their gilts to BoE at inflated price.

(b) Use the proceed to buy shorter term DMO issues to enable our esteem leaders to spend more than they have. This all go a full circle but allow HMG to spend more money.

Mark Wadsworth said...

Deniro: "the treasury pays the capital and interest due, over time, to the BOE." Don't you realise that the BoE is part of the treasury? How can you pay interest or capital to yourself??

"The purpose of the QE exercise is to increase the commercial and investment bank reserves at the BOE, which is then available for lending."

That is what they want you to believe, but on closer inspection it is bollocks. There is a ready market for gilts, so if the holder of gilts wanted to lend that money instead, the holder of the gilts would just sell them and lend the money. The fact that banks didn't lend the money but left it on deposit with BoE is a bit of a clue there.

Anon: "However, the money printing and screw the tax payers bit come in when:
(a) Banks sell their gilts to BoE at inflated price.

(b) Use the proceed to buy shorter term DMO issues to enable our esteem leaders to spend more than they have. This all go a full circle but allow HMG to spend more money."


I completely agree with your point (a) (did I not mention that in the post). As to (b, that again is the whole point - if you look at actual facts, banks did NOT 'use the proceed to buy shorter term DMO issues', they left most of it on deposit with BoE (which to all intents and purposes is the exactly the same as 'buying shorter term DMO issues').

As to the missing £68 bn, that is a good suggestion and we'll run with that for now.

Anonymous said...

Hi MarkW,

Not sure about that regarding the bank reserve. Remember that Gov is running £150bn deficit, so bank can buy short gilts and government spend the money and the BoE reserve will remain more or less the same in the following manner:

BoE-(QE)-Banks-(buy short gilt)-government(spend)-civil servant/private sector(deposit back at banks which ultimately are transactions at BoE).

Basically, unless the QE money goes to foreign central bank or used to pay back loans from BoE, it will still show up as total m0 deposit.

Even HMG banks with commercial bank - this is when it gets brilliant.
DMO sells gilts to say RBS, RBS credits DMO account at RBS with £10bn with no movement of m0 at all. (And yes, RBS will charge DMO interest for the priviledge).

When DMO give the money to a department and then department pays a supplier at LBG, RBS sends money from its BoE account to LBG's. Total m0 remain the same.

That is why it is so lovely to be a banker...

Anonymous said...

@sober - bank always holds their money at BoE - despite what you read in the paper - where else can the banks hold these electronic credits? (other than other central bank accounts, or to pay back loans owed to BoE, which extinguish the m0, or conversion to paper cash).

All electronics m0 are held at BoE. If one bank lend the money to a plumber who deposit it at bank b, after netting out, bank A transfer its BoE sterling balance to bank B's boe acount.

We have inflation right now. The reason we don't have high inflation is because the velocity of the money isn't high. Just wait until people gets annoyed and start spending..

Lola said...

Bear with me on this...

If the government 'buys back it's own bonds' from banks and 'pays for them with cash it has 'printed'' then it has, momentarily, increased the banks cash position. And as we know from our 'creation of credit' studies this allows FR banks to create (say) another bunch of money. I was taught that banks had to hold 8% in cash so that means that if the deposit receipt for the sale back of the Gilts was £200Bn FRB could 'create', 12.5 times taht sum.

Now, that's some inflation!

Mark Wadsworth said...

Anon, QE has nothing to do with government increasing government borrowing.

It is a quite simple and observable fact that QE ran for about one year (from March 09 to March 10) and by a coincidence, the total volume of QE was approx. equal to total new govt borrowing in that year.

QE stopped in March 10, and since then, without a penny of new QE, the (new) government has borrowed another £160 billion.
------------------------
S: "It doesn't issue IOUs to benefit claimants, or to suppliers for goods. It gives them cash. Which it gets from people by giving them the IOU. And then spends the cash."

Nope. But what you overlook is that coins and notes; NS&I savings accounts; gilts; balances at BoE and so on are all different forms of government borrowing, they are nigh inter-changeable.

As you later explain in your example with the motorway, it makes little difference whether the govt issues bonds for cash, takes cash off investors and then gives the cash to the motorway builders or whether it just prints new notes to pay the motorway builders.

The gilts show up as borrowing in the DMO's accounts and the bank notes show up as borrowing (liabilities) in the BoE accounts. As it happens, printing notes tends to be inflationary and issuing bonds cancels itself out, but that is only if there are no future tax rises to repay the bonds or to claw back the extra notes.

I am not talking about the morality of government spending or whether it is a good thing or a bad thing, I am not having a political discussion, I am merely explaining that QE is completely different to new borrowing. it is not 'printing money' and it would be perfectly possible to have QE during a period in which government borrowing is reducing or being paid back.

What's not to understand about that?

But like I'm saying, if you want to take your advice from newspaper columnists and politicians rather than from people who actually understand QE, then feel free. I'm just trying to provide a public service here.
--------------------
Anon, you are along the right lines there, thanks.
--------------------
L, you are way off piste this time.

The old fashioned FRB model says that banks can lend out 8 times what they originally take in deposits of gold coins, i.e. if the bank starts off with one gold coin deposit (a liability), it ends up with loans (assets) worth 8 gold coins and deposits (liabilities) also worth 8 gold coins.

But when the bank hold gilts or deposit money at BoE they are not TAKING deposits (assuming liabiliities) they are MAKING deposits (i.e. converting one kind of asset into another kind).

Governments borrowing NEW money (or printing NEW money) is indeed inflationary BUT (for the dozenth time) QE is merely a paper shuffling exercise, which converts one kind of asset/liability (gilts) into another kind of asset/liability (reserve balances) - QE neither increases nor decreases money supply nor government borrowing.

Anonymous said...

@MarkW,

Sorry..correction. I have checked and confirmed that DMO account is held at BoE (and not commercial bank). So, primary market gilts will have to be bought using m0.

Though once government spends, the money goes into commercial banks reserve as described above. So, high m0 reserve is no proof of commercial banks not buying short gilts.

Also, Q4 2009 commercial banks and building soc holds 38.57bn of gilts, Q2 10, this becomes 76.18bn. So, they are buying it on their on books.

Insurance companies holding also increase from 253bn to 266bn and these are most probably settled via commercial bank moving m0 into DMO account (and then back out).

So, BoE (i.e. tax payer) buy gilts from banks/insurance/pension so that banks/pension/insurance can soak up the newly printed gilts (i.e. money).

Despite the smoke and mirrors, it is money/gilt printing afterall.

As long as their is deficit, there is money printing, simple.

Anonymous said...

@Lola,

UK does not practise FRB. UK practises Risk Weighted Basel 2 (then 3) banking which is far more advance(!).

Gilts carriers zero weight on bank's book so banks can buy (i.e lend to government) as much as it please with the following 2 caveats:
(a) If it holds a long term gilt and rate rises, its carry cost > interest income and it goes bust.
(b) If it is short dated gilts and it does not have enough m0, it will have to go to BoE repo window to ask it to print money at a cost of about 0.75% above the interest it gets on the gilt - and if do too much, also go bust.

Mark Wadsworth said...

Anon, yes of course UK banks' holdings of gilts increased a lot over the last two years.

This is because the government has been borrowing like topsy for the past few years, those gilts have to be held by somebody.

This has nothing to do with QE - QE stopped nearly a year ago and holdings of gilts has continued increasing for the simple reason that the UK government is still borrowing more and more (or spending more than it raises in tax, or however you want to define it).

Yet again (for the thirteenth time): governments running up debts has been going on for centuries. This is easy to understand, and I think most people understand it. QE is NOT NEW BORROWING! It is something quite different and fairly irrelevant.

Or for the forty-seventh time, seeing as QE stopped a year ago and government debt has continued to rise, what makes anybody think that QE and new borrowing are the same thing?

Does anybody on this thread have the faintest idea about basic bookkeeping?

Lola said...

MW and Anonymous.

Gents, I was asking a question - badly.

I see that the Gilts are an asset as afar as the commercial bank is concerned. Really I do. Then Gummint bought these back with cash it printed. And I really see the point that it's two gummint departments shuffling paper.

The point I was making was that,momentarily, the cash paid to the comemrcial banks for the gilts was in the banks own possession before they then deposited that cash with the B of E.

In which case the 8 x's / 12.5 xs - take your pick FRB thingy kicks in.

Look, this IS a question?

Anonymous said...

Hi MarkW,

On the surface, it is as you described (QE does not affect gov ability to borrow).

The less m0 you have, the faster these has to spin around. So, if there is only £31bn of m0 (before 2007), the government cannot borrow £32bn in one go. With a £200bn m0 now, it can borrow up to £200bn at one (though bank won't go that far, of course, which basically reduces the reserve to 0, until government start spending the next banking day).

So, yes, of course deficit is the real money printing culprit. QE is not money printing per ser, but I suppose it is like an speed upgrade to the printing press.

Mark Wadsworth said...

L, I tried to answer your question.

The old fashioned explanations of FRB compares total assets/liabilities with the initial deposit of one gold coin, and we know that we end up with a balance sheet approx. 8 times as big.

(This is quite different to Basel rules which compares assets/liabilities with shareholder's capital, also using a ratio of 8-to-1).

But cash that a bank puts on deposit is an ASSET, that is the end of the line, the bank clearly cannot lend out money that is has deposited somewhere else. If a bank has £1 with BoE it cannot lend out £8, it cannot even lend out £1.

This is quite different to the old fashioned FRB model where the banks takes a deposit which is a LIABILITY of £1 (or one gold coin or whatever). Ultimately, it can then lend out £8 or 8 gold coins (or the same gold coin 8 times, as it keeps coming back as a new deposit).

Ergo, QE does not enable banks to lend out more money.

Mark Wadsworth said...

Anon: "With a £200bn m0 now, it can borrow up to £200bn"

Yeah, but with QE, the government has already borrowed the £200 billion - as Sobers says, it borrowed it years ago, and after QE it has still borrowed it by taking deposits from commercial banks.

That money is out of the system, it was spent years ago. QE is no different to bonds falling due for redemption and the government issuing new gilts to raise exactly enough money to repay the old gilts.

Anonymous said...

@Mark,

Basel capital rule states that banks risk weighted asset to capitial ration shall be 8%. This is a 1:12.5 ratio (not 8)

Secondly, risk weighted means the loan is risk adjusted, gilts (and other sovereign bonds, including Irish/Greece) is given a weighting of 0 (so does add to 'asset' for Basel 2 RWA purpose at all - there are other pitfalls, as described above). Mortgage has a 0.5 multiplier (so £100k mortgage counts as £50k for this purpose). Other loans has a 1:1 ratio.

Now you wonder why European banks can go up to at 40x leverage without risk weighing adjustments (like RBS before crash)

Lola said...

MW, Ah, got it now (it is Sunday and I am knackered). But, even so, I am not happy with any gummint just 'printing' money. One way or another it is going to end in tears.

Sobers said...

'As you later explain in your example with the motorway, it makes little difference whether the govt issues bonds for cash, takes cash off investors and then gives the cash to the motorway builders or whether it just prints new notes to pay the motorway builders.'

There's a huge difference! If the State works out that if it builds the motorway (from a natural resource rich area to a port for example) it will stimulate new trade, then tax revenue will rise and they will be able to repay the debt they have incurred. No inflation takes place as the money to repay the debt comes from wealth creation, from extra work done. If they just print the money to build the motor way, yes the higher tax revenue will neutralise the extra money printed over time, BUT ONLY IF THE STATE COLLECTS THAT CASH AND DESTROYS IT. Not if it then spends it on more State spending, benefits and extra State employees etc etc.

Imagine a State that says 'We will print loads of money and give everyone £1000.' Even you must admit that's inflationary, certainly in the short run. Prices would rise, as everyone spent their new found wealth. Profits would rise, and tax revenue too. Now if that extra revenue was destroyed the system would slowly revert to equilibrium. If its spent the prices stay high and go higher.

If QE has not created any new money in the system as it exists now (£200Bn having been spent on Gilts), what will happen if they then sell them back into the market and destroy the money they receive? Will we be back with the same amount of money in the system as we started with (this is my contention) or will there be somehow less?

And IMO notes and coins are not govt debt, because they can never be repaid. There is no gold standard. You can't go to the BoE and say 'Here's my £10 note, give me some gold'. They can give you another £10 note, but thats it. Fiat money (ie not backed by any physical asset) is a pure confidence play. I accept £10 notes for my goods because I have confidence that others will accept them when I wish to purchase anything. But I cannot redeem them with the State for anything. What sort of debt is it that can never be redeemed by the entity that issues it?

Mark Wadsworth said...

Anon, yes, the Basel rules seem quite sensible, apol's about saying it's 8 to 1 instead of 12.5 to 1. But conceptually this is different to the FRB model you learn in textbooks, but as I was explaining this for the benefit of Lola I probably don't need to explain it to you.

L, look, when a government borrows money that is 'printing money' but QE is neither borrowing money nor printing money.
---------------------------
S, "And IMO notes and coins are not govt debt, because they can never be repaid."

Wrong.

There is such a thing as perpetual government debt that has no date for redemption and that will never be repaid. Are you suggesting that this isn't debt?

Basic logic says that notes are govt debt. Even by your own standards, if notes are not debt, and ordinary gilts can be redeemed by the bearer being given notes, then why counts the gilts as debt, if they can be easily converted into non-debt?

But if you want to believe things that are quite patently untrue, feel free to do so. Today's public service has obviously fallen on completely deaf ears.

Deniro said...

You say that it doesn't make any difference what happens to the bonds in the BoE's safe, That is not true. The money supply is reduced by the act of the Treasury directing revenues towards Gilts held at the BoE. Money going to the BoE is out of circulation.

Bayard said...

S. "In your example, someone buys something, has no cash so issues an IOU. The State doesn't do this."

Oh yes it does! What do you think bank notes are? It even says "I promise to pay the bearer on demand..." on them. If that isn't an IOU. I don't know what is.

"And unlike the State, you can't print pound notes!"

but you can issue pieces of paper (IOUs) that are exchangeable with goods worth a pound, which are, for all intents and purposes, pound notes.

Deniro said...

That is to say money going to the BoE becomes out of circulation.

Lola said...

Money notes as tokens are clearly debt. They are a sort of IOU against (traditionally) bullion?

MW - QE is not printing money because it was used to buy back debt. It's just going round in circles?

All I meant by my 'printing money will end in tears' statement is because it will. I didn't mean to imply that QE was 'printing money'. At least that is what I think I was trying to say!

Mark Wadsworth said...

Den: "You say that it doesn't make any difference what happens to the bonds in the BoE's safe, That is not true."

Yes it is true. Let's not worry about how they got there in the first place and address the point I was making in the actual post. It does not matter by which circuitous route the IOU for £6 ends up back in the hands of the man who originally issued it. The point is, once it is back in his possession he neither has an asset nor a liability. It does not matter whether he keeps the physical bit of paper or burns it.

In the same way, once gilts are back in a safe at the Treasury, it does not matter whether the Treasury pulps them or not because they represent money that it owes to itself, and you cannot owe money to yourself.
--------------
B, thanks for back up, that is spot on and exactly the point I was making.
-------------
L: "QE is not printing money because it was used to buy back debt. It's just going round in circles?"

Correct. In fact it's not going round in circles, it's a straight swap of paper for paper (or electronic balances), both of equal value and both backed up by the government.
----------------
S: "Oh well you clever clogs can run the economy by printing money if you like. This dim farmer thinks that such a course of action ends in tears. I'm glad I own land. You can't print that."

Where have I ever said that 'printing money' is a good idea? I never, ever said that. What I am explaining is that QE is not 'printing money'. It is a self-cancelling transaction.

And no, you can't print land but you can tax it.

"And you haven't answered my point re the fag buying example. In the example the fag buyer has to either use savings (money he already has, having foregone spending in the past) or work extra to get the money to buy his IOU back.

The govt just prints some more notes to get its IOUs back. It has no savings and does no extra work."


I was vaguely hoping that you would apply common sense and spot the analogy.

Clearly, the man's source of income is plumbing work, and what he has done is exchanged a few minutes' work for a packet of fags.

Similarly, the govt has a source of income, it is called "tax".

So if you have £10,000 in UK bank notes (your asset, the govt's liability) and a tax bill of £10,000 falls due (your liability, the govt's asset) then you can take the notes to the post office (subject to money laundering reg's) and pay your tax bill.

Once paid, you have neither an asset nor a liability, and all the govt has is a pile of paper which is of no further interest.

Remember The Golden Rule: YOU CANNOT OWE YOURSELF MONEY. So if the govt has some pieces of paper saying "I promise to pay the bearer" and it can neither owe itself nor pay itself, those notes in the Treasury safe are analogous to the £6 IOU which ends up in the plumber's wallet. They are null and void.

Deniro said...

The Bonds are not in the Treasury safe they are in the BoE safe.

Mark Wadsworth said...

Den: "The Bonds are not in the Treasury safe they are in the BoE safe."

Look, the UK government has lots of departments, one of which is HM Treasury. HMT in turn has sub-departments, such as HM Revenue & Customs, Debt Management Office, Bank of England etc etc.

Please go back to the original rule YOU CANNOT OWE YOURSELF MONEY. Therefore if DMO 'owes' BoE money, but both are sub-departments of the same larger department which in turn is just one department of HM Government, all these intra- sub-departmental assets and liabilities can be netted off, in theory as well as in practice.

Deniro said...

The BoE is not a government department. It operates under a charter and was established in 1694. Even if a commentary treats it as quasi governmental department, then that commentary quickly becomes unstuck if it's balance sheet is not treated as a separate entity from the Treasury's balance sheet. If you conflate the two then then you are simply not commenting on the actual system as it actually is. The two are separate beacause that is actually how the central bank money system is constructed. If you are not commenting on that system then you are not commenting on the central bank money system of the UK in which the BoE and Treasury operate.

The concept of the two being netted out is an anathema to the process. It would be hyperinflationary and the whole concept of the UK currency would gradually become meaningless.

Mark Wadsworth said...

Den, I'm really not sure what level of reality you are operating on, but in the real world, the BoE's own website says:

As a public organisation, wholly-owned by Government, and with a significant public policy role, the Bank is accountable to Parliament.

The BoE is part of the government. It is owned by the government. Its assets and liabilities therefore also belong to the government.

Deniro said...

OK thanks for that. They have a slightly contrary statement on the top of the page entitled
About the Bank

Anyway ownership aside I think it is flows of money that you are more interested in.

Sobers said...

So QE does not increase the money supply. If so why do we bother raising tax revenue at all? Why doesn't the State issue bonds, take the cash, spend it on goods and services and benefits, then get the BoE to buy up all the bonds so the original bond buyers are back where they started. Then cancel the bonds and do it all again.

You appear to have invented the perpetual motion govt funding mechanism. We can all be made wealthy by QE. Wonderful!!!

formertory said...

This gets my vote for blog post and comment thread of the year, I think. Excellent.

OK, how about this as a summary:

QE isn't borrowing or lending because it's just a way of increasing the Banks' cash reserve ratios at the BoE to the newest levels demanded, by mandatorily "buying" things the banks already owned - creating "cash" to do it.

Because the "cash" is "created" and "stored" at the BoE it can't affect the total cash (M0) circulating in the economy.

BUT: Doesn't M0 include bank cash reserves? So isn't it inflationary? (And I ask that recognising that this wasn't the point you were wanting to make).

Or am I just being very dim?

Mark Wadsworth said...

Den, clearly, if you subscribe to the view that the BoE does not belong to the govt and is not controlled by the govt, then the whole post and thread is wrong.

Only it does and it is, so my post and all my comments are correct.
-------------------------
Sobers: "Why doesn't the State issue bonds, take the cash, spend it on goods and services and benefits, then get the BoE to buy up all the bonds so the original bond buyers are back where they started."

BECAUSE when the DMI issues bonds it takes cash from investors in exchange (this is easy to understand and I hope to G-d that we are agreed on this).

HOWEVER when the BoE does QE and buys bonds, it gives investors 'reserve balances' (which are close to being cash from the banks' point of view and are of course liabilities from the BoE point of view) in exchange. QE is the opposite of issuing bonds, quite clearly because the BoE is buying back bonds.

So while the bonds themselves could be cancelled, the original liability from govt to outside world (which existed prior to QE) is still there because the BoE now records the 'reserve balances' as a liability to the banks instead of the DMO recording the gilts as a liability to the banks.

My tip for the day: learn about bookkeeping and look up actual balance sheets before you make a fool of yourself yet again.
-----------------------
FT, that is an excellent summary, thank you.

Whether all this is inflationary depends on what the banks do with their reserve balances. As they are doing nothing (because they need to hold on to that money to repay SLS and CGS) in practice it is not inflationary.

Deniro said...

The QE process is much more apparant when the BoE buys cooperate bonds, then you can visualise the money going straight into commercial transactions and thus the money supply. The coorporate bonds that would have otherwise have gone begging due to low activity in the credit markets. The BoE buys these bonds and the cooperation in question then has these monies and makes commercial transactions.

Mark Wadsworth said...

Den you are dealing in hypotheticals and not facts.

If you actually read my post you would see that there is a link at para xiii. to the BOEPFF showing that 99% of QE money was spent on buying UK gilts. That is a fact.

What happened in the USA is quite different, of course. Over there it was outright fraud and the Fed bought up any old crap.

Derek said...

I won't add to the confusion by doing more explaining. Others have already made good attempts without success. It's obviously a difficult subject for some people to get their heads around. So I will just say that Mark is right and leave it at that.

deniro said...

To describe a money flow from the Treasury to the BoE correctly within the context of the monetary system, it is important to aknowledge that the money flowing to the BoE is being taken out of circulation. Once you do that you can see that critiqueing the process with the tautology "You cannot owe money to yourself" is not appropriate as once the Treasury pays the money to the BoE it no longer has it. The Treasury cannot dip into the BoE coffers to retreive the money after it has been paid in.

Deniro said...

I'm not contesting who owns the BoE. Just noting that the Treasury cannot dip into the BoE coffers to retreive the money after a Bond payment has been made. So the concept of the Treasury oweing money to itself is wrong.

Mark Wadsworth said...

Den: "once the Treasury pays the money to the BoE it no longer has it."

We are now descending into the realms of complete nonsense. To recap for the thousandth time as clearly you have not grasped this yet

1. The BoE buys gilts off commercial banks (and leaves the purchase price outstanding as a real liability, i.e. reserve balance). This bit need not concern us further (I trust that there is nobody so stupid as to deny this).

2. As between BoE and DMO (two departments of HM Treasury) there is NO transaction until the interest falls due (separate topic).

3. To sum up in capital letters: THE TREASURY DOES NOT PAY ANY MONEY TO THE BANK OF ENGLAND IN THE FIRST PLACE. WHAT ON EARTH ARE YOU TALKING ABOUT?

4. In any event, even if HMT did pay money to the BoE, seeing as BoE is bound by law to pay all its profits back to HMT as a dividend, what f-ing difference does it make?

In future, please try and stick to REAL FACTS AND REAL CASH FLOWS and not some fantasy doolally.

Sobers said...

This has nothing to do with book keeping. Its down to the fact that gilts and cash balances are NOT the same thing in the real world. They may both go down in the govt accounts as liabilities but they don't affect the amount of money people can spend on stuff in the same way.

Cash can buy stuff. Gilts cannot. Try walking into a car show room and buying a car with a gilt certificate. If you own gilts and wish to buy something you sell it to someone for cash, and then buy something. They then have the gilt, you have a new car (for example) and the car dealer has the cash. There's no new cash in the system.

But after QE there's twice as much cash in the system. Theres the intial sum raised by the sale of the gilt, now spent by the govt, and residing somewhere in the economy. Then there's the reserve balances that the bank who sold the gilt back to the BoE has at the BoE. Which presumably it can take out of the BoE and spend, if it so wished. Or lend to people, or whatever.

Unless the govt is in some way forcing the banks to hold the excess cash at the BoE and refusing to let them spend it, it will at some point be reintroduced to the real economy, where it will bid up the prices of goods and services.

The BoE themselves say that QE will be reversed at some point, thereby 'sterilising' the money injected into the system. If it had no effect on the money supply, why would they bother doing that?

Sobers said...

The BoE admit as much here:

http://www.bankofengland.co.uk/monetarypolicy/pdf/qe-pamphlet.pdf

QE is designed to increase the amount of money in the economy, to boost spending, and prevent deflation.

If inflation looks like rising too fast, QE will be withdrawn, reducing the amount of money in the system.

So there you have it. The BoE says QE increases the amount of money in the system. Do you know better than the BoE?

Mark Wadsworth said...

S, you have fallen for BoE propaganda! I can't believe you are that gullible! You're as bad as DBC Reed!

1. As a matter of fact, QE does not (necessarily) increase the amount of "money in the economy", in the UK, by and large it has made no difference. (it was the reckless borrowing by homeowners and government which increased it).

2. The whole QE thing was made up by the BoE in order to be able to overpay for gilts held by its mates in the commercial banks, thus making a few billion easy profit for them to pay this year's bonuses.

3. As to "if it looks like inflation is rising too fast", clearly, they don't understand grammar*, and in any event, what is "too fast"? They are clearly quite comfortable with 5% inflation, because it helps erode Home-Owner-Ist debts, so why not 10%?

4. So let's imagine they did reverse QE. They then say to all the banks who have patiently left that money on deposit with the BoE "Do you fancy buying those old gilts back again at undervalue this time, earning you another couple of billion easy profit to pay this year's bonuses?"

* Do they mean "if prices are rising too fast" i.e. "if inflation is too high"? Or do they mean "if inflation is rising too fast"? If the latter, then clearly an increase in inflation from 5% to 5.25% is not too bad.

So yes, while I do not claim to know more of the details than the BoE, at least I am not a cheerleader for Home-Owner-Ist vested interests. I understand bookkeeping and have actually taken the trouble to look at balance sheets (unlike you, for example) and I can be honest about it. Neither am I some hysterical right wing newspaper hack who claims that "QE is printing money" because quite clearly it isn't.

Ordinary govt borrowing is "printing money" in a sense, but they can do that with or without QE, it's two separate topics.

Mark Wadsworth said...

S: "Unless the govt is in some way forcing the banks to hold the excess cash at the BoE and refusing to let them spend it"

Are you overlooking the SLS and CGS liabilities of a few hundred billion? These are due for repayment in the next couple of years, and there is an outside chance that the UK government will actually ask the banks to repay these loans according to the originally agreed schedule, so clearly they would rather have a bit of ready cash (i.e. reserves with BoE) just in case. And why would the banks bother lending it to people to buy overpriced land and buildings?