Wednesday, 30 September 2009

Bank says QE is making a difference

"Well, they would, wouldn't they?" - Mandy Rice-Davies

From The Times October 1, 2009

"Gordon Brown isn’t the only one launching a fightback. The Bank of England has started a campaign to win round public opinion. In its case, the Bank is trying to combat scepticism about its quantitative easing policy that injects new money into the financial system."

The BoE is creating money (£175Bn so far via Quantitative Easing - a term apparently invented in Japan in 2001 for economic policies which produced questioned benefit) by buying Gilt-Edged stock at prices which have been pushed up by the Bank's own policy of low interest rates.

Government schizophrenia/doublethink Part 1: The Treasury through the Debt Management Office - DMO - (which formerly reported to the BoE) is busily selling Gilts to fund immediate government current expenditure.

The banks which held Gilts have made capital gains which they have prudently applied to rebuilding their capital reserves which were devastated by their bonus-driven imprudent lending to fund the housing bubble at home and away.

Government schizophrenia/doublethink Part 2: rebuilding balance sheets versus lending.


In the US banking system the reserve ratio is fixed a 10% (or 10 times) capital. In the UK the Bank of England now holds to a "voluntary reserve ratio" system having abandoned a compulsory limit. In 1998 the average cash reserve ratio across the entire United Kingdom banking system was 3.1% (approximately 33 times); it has probably been significantly lower since.

UK Reserve Ratios
1968 1978 1988 1998
20.5% 15.9% 5.0% 3.1%

It appears that, the BoE having relaxed its controls, the Financial Services Authority had responsibility for monitoring this situation. No-one is to blame.

Now: the BoE holds Gilts on which it has spent £175Bn of new money a la Weimar/Zimbabwe school of economics.

Sometime not too far away:-
1) the DMO will have difficulty selling x £100Bn and will have to offer higher interest rates.
2) the BoE will become concerned about inflation and will increase the bank rate.

The prices of Gilts will then fall.
“It is unclear quite how the Bank will unwind QE. But it has every reason to take its time.”

As it will be the taxpayer who sustains the loss, I guess this time will be when all those involved (no-one is responsible) have retired on their risk-free inflation-proofed taxpayer-funded public sector pensions.

I shall be delighted if someone can prove my cynicism unfounded and that QE is really the best of all possible worlds - or even all possible multiverses.

“This is, of course, completely impossible.” - Douglas Adams.

“The truth is out there”, doubtless with “42” as a significant factor.

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