Monday, 8 March 2010

Quantitative Easing (financial laxative): QE not QED - revisited

Comment on Roger Bootle article

So 'My Uncle'* Mervyn at the Bank of England pawnshop has been buying £200Bn of gilts.

Now that selfsame BoE has cut interest rates to an historical low; this has caused a corresponding rise in the price of gilts. So, the BoE is buying at high prices and the financial institutions which were holding the stock have made a tidy profit with which to pay bonuses.
Alternatively, the opportunity has been created for the institutions to make arbitrage deals between the Treasury's Debt Management Office and the BoE.

Roll on a couple of months and we see that the inflation number is not a “blip”.
The BoE raises interest rate; gilt prices fall correspondingly.
The BoE now starts to sell its holding and incurs losses.

Who is paying for this capital loss?
Presumably the cash has gone to “money heaven” as in the Iceland debacle.

* The English term of ‘my uncle’ as a euphemism for the pawnbroker dates back to the middle of the seventeenth century.

According to Tim Congdon of Lombard Street Research, the whole process "is quite idiotic, frankly". He believes that the Bank, if it ran the DMO, would simply issue fewer gilts in the first place and "quantitative easing" would be achieved by buying bank debt.
- Daily Telegraph 26/3/09

Q&A: Quantitative easing "Q&A: Quantitative easing Are there any risks?
QE is a high-risk strategy. If it is not done aggressively enough, banks will remain unwilling to lend and the crisis could drag on. To some extent that is what happened in Japan when this was tried 10 years ago. Like old-fashioned money printing, QE also runs the risk of going too far: pumping too much money into the economy and causing high inflation - even hyperinflation - as seen in 1920s Weimar Germany and modern-day Zimbabwe.
Why are the UK's actions different from 1920s Germany and Zimbabwe?
Printing money can be defined as the central bank financing of government debts. This is what happened in both 1920s Weimar Germany and Zimbabwe and what the British government will insist it is not doing, although the short-term effect is similar. According to the Maastricht Treaty, EU member states are not allowed to finance their public deficits by printing money. That is one reason why the Bank of England will buy government bonds from financial institutions, not directly from the government. The Bank believes this form of QE is different because it is "printing money" as part of monetary policy - to prevent deflation. It is not printing money to help the government finance its deficit. Also, unlike Zimbabwe, this is a temporary policy: the Bank expects to sell the government bonds back into the market when the economy recovers. " 6/8/09

"an elaborate game of pass the parcel sees cash effectively shifted from one arm of government to another via third parties" - Rodney Hobson 6/8/09

So the story so far: the BoE has cuts interest rates; gilt prices have risen.
Next "the Bank expects to sell the government bonds back into the market when the economy recovers. " i.e. when interest rates will have increased; gilt prices fallen.
The BoE sustains a loss; paid for by?

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