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Ahead of the curve

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Stephanie Flanders | 12:46 UK time, Wednesday, 11 March 2009

Say what you like about the Bank of England, in launching its first £2bn purchase of government bonds today it is definitely ahead of the curve.

Bank of EnglandEven the US Federal Reserve, which has been several steps ahead of our central bank for most of this crisis, has yet to press the button on this form of QE.

The Fed has been buying up corporate bonds for several months, but the Chairman, Ben Bernanke has so far resisted calls to buy US government debt. Does he know something that Mervyn King doesn't?

When asked, Ben Bernanke says he has no ideological objection to buying government debt - he simply thinks that right now, it's more effective to tackle the corporate credit shortage directly.

There are several reasons the Bank can't follow his lead. One is simply that the US corporate bond market is much, much bigger relative to the size of the economy than ours is.

If the Bank of England tried to buy £75bn-worth of corporate bonds it would find itself buying up roughly the entire market. It would then be in the uncomfortable position of being the sole purchaser of the debt of some of Britain's biggest companies. (Incidentally, the pool of corporate assets to buy would expand greatly if they could buy up syndicated loans as well. They may do that some time in the future but that's not on the cards right now.)

Our central bank is also concerned about taking too much corporate risk onto its balance sheet. That doesn't seem to be much of a worry to the Fed (though some at Threadneedle Street wonder why not).

As I mentioned last week, the danger in taking on too much private sector risk is that you push up the risk premium on government debt, raising borrowing rates for everyone and defeating the whole exercise.

Of course there is the opposite risk, which you might call the price of QE's success. What if the policy succeeds - the economy recovers, interest rates go up, bond prices fall and the Bank ends up selling these assets back at a loss?

In a sense, that is an inherent part of the policy. It would certainly come as no surprise to Bank officials. That is why the Bank of England had to obtain an indemnity from the Treasury to make these purchases through a special subsidiary - the Asset Purchase Facility.

Any paper loss on these assets when they are sold back to the market will have to be made good by the Treasury, so there isn't a hole in the Bank of England's accounts. But it's part of the oddity of QE that the loss to the taxpayer, in this case, will also be the taxpayer's gain. For who will have benefited more from the initial fall in gilt yields than the government itself?

Think about it. For the next three months, the Bank of England's going to be buying up more medium-term gilts than the government is issuing. For decency's sake, the Bank has to wait until the debt has been on the market for all of a week, but the effect is the same.

If those purchases push up the price of gilts, that will make it cheaper for the government to borrow during this period than it would otherwise have been. That means the debt will cost us taxpayers less.

If and when gilt prices fall again, the Bank of England may have to sell them at a loss. But that loss is the mirror image of the earlier gain. You never know, we might even come out ahead. And we'd no longer be in a recession. It's a little Alice in Wonderland perhaps, but that's the nature of QE.

Comments

  • Comment number 1.

    Oh good, the BOE ahead of the curve.
    Sorry being first to do something stupid doesnt mean their going to get any credit from me.


    Sorry for the sarcasm, Stephanie but im thoroughly fed up with Gordon Brown, the BOE and economists telling me how wonderful they are and how we should all be grateful for mucking up.

    Im just glad that after its all gone down the pan ill be able to tell everyone I TOLD YOU SO, cos that will be a great comfort.

  • Comment number 2.

    Stephanie, have you got anything to say about the total amount of outstanding derivatives numbering $1.28 quadrillion, which is 20 times global GDP?

    Seems to me all this debt can never be repaid nor serviced.

    Eventually the whole economy has to collapse under the sheer weight of this funny money.

  • Comment number 3.

    Robert Peston's article today is a bit more confused than Stephanie on this whole issue. He has forgotten about the Treasury's potential profits when discussing the Bank of England's losses.

    He does raise an interesting question about the rationality of traders. But the answer is not a simple one of "they're rational" or "they're not". Rationality has limits and bond traders are subject to those limits just the same as the rest of us. They are rational to a certain extent and no further. Here's an explanation:

    http://www.knowingandmaking.com/2009/03/multi-level-rationality.html

  • Comment number 4.

    That is the theory, Stephanie. It is not what may necessarily happen.

    Existing gilt investors may sell at this price, realising the capital gain from the pop and expecting to buy back later when the same gilts are sold at a loss. I am sorely tempted. Better yet if they can go to forex and ride sterling devaluation at the same time. This sounds like a potentially beautiful long-term arbitrage play. For the man in the street, I chuckle, he will lose one way or another for that promise of a recovery one day.

    Existing corporate debt investors may decide to scale back their activities when the Bank of England's forthcoming operations suppress yields and mess with risk/reward profiles and market price signals regarding creditworthiness. The government may want some company's borrowing cost to be down to 7%, but if true credit risk is only covered at 10% and this may not be signaled in the market data due to intervention, no bid. The Bank of England would then become "the sole purchaser of the debt of some of Britain's biggest companies" as you put it, by default, whether it likes it or not, because the private market will be reduced to "dumb money" suckered in by yields unrepresentative of true conditions. Once again, this is the problem of unintended consequences and confidence in a different guise.

    Sterling may fall, leading to imported price inflation in a credit deflationary environment, and depending on the damage done by the resulting unpleasantness, may not necessarily recover. Good news if you want to buy back into gilts once they yield north of 10% after the (possible/likely) crash though, and if you had the good fortune to hold the right forex.

    So I see hazards. You say "definitely ahead of the curve," I say definitely first into the breach.

    As the Great Went said - "Hey, slow pokes... guess what? There's no tomorrow. Know why baby? 'cause it'll never get here."

    Food for thought for us all, when tempted by fairytale promises that the end justifies the means.

  • Comment number 5.

    Problem is when gilt yields fall it gives even less incentive to buy UK debt.

    More pressure on sterling - hence the near low values vs. dollar already reached one day into this QE process.

  • Comment number 6.

    How did it come to this?

    Central banks using fictitious money to create debt to be bought and sold by insolvent financial institutions - and an economic correspondent who believes it may be profitable.

    It's not "a little Alice in Wonderland" it's complete & utter madness.

    It may be too late, but I think it's time to create a parallel society where things have inherent value and meaning.

  • Comment number 7.

    #2 scotbot:

    Do not confuse notional with net values. Most of that cancels out. Much of that should be void anyway, in a perfect world I glimpsed at a quarter past midnight.

  • Comment number 8.

    No. 2. scotbot wrote:
    "Stephanie, have you got anything to say about the total amount of outstanding derivatives numbering $1.28 quadrillion, which is 20 times global GDP?"

    Remember, one person's loss is another person's profit.
    All those derivatives contracts net off to zero, or only a couple of quid at worst. There is no need to worry..........

  • Comment number 9.

    You've just given me a big big shock.

    The US have been using QE for some time so if it's good enough for them it's good enough for us.

    Well according to your blog today they haven't.

    Which leaves us out on a limb as the only ones daft enough to risk it.

    No wonder GB is so desperate to encourage other members of the G20 to go along with his ideas.

    Without the same coordinated approach from others it is doomed to fail.

    Your blog paints a fairly optimistic view of Alice in Wonderland but where is the reality check if or when it fails?

  • Comment number 10.

    Stephanie, from your description, this is shuffling paper. I can't see how this won't lead to a serious devaluation of sterling. The treasury is after all paying its obligations in sterling funded by this fantasy money.

  • Comment number 11.

    So, Stephanie, this is all a clever government debt management exercise, is it? What are the Insurance and Pension funds and Overseas investors going to do with their newly gained liquidity in the secondary gilts market? Buy riskier assets, put the money in the bank for not much interest or invest in new gilt issuance to cover their long positions?If the banks sell their gilts they'll have to hoard their new-gained liquidity for Tier One capital reasons wont they?

    I thought we were told this money would go into the wider economy to support the inflation target? It would help if you could track through the scenarios depedning on which type of gilt-seller materialises.



  • Comment number 12.

    Oh, yes! Well ahead of the curve alright.

    May I suggest we get ahead of the curve as well and start purchasing wheel barrows while they are still cheap enough and before the Old Bag Lady of Threadneedle Street comes along and snaffles them all up?

  • Comment number 13.

    If I were to 'say what I want' about the BOE (or HMG) the moderators would axe it promptly, I suspect!

    What baffles me, given the predictions that become increasingly doom laden as the months go by, is just why the BOE and HMG are really doing this.

    O.K. create money out of thin air - if you will - but why then go and buy government debt and corporate paper with it? Isn't it all a wee bit late in the day for that?

    Doesn't that rather presume there is some way back to the kind of financial 'normality' of a couple of years ago? That is, with "stable" markets and all the associated paraphernalia, e.g. available credit, decent interest rates, stable and reliable financial industry, customers that trust the banks with their money, property prices on the up, etc. etc?

    Surely better to have put the money into regenerating the U.K.'s ability to meet its basic needs, e.g. micro-energy, farming and fishing, horticulture, infrastructure and the like? That way we would perhaps stand more chance of surviving the increasingly probable societal break-down, unemployment and enforced poverty caused by more and more people find their savings shrinking, their jobs gone, their pensions worthless, etc. etc.

    Or is QE really just a bit of spin to try to re-assure the public that HMG IS actually doing something?

  • Comment number 14.

    Stephanie,

    Excellent, concise, analysis. The problem with QE is - let's face it - that it has never really been tried. There could be any number of effects, not least the effective revaluation of short-dated gilts between the financial planning and execution of an issue, making a mockery of HMT talk about 'rationale financing'. More than ever we are in novel territory here. I'd love to know what monetary economists think the consequences could be in the markets, on the government's balance sheet and in corporate sector assets.

  • Comment number 15.

    Stephanie, have you got anything to say about the total amount of outstanding derivatives numbering $1.28 quadrillion, which is 20 times global GDP?

    This is one of these meaningless numbers - if Bank A insures a debt of $1b for $10m a year, and then sells on the debt to Bank B who will insure it for $9.5m (arbitraging it), is there now $2b in debt involved? Only on paper - most of it nets out in the end (even if one of the banks involved fails in theory).

  • Comment number 16.

    It appears that the "Royal Bank of Scotland" now 64% owned by the ENGLISH taxpayer has suddenly made £1.7 billion available for mortgages in SCOTLAND!

    With Scot run Labour in charge and desperate to buy votes in their homeland one has to ask the question...

    Will this £75 billion be going the same way?

  • Comment number 17.

    Ahead of the curve? Surely you meen further round the bend! This government continually claims to be leading merely because it has to act where our situation is so much worse.

  • Comment number 18.

    I'm afraid that anything our great leaders and market makers do that has the label attached 'it is a little Alice in Wonderland' fills me with dread, isn't that how all these clever fellows got us into this mess in the first place? Can the Tories not impeach Brown or something, as far as I can tell he seems to be purchasing the whole country using a combination of my money and funny money, and his bloody tax office are chasing me for thousands when he is squandering Billions. Had he given the money to me and others like me we could all be out of debt or at least less in it, in a truly Fairytale Fashion. Even more annoying is, as a small shareholder in HBOS and Lloyds who saw the disaster coming so said 'no' to the takeover, my shares have have gone down the pan so I can't flog them to pay all my taxes, and to add insult to injury, GB will save the hides of his two mates at Lloyds. Well, I heard today tha Jail food is better than hospital food, so I'll wait to be arrested rather than attempting to injure myself. We are a Banana republic, as corrupt as any failed African State, and possibly on the way to having their inflation rates!

  • Comment number 19.

    Robert Mugabe was the first into financial easing ~ does that mean it is now a wise policy ?

  • Comment number 20.

    Hi Steph.

    Care to explain how the concept of profit can be applied to an organisation which can print as much money as it happens to feel like?

  • Comment number 21.

    You say confidently that the Bank of England is ahead of the curve - which presumably means you know where the curve is, since you know the BoE is ahead of it.

    In which case would you be so kind as to tell the rest of us where the 'curve' is?

  • Comment number 22.

    Funnily enough I was saying exactly the same thing to my mother via IM today.

    I reckon that the BoE/Darling are doing the right thing, in going early they get more of a boost that if they had to compete with the US and the Eurozone going the QE route too.

    My mother asked me when we would know if it worked? My answer was that we wouldn't.

    Personally I doubt it's a silver bullet, but I reckon that chances are that it'll put the brakes on and ensure a severe recession rather than something worse. Given the alternatives of debt deflation, etc. this is no bad thing IMO.

  • Comment number 23.

    Be kind to your readers and try not to use acronyms or put them in full the first time you use them in an article. I know now that QE is quantitative easing, but I had to hunt to find that out. If you'd have said Quantitative Easing (QE) the first time, it would have helped. Thanks for a great article.

  • Comment number 24.

    Am I missing something, but if the BoE in effect creates money out of thin air, whilst the assets of the nation remain the same (or reduce), then won't the real value of each pound fall to compensate?

    Unfortunately there only seem to be two solutions to this huge debt mountain - either a prolonged depression while we pay off most of the borrowings, or we allow inflation to take off. If inflation were to average 7.5%, the value of fixed debts would fall by half in 10 years, effectively transfering wealth from (mostly elderly) savers to (mostly younger) borrowers.

    I suspect that higher inflation is the more politically acceptable course, especially since the dermographics of an ageing population will put a greater burden on younger people anyway.

  • Comment number 25.

    After all the pain we have had in the last 12 months , you would think the BOI would know better .I can't believe the BOI thinks this is a good idea . It's completely untried and is very likely to blow up in our faces . It may have some short term benefit , but there will be a bigger problem to sort out later .
    The only answer is to pay our debt off of as quickly as possible , this means significant cuts in public expenditure . We are simply living beyond our means and need to cut back now to have a chance for a better future . Printing money is not the answer !!!

  • Comment number 26.

    "What if the policy succeeds - the economy recovers, interest rates go up, bond prices fall and the Bank ends up selling these assets back at a loss?"

    It's certainly a risk. However I question whether the Government will ever fully reverse this QE by selling all of the gilts back.

    The balance of the system has changed. For the last few years the Government only created a small percentage of the money supply, while the banks created the vast bulk of it through lending. They were able to do this by mispricing risk, both through lending an excessive amount relative to their capital, and through securing loans against vastly overpriced assets.

    That's what's got us into this mess, and surely we don't want it to happen again. So going forward we should expect the banks' lending to contribute less of the money supply and the Government more. Thus the printing of money which QE effectively involves is not a short term reversible fix, but a long term, perfectly healthy change in the balance of the economy.

  • Comment number 27.

    Stephanie

    Am i missing a trick here? Surely if the BoE are buying up government debt in the form of bonds, with the treasury (public money) underwriting any losses incurred as a result of QE strategic success, the tax payer loses either way .. where is the win for the man on the street and how quickly will the cash hit the street? .. chaps like the clearly well-informed/well-positioned 'werringsilent' will scoop up in buckets .. whilst I'm sure he/she should be rewarded for having studied so thoroughly, can I suggest that a 'fairer' method of distributing new money to the average chap would be to throw it out of a helicopter over the UK.

    I'd be happy to provide pilot and shovel..

  • Comment number 28.

  • Comment number 29.

    Stephanie, I am not sure I can agree with your "mirror image" theory.

    The Government are buying gilts in todays market, but will be selling in tomorows.

    The volume of government debt available to buyers in tomorrows market is likely to be far greater than that which is available today.
    Governments all over the world are going to be involved in massive gilt issuance programmes.

    Greater supply is likely to lower the clearing price in the market.

    Add in the concerns about inflation (which will almost certainly rise as we come out of recession) and interest rates returning to more normal levels generally, the likely return on the gilts purchased under the QE scheme is likely to be considerably less than the sums paid.

    The losses on this £75Bn to £150Bn of QE will be far greater than those suffered on Black Wednesday. But like Black Wednesday, they may crystallise under the Tories.

  • Comment number 30.

    #9 virtualsilverlady:

    You understand the risks perfectly. Britain is first to put the words of printing into practice, at least according to what is in the public domain. If Crash Gordon does not get G20 to go along with this, then currencies being a relative matter and sovereign bond markets offering numerous alternatives, he will be faced with the choice of an embarrassing u-turn or sailing us onto the rocks. You can see why he keeps dropping "global" into every speech. He knows he needs international investors to buy in to this, otherwise we are left hopelessly exposed.

  • Comment number 31.

    This is like having a ringside seat in a casino, with Steph whispering critiques in my shell-like ear from time to time.

    Exciting, but it's going to be a long, long sit, and, for most of the time I won't know whether we're winning !

  • Comment number 32.

    LUNACY IN THREADNEEDLE STREET!!


    WHATS NEW?



    ITS BEING GOING ON FOR 12 YEARS!

  • Comment number 33.

    THREE HOURS FOR MODERATION ??

  • Comment number 34.

    #2

    I agree with your concern and, although your headline figure overstates the quantum, an uncoordinated unravelling is possibly sufficient to finally topple the already toppling tower. In theory these derivatives could be unravelled and cancelled. The big problem is the counter-party risk, which is multi-faceted. The avoidance of a collapse is the main reason that AIG have received so much unhesitating support. Behind them stand a whole bunch of banks led by JP Morgan Chase.

    The problem is a little like the LMX spiral that brought Lloyds of London to its knees. The truth is that no one knows how to unravel such a spiral. At Lloyds it was not too difficult to force through an approximation. The situation with derivatives is global, not a bunch of chums in a room.

    As to QE, all it is in effect is a massive increase in government debt that can only be cancelled by overt default, covert default/currency depreciation/inflation and/or taxation. The likely outcome is a combination of all three.

  • Comment number 35.

    As the government keeps on insisting, the big idea here is to get “credit” moving again. Credit, they say, is the lifeblood of the economy. And that in order to get it to businesses and individual borrowers so that they can continue to spend, consume and thereby stimulate the economy, the BoE, in addition to money it has already created, is going to monetize £75bn of government debt.

    If generating wealth is as easy as printing money, then why doesn't the government recruit a squadron of RAF C130 Hercules', load them up with medium stress pallet full’s of money, then fly all over the UK and throw them out of the back?

    That would cut out the middlemen (the banks) and would be a faster, more efficient method of getting credit flowing again, wouldn't it?

  • Comment number 36.

    Is this what is meant by making money?

    It all sounds as if we have managed to expropriate by nationalisation the gold of the Leprechaun King. Never fear, His Littleness will have the last word.

    I love rainbows as they never end.

  • Comment number 37.

    #26 random_thought wrote:

    "Thus the printing of money which QE effectively involves is not a short term reversible fix, but a long term, perfectly healthy change in the balance of the economy."

    You are completely wrong on this. It is not healthy, and it is not sustainable long term. If printing one's own funding requirement was so great (and economic stimulus and special asset facilities), every human on Earth would be living in a utopia by now. These things are the last resort bar the truth for a reason. They carry with them the certainty of harm to an unknown degree.

  • Comment number 38.

    I am sure QE easing is the only effective tool in the current circumstances and should have been tried sooner - interest rate changes are too slow acting and in this situation, as Keynes said, are like pushing on a string. QE should have begun at least 6 months ago to aleviate the deleveraging we have seen, which was anticipated by many commentators last September, if not sooner. The Zimbabwe example is irrelevant - the quantiative difference, as it were, is so great as to be qualitative.

    The way the BoE is proceeding is however bizarre - on one hand, its debt management office is selling gilts and on the other, its asset purchase facility subsidiary is buying them, with at least a weeks gap. Not only is this a strained mechanism to pretend not to be indulging in deficit financing, the gilts to be issued over the next 12 months at least double the 50 billion currently authorised for purchase over the coming quarter. Therefore, to be 'easing' over more than the very short term, BoE needs to buy far more gilts.

    Why don't they simply come clean and commit to funding the PSBR for the foreseeable future? This will leave far more liquid funds in private hands, looking for a home. As something like normality returns, the Bank could return to using interest rates to control credit & the money supply, holding its bonds to maturity, effectively writing them off so far as the public purse is concerned.

  • Comment number 39.

    #21

    I realise you're trying to be clever, but just in case anyone wants an answer:

    http://www.investopedia.com/terms/y/yieldcurve.asp

    Or

    http://en.wikipedia.org/wiki/Yield_curve

    If that's too simple, try this:

    http://acrossthecurve.com/

    #24

    I'm with you, I think inflation is ultimately the choice that will be made. Either that or there has to be some serious debt forgiveness, writedowns on senior debt and the like.

    With inflation, it might make sense to take out a few loans prior to that, buy (physical) gold and Inflation protected securities, and then lay back and let your debt work for you too. :)

  • Comment number 40.

    englandrise (#16) wrote:

    It appears that the "Royal Bank of Scotland" now 64% owned by the ENGLISH taxpayer has suddenly made £1.7 billion available for mortgages in SCOTLAND!

    With Scot run Labour in charge and desperate to buy votes in their homeland one has to ask the question...



    You're a complete shower, aren't you, Englandrise. Every other post you make is just another unobjective, prejudiced anti-Scottish rant.

    Pray tell, did you bother to investigate the story further? Nope, because if you had you would have found out there's more to the story than the Beeb published.

    Anyway, I'll refer you to my post on one of Robert Peston's blogs, "Nationalism may impoverish us", which quoted an article in The Scotsman:


    RBS Group, which has been effectively nationalised by the government, disclosed that it is to free up £9 billion for the housing market across the UK in 2009, £1.7 billion of which will go to Scottish customers.

    RBS also said it would go further if demand for home loans went further than the £1.7 billion total. Another £16 billion is to be made available for loans to small and medium-sized business across the UK.


    http://www.bbc.co.uk/blogs/thereporters/robertpeston/2009/03/nationalism_may_impoverish_us.html
  • Comment number 41.

    The public might yet make a profit out of all this? Increase the money supply hugely without massive inflation? Out of recession in months?

    I'd love to believe it, but I keep being drawn back to the Iron Law Of Entropy which tells us, amongst other things: "Everything has to be paid for" (i.e. there's no such thing as a Free Lunch) and the derived: "If you are getting a Free Lunch, someone else has to be paying for it".

    It's as universal as gravity and applies as much to economics as cosmology. The effects can be delayed - to the next generation, for instance - as with the sometimes quoted aphorism on gravity: "It's the landing, not the fall, that kills you."

  • Comment number 42.

    Dear Stephanie,

    Robert Peston and yourself confine your comments to "what happened today" or "breaking news before it has broken".

    Please advise on the pros and cons of fiscal stimulus. Should we take the pain as Jim Rogers recommends. Can we buck the market? Should the housing bubble take its course and deflate from a peak of 9.3 times average income to its historical norm of 3 and allow first time buyers to buy houses with loans of three times salary and not be forced into unreasonable debt with the consequent risk of default

    Regards,

    David Lilley

  • Comment number 43.

    Hang on a minute, isn't printing money to buy government debt exactly what Mervyn King said this wasn't about?

  • Comment number 44.

    Ms Flanders

    Both WerringtonSilent and virtualsilverlady have made the point that the success of this policy is dependent on the UK continuing to be able to sell new gilt issues to institutions outside the UK, and that QE's raising of gilt prices, with the concomitant loss of attractiveness for foreign investors, makes it by no means certain that these necessary overseas placements will continue to be available. It's not, I think, stretching it too far to say that the UK's QE cannot succeed unless there is co-ordinated world action to drive up the price of sovereign debt globally.

    Is this a fair representation of the situation? If so, why did you choose not to mention it in your post?

  • Comment number 45.

    Round one and already we have the basis of banks milking the system. RBS will lend £17m etc., etc.
    It proposes to demand arrangement fees as the price of dealing and accessing the mortgage. This is twice the level pre-crash.
    The equity for the buyer is higher. Income must be assured. Guarantors are required too.
    Its like credit cards. All publish "APR" but one can never ever get at its means of calculation because the credit card companies bury "fees and administrative costs" within the published figure.
    The actual net cost of borrowing with a view to axc

  • Comment number 46.

    We are really in the soup as a country and should be preparing ourselves for tough times. The UK is no longer a global financial and industrial country. We had better get used to this idea right now.

    Hidden amongst the rubble of public domain information, I read the Bank of England Feb 09 Inflation Report. I found this little gem.

    "Markets for sub-investment grade companies remain effectively closed — there has been no issuance by a UK PNFC (Part Nationalised Financial Company) with a rating of BB or below since the onset of the financial crisis."

    Translated into English this means the banks are shut for 98% of British businesses as far as new lending is concerned. Good businesses cannot rely on credit to ease their trading anymore. Some will fail. Result is unemployment rising and benefit claims increasing as tax revenues dwindle proportionately.

    I go on. The BoE also charted the cost of borrowing for companies.

    Corporate Bond spreads now attract a 600bp "risk premium" compared with only under 100 bp in 2007. UK PLC is a high soverign risk country and higher corporate risk country for its businesses.

    The BoE also said

    "The time taken for UK companies to settle debts increased over 2008, according to factoring and invoice discounting companies."

    So cash flow is tight from trading, companies take longer to pay and banks have all but stopped lending new money and are busy trying to contract the lending market by "cashing up" and "accelerating" loans to its customers.

    In short, we are undergoing a financial cardiac arrest in slow motion.

    The BoE never above talks about real money or M4 - the broad supply of money. It is growing at around 15% pa before the £75bn QE facility. This will increase the YOY position to over 25%.

    However, banks have shown until 2009 that their total assets on their balance sheets are far bigger than the M4 supply of money. Much of these assets are illiquid derivative assets - chipboard loans - made up of fragments of lots of loans and squeezed together under high pressure to form derivative products (wrapped with credit insurance). Many of these assets are comprised of "funds of funds" in other words, a massive over valuation of assets measured "in real money" in the form of these instruments. They are virtually worthless right now as no one can actually value them. Our banking system in the UK could be described as insolvent.

    We have to be grateful that Lehmans went bust. I hope that the administrators of that business in the US can truly unwind their positions so that the full extent of loss can be calculated and then each counterparty writes off this debt. Then, we can see the true extent of the mess. However, I don't believe in Santa Claus and the public will never be told the real and horrid truth, that we have backed a dud (our banking industry).

    Now, the UK Government is borrowing even more money in the hope of digging us out of the mess. Betting the ranch on a grand scale. I fear the worst. Cash is king..just but with a real possibility of falling in value like a stone soon if QE fails.

  • Comment number 47.

    As a basic state pensioner with my savings residing with RBS/Nat West Accounts all the foregoing comments are meaningless.

    I've endured the 3 major financial hiccups of the last 60 years and my only assumption is that the pennies I have saved will not vanish overnight. Meanwhile I shall continue with my frugal existence in the sure and certain knowledge that the rich get richer & the rest of us just endure.

    A lifetime of working, never getting into debt and having a social conscience is, amazingly, the norm for some of us.

  • Comment number 48.

    Why doesn't the great Gordini just drop the QE'er stuff and SIMPLY say

    "SHAAAZZAAAM" give me your tiered and mhuddled AAA's repositories yearning to be free to fans of things can only get better .

    Then the picture would be clear for the economic illlitterates in par lamment


    Cartomb Gorden deserrves a viking burial in a sinclair c5 for throwing down the gauntlet to every other central blank, challenging them to debase their currencies to infinity and beyond in tandem and be as noticeable as the relative movements of the sniffy passengers of a lift in freefall accuing eachother of the globalized rassberry

    QE equals Mc squared where c equals the caxtonian constant

    QE is like the wallace an grommet caper where grommit has to lay the track as the train trunldes along to avoid derailment.

  • Comment number 49.

    this is the last roll of the dice , they can do no more, and it will fail



    You can take your curves and your graphs and your past experiences and throw them out the window.

    Printing money is the end game, other countries and institutions and the Soros figures of this world will bury the UK

    The banks should have been left to rot

    the sensible banks should have been supported to move the money from the bad banks to the good

    The system is broken and a new system needs to be put in place.

    It can be done, but yet people even though the place is falling to pieces, are looking for ways to make money by non productive means

    The pound is finished and the dollar will follow, with mass defaults on payments on loans to other countries, especially China

    Something big is about to kick off

  • Comment number 50.

    First, my apologies for not replying directly to the contributors who replied politely and reasonably to an earlier perhaps rather provocative post of mine. I have to work for a living, like no doubt many others here.

    I can't work my way through the logic. I thought the QE was supposed to be about freeing up liquidity for the banking system. What the Bank is doing now is not that, it's a direct monetary stimulus to demand. That is troubling. Of what size? Can someone please point me in the direction of the aggregate money supply figures? Looks like we're going back to the 1980s, in reverse.

    Here's a radical alternative. If consumers won't spend, another way to raise aggregate consumption in the economy is to increase taxes and spend all the extra government revenue on improving infrastructure and on vouchers for the less well off. The Australian government (where I'm writing from) has distributed vouchers, with some early signs of success.

    Hang on, isn't that Keynesian? Hush my mouth.

  • Comment number 51.

    Gordons boomerrangue pie in the sky is on its way back ,in that sense he is ahead of the curve.

    Soon he will only be able to say "thats another fine mess ive got myself into "

  • Comment number 52.

    Morning Stephanie,
    thank you for your Blog explaining how QE has started.
    I'm confused (easily), I cannot work out the purpose of this procedure. Is it to increase lending by the banks, is it to increase inflation, is it to make our debt easier to sell to foreign investors?
    Why only 2billion, (which was 5 times oversubscribed), isn't that a drop in this financial ocean? I have this awful feeling that nobody knows what will happen with this policy (unintended consequences and all that).
    Why is HMG pushing this idea?
    Why didn't HMG wait and see what happened to their previous stimulii or will they now admit that it has been a complete and utter failure?
    Money is being created at a frightening pace and is just disappearing with no accountability by anyone on what it was spent. I smell a rat here, someone is only giving the public (and you journalists) part of the facts.
    Isn't it the case that HMG still haven't understood that their previous financial regime is over and cannot be recreated ever?
    I note two conflicting stories today, one about motor manufacturer being bailed out and one about a building firm forced into administration by their bank (RBS) which is now owned by the Government. Who makes these decisions on our behalf and are they subsequently reported to Parliament?
    As an aside (but relevant), it is reported that China has now entered Deflation in Feb 2009 and they are scrambling to try and stimulate their local economy. Is that a bad thing for the rest of us?

  • Comment number 53.

    Ben Bernanke was on C-Span the other night explaining his version of the financial crisis and its causes. According to him, the problem resulted from an imbalance of trade where East Asians acquired a lot of cash which they saved and invested heavily in the West while in the West, the imbalance resulted in attracting investment from the East, "like water seeking its own level" as he put it. With all this investment, there were unregulated financial instruments by unregulated investment companies. That's when I turned him off unable to stand it any longer. So if there hadn't been a trade imbalance and the investments had come from domestic sources, that would have made a difference? Funny how these financial banker types always try to deflect the real blame from where it belongs, their friends...and themselves.

    Why shouldn't the Bank of England buy up the bonds of all the other bankrupt companies now that they've bought the bankrupt banks out lock stock and barrel? The government could own the entire country now that it is bankrupt proving Socialism doesn't work :-)

    On the chance that they just might buy out ever scrap of paper, I should think now would be a very good time to incorporate in Britain, issue tons of bonds, deposit the proceeds in a Swiss bank account after the BOE buys them all, and then declare bankrupcy....just like the rest of the companies in Britain did. Bernie Madoff step aside.

    If you're counting on the likes of Ben Bernanke to bail America out, don't hold your breath. I've been saying since this disaster broke wide open, that we are depending on the very same people to get us out of this impossible mess who created it and got us in it in the first place. How could we do worse than to listen to them again?

  • Comment number 54.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • Comment number 55.

    Scotbot #2: all money is funny.

    Money is just an indicator of value, a very human concept. Who or what determines value? The market? The government? The individual? All of them?

    Value changes depending on situation and circumstance. A diamond might have great value to some for its beauty but a parched desert traveller would happily swap it for a life-saving glass of water, surely?

    This is why words like "confidence", "sentiment" and "irrational" are thrown about. It was the very human emotion of greed that helped get us here in the first place, compounded by faulty human intuition in the matter of risk - clearly very few people understood well enough the mathematics of complex derivatives from sub-prime mortgages to be able to make a properly reasoned decision.

    The figures being talked about now are outside what we can really imagine anyway. I know I can't really comprehend $787 billion (the size of President Obama's stimulus package). Even when it is translated into distance it's pretty mind-blowing: stacked, that many dollar bills would girdle the earth more than 13 million times. How about $116,000 for every single man, woman and child on the planet?

    It's clear that absolutely no-one has any idea whether any of these measures, including quantitative easing, will or can work. We hope it does because we want to get back to a system that we sort of understand - we don't understand it, obviously, but we like to think we can.

    If it doesn't work, we're going to have to think of something else. Any ideas anyone?

  • Comment number 56.

    I know its all in a good cause but it seems to me that QE is yet another stealth tax:

    The uk plc cake is the same size today as yesterday but QE increased the money supply (shares in the cake). It follows that every share loses value except the ficticious ones created by the BOE. Its a neat way of transfering money from responsible solvent citizens to fund the greed and past mistakes of the few but without raising direct taxes.

    Make no mistake, we are all poorer with every throw of the QE dice

  • Comment number 57.

    The fait production of money has been a substantial cause of the current problems. It seems ironic that the BoE believes that to solve this problem you merely create more money and thus debase that currency further.

    If money is not a good then its quantity has no bearing on the wealth of a nation; it is merely a medium of exchange. This was well understood by the classical economists.

    There is absolutely no reason why an increase in he quantity of money should create more growth. Firms and businesses (such as the clapedout car industry) may benefit but this is at the expense of the rest of us who own money.

  • Comment number 58.

    #53 MarcusAureliusII

    Ben Bernanke seems to me to be doing similar to GB. It all feels like they are saying "there, there - there's nothing to be upset about - everything's going to be alright".

    And that is what truly scares me, because there is little evidence that things are going to be alright.

    In fact - and I am not and never have been a conspiracy theorist - but it sounds increasingly to me like they know for certain it's all going to go belly up, but have a need to make reassuring noises in the direction of the masses, because after all we wouldn't want all those ordinary people getting uptight and out of control.

    If there is no-one out there who can say anything that actually makes people feel a tad more confident about their financial futures, then we don't need, politicians, economists or financial theorists - we need prayers for Divine intervention of some sort.

    (Apologies to atheists).

  • Comment number 59.

    Spare a thought for me. I knew GB when he was a radical socialist and have corresponded at length in recent years with Alistair D. I've also met and he's not the brightest fireword in the sky. It is all much more scarier than you can possibly imagine dear bloggers.

  • Comment number 60.

    If the government, say, buy a million's worth of gilts from Joe Bloggs using printed money, then later sell the gilts on the open market then all they will have succeeded in doing is debasing the value of sterling.

    In fact it's worse than that, because they will end up having paid more for the gilts than they will be able to recoup when they sell them again.

    So in effect they have just given Joe Bloggs a nice present of the money he made by selling the gilts at a profit, at the tax -payers expense.

    It really makes no difference if it is the BOE or treasury buying or selling - it all comes back to the tax-payer in the end.

    So, in summary, the effect of QE is purely to debase the currency while at the same time giving free money away to those trading in gilts. Nice one Gordon.

  • Comment number 61.

    Yesterday, the FT refered to buying a Smythson handbag as investing in handbags.

    Well, I have seen Hermes bags at auction but I doubt that the seller got back their 'investment' though they might have got more dollars or pounds.

    They certainly wouldn't have got enough to buy a new Hermes bag at current market values - you'd have to trade down for a new bag. At least the seller might have got some use or value from the olde bag and a contribution to the new one.

    In this case, I cannot see what 'value' will be extracted from a bunch of paper sitting in the BOE's archives. I can see no mechanism whereby the dusty paper can increase in value over time before being resold.

    What I can't quite work out is how, over time, increases in interest rates might impact on the outcome.

  • Comment number 62.

    Stephanie,

    Well we certainly need your help towards deeper analysis and accountability in all this.

    The headline 'Ahead of the Curve' appears to be slightly misleading in that it implies that the Govt and BoE actions are ahead of the global game in restoring the previous status quo.

    Such a view might be taken if one looked at this 'part' and made a judgement about only that. Based on the 'whole' we get a different picture.
    however, looking at the 'parts' would give us

    'Brown and King lead the World in jumping into the abyss of unknowns henceforth called QE - others may or may not follow'.

    and that is all it gives us, no more and no less.

    Whereas if one looked or even glanced at the 'whole', then amongst a number of other disadvantages, it could be seen that the Pound is running at some 35% below last year, measured against other major currencies. Many are aware of the consequences of this.

    Yet this raises the question as to why are we alone in this 30%+ slump of the national currency ?
    The conclusion must surely be that other economies are better managed and better governed than ours.

    Meanwhile our financial press appear to think the 'whole', which includes the slumping Pound is unimportant, inconsequential and not worthy of comment.

    Now why would it be that our Economic Press would not discuss the 'whole' ?

    Could it be that by doing so it would be apparent that overall the Govt and BoE actions are simply disastrous for the previous wealth of the Country ?
    And on the wrong tack perhaps?

    Can I suggest a piece on

    'The Story so far...
    - where we were, where are we now, what the future looks like'

    many thanks

  • Comment number 63.

    It sad to see that all these so-called experts in the field - economists and commentators alike think QE is the silver bullet for all our woes.

    Stephanie Flanders gives the impression that QE is a win-win situation. One wonders why everyone isn't doing it!!

    Unfortunately, as usual; it is the wrong answer to the wrong question.

    The capitalist model needs a radical overhaul and there seems to be a dearth of people who dare to think outside the box.

    In the meantime my advise would be to lie low and try and ride out the storm.
    Things are going to get a lot worse and the pain will be continued to be felt by this and future generations to come.

  • Comment number 64.

    #55 re: How about $116,000 for every single man, woman and child on the planet?

    Forgive the typo pointing.. surely there's three zero's too many in your calculations - $116 per man, woman and child? The figures are crazy enough without further inflation.. On value, absolutely..

    what alternatives to this plan have any credibility? does anyone have a better solutions (if so I'm sure you'd get a fair price right now from a number of interested parties) or should we all be putting our energies into ensuring this plan works?






  • Comment number 65.

    Tuesday Treasury auctions 3bn of gilts to the marketplace

    Wednesday BofE buys 3bn of gilts from the marketplace by auction

    Why not just have the BofE print the money and give it straight to the Treasury?

    Looks to me like this is the only way that the treasury will be able to fulfil their spending committment so why try to hide it with this pantomime.

    Inflation here we come!

  • Comment number 66.

    #37 WerringtonSilent

    "...the last resort bar the truth..."


    Indeed.

  • Comment number 67.

    Make something out of nothing.
    Hand it to your friends who promise they will pay you back what you didn't have to start with.

    They make a profit out of the nothing you had to start with.
    They give you back the nothing you had to start with and possibly a bit more that they made from the nothing that was there to start with.

    Alice and her wonderland friends are happy.

    Pavlovomics !

  • Comment number 68.

    This is actually not complicated at all.

    The government is running a huge deficit and funding a big chunk of it by creating balances at the Bank of England, aka "printing money". If the objective is to avoid deflation, fine. But we should all understand that this is just a different way of getting us all to pay for the voracious funding appetite of the government. They can raise taxes, or they can reduce the value of all our savings, pensions etc by printing money.

    The root cause of this whole problem is excessive borrowing over many years, and the biggest culprit is the government itself. Led of course by Mr Prudence, Mr "I've abolished Tory boom and bust" Brown!

  • Comment number 69.

    Stephanie, I'm sorry to say that there is only ONE fundamental problem with doing ANY financial stimulus.

    The current foundation for pricing of ALL goods is not stable.

    I'm talking about Housing, Food and Fuel.

    If it was just a matter of credit and hey presto everyone can afford to live as before then there would be a chance.

    The government has allowed 600 billion pounds of foriegn money to be spent in the UK economy over the last 6 years or so. No surprises this caused asset inflation. FACT.

    The bubble has burst, people CANNOT afford to live when a house costs 8 times the national average wage. FACT.

    An average wage value which is decreasing day by day with less and less people able to buy anything. FACT.

    The route we are heading down is inflation, this will over time reduce the relative value of debt based to average incomes (When wages rise). While ensuring those who would have lost big time dont, no we ALL lose.

    Rather than tackle the actual fact that house prices have been the root cause and actually treating the cause - no we get a stimulus to reflate the problem.

    Say bye bye to your pension, to your savings and your standard of living.

    The sensible ones got out about a year ago - see the exchange rate ?

    The government had the option of just walking away from this asset bubble of debt by letting the banks fail. But now they have saddled all of us with the problem.

    There is NO excuse, the banks should have failed. The risk was theirs, not "ours". The excuse of turmoil and risk of systemic collapse is quite frankly ludicrous. All the government had to do was to buy the failed business and hey presto the infrastructure was "magically" restored. Savings could have been ring fenced - how ? because the government can do what ever it likes and here with more than just cause.

    Some sensible investigation into why the general public's jobs, pensions and savings are being put at risk rather than reducing house prices is well, well overdue.

    Of course, when inflation comes along they will just say it was the "only thing we could do" or "everyone else was doing it".

    Stop letting us down and start doing some reporting.

  • Comment number 70.

    It's strange watching politicians and pundits today pointing fingers and telling each other what should be done. This is like arguing which leaf of the barn double door to close first and where to go looking for the horse now that he's long gone. It's a little late for that. The damage was actually being done when these people had nothing to say. What is happening now is deciding where the consequences will be most heavily felt. There is no one group to blame. Even in a less than democratic system like Britain's, there are still checks and balances even if the voices doing the checking and balancing don't have the force of law behind them. Were was the loyal opposition and where were the economists and regulators when the store was being given away right under their noses? If you want to be in government, then it is your obligation to become expert at least to a degree on how the finances of government work, how the economy works, and government regulation of the economy is supposed to work to avert disaster. None of the political parties or regulators did that. They walked through their days wearing rose colored glasses and smiles either indifferent to or more likely unaware that the pillars that held up the economy were being eroded to the point where the entire edifice would collapse precipitously. Just go back to the nonsense they argued over a year or two ago. One big issue was the war in Iraq. A couple of hundred British soldiers died and while tragic it was no more than the number who would have died in a plane crash or two. And a lot of money was spent, but it was chump change compared to the bail outs and money thrown away by banks and other financial institutions and now being paid for by taxpayers. And then look at the other subjects of prominence. The real issue was being completely missed.

    So who should pay for the catastrophe? First of all, it can only get better at the margins at best until the US straightens out its own act. The myth that the US economy does not still drive the rest of the world's economies should be set aside as inconsistent with reality. Facing the fact that huge sums have been lost and belt tightening in all areas is a necessary consequence has to be faced. If the currency does not devalue, if they try to pay for it with taxes, then there will be a depression that will last indefinitely. If the currency is massively deflated, then banks, corporations, and foreign governments who own debt will get clobbered but that debt will be written down relatively quickly and the world will start moving again. The idea that you can print mountains of money now and then buy it back later to prevent inflation is naive. And the whole point is frankly to cause inflation which makes the debt look smaller when measured in cheap dollars. How much smaller does it need to look? How big a mountain is it? Everest? The conservatives who argue against the "monster" of inflation are only trying to protect what is left of their already nearly worthless assets. This is a true leveling of the playing field. Even billionaires are feeling the bite. And they ought to. They helped sharpen the fangs.

  • Comment number 71.

    Since it seems they are creating so much extra money, more than what would have been collected in tax revenue... any chance they could keep that extra money and give us all a 100% waiver on the next two years of taxes... much more efficient than this bail-out bubble they're creating.
    No income tax for two years... that would really change my mood.

  • Comment number 72.

    How about publishing an article on how the prudent savers have been kicked in the teeth and left to rot due the the greedy bankers, greedy borrowers and the Government looking to score more votes?

  • Comment number 73.

    #50 verymuchso wrote:

    "I thought the QE was supposed to be about freeing up liquidity for the banking system. What the Bank is doing now is not that, it's a direct monetary stimulus to demand."

    Where gilts are concerned, I agree. A bank holding a gilt may want all its cash back right now, rather than the coupon, but there is a very liquid secondary market for that. Bank of England purchases are not required, a pension fund would be happy to take it. So in this case we must conclude the banking system is just acting as intermediary for government sales of gilts to the Bank of England for printed cash. If the gilt portion of QE is indeed just government deficit financing by printing press dressed up to look respectable, I think even Keynes would turn in his grave.

    Where private debt is concerned, QE may still be about freeing up liquidity for the banking system, PROVIDED NO OTHER BID EXISTS, ie no liquid secondary market. However, I suspect private bids DO exist for a lot of the securities in question, but the banks do not want to accept them because they would have to recognise a loss which current accounting practices sadly allow them to leave unrecognised until a transaction takes place. Like a householder in negative equity and fashionable denial, they may hold an asset at a discount of their own choosing, but they are unwilling to accept a discount of the market's choosing. Enter the Bank of England and its QE machine to relieve them of their assets at close to par and transfer the losses to the taxpayer and anyone long sterling.

    The winners are the banks and beneficiaries of government largesse, at everyone else's expense. But then that is the whole point and has been from the beginning.

    #55 hughsorrill wrote:

    "If it doesn't work, we're going to have to think of something else. Any ideas anyone?"

    Full disclosure, if we can handle it. One Pandora's Box coming right up. Want to know who is really broke and who is not? Sure about that? I say bring it. We seem to have done everything else with reckless abandon and forced bravado, why not this too?

  • Comment number 74.

    Alas hughsorrill's statement that Mr Obama's $787billion financial rescue package would stretch 13 million times round the world if stacked in 1 dollar bills is a slight exageration.

    Assuming a $1 bill is around 1/100th inch thick I make the stack around 124,000 miles high. ie enough to go round the world about 5 times.

    However hughsorrill's point is perfectly valid - even at 5 times round the globe $787billion is an incomprehensibly large sum.

  • Comment number 75.

    @ 72
    true
    our accountant was on the phone this morning, a man who never ever swears, and he f'd and b'd
    about pensions, we have just had our pension statements in.
    all the money we put in last year in prudent safe pensions, is gone and the pot has devalued more.
    In order to perform or get back ontrack would require gargantuan increases which wont happen.

    we asked him what now, he jokingly replied, go and spend it all before it is worth nothing anyway.

    So this is the real issue facing most of us that have saved and spent within our means, we will lose no matter what, after the bang we will have a level playing field, but there will be the new batch of bankers and charlatans ready to take advantage then.

    look at all the property being bought by those with mega money ready to reap an income once sterling is finished, Im off to put my money into assets that will be worth something to someone when my pound wont buy anything.

  • Comment number 76.

    #73 "If the gilt portion of QE is indeed just government deficit financing by printing press dressed up to look respectable, I think even Keynes would turn in his grave."

    I can't see that it is anything but as you describe, unless the BoE is actually going to purchase even more gilts than the Govt needs in the current financial year.

    Indeed, at the moment, it looks to me overall like a degree of quantitative tightening, given the ballooning rate at which gilts are being issued.

    Perhaps I am misunderstanding the situation but it really does often seem as if the facts are the reverse of what we are being told.

  • Comment number 77.

    That's alright then because we can just print the money and give it to the IMF and then have as many fiscal packages as the US tells us we have to have.

    Money's no longer a problem for this country.

    Although aren't there rumours that the treasury have finally clamped down on any further spending by Gordon Brown?

    The rows won't just be at the G20 the biggest ones could be going on between number 10 and number 11 Downing Street

  • Comment number 78.

    hughsorrill wrote:

    Scotbot #2: all money is funny.

    Money is just an indicator of value, a very human concept. Who or what determines value?



    I understand that, but this money just happens to be funnier that most.
  • Comment number 79.

    Ahead of the curve = Down the pan!!!!

  • Comment number 80.

    "If and when gilt prices fall again, the Bank of England may have to sell them at a loss. But that loss is the mirror image of the earlier gain. You never know, we might even come out ahead. And we'd no longer be in a recession. It's a little Alice in Wonderland perhaps, but that's the nature of QE."

    I have enjoyed your posts Stephanie but this last section is utter rubbish. It is not a mirror image at all. In the time between transactions much can happen and we have chosen to do the following.

    a. Buy long dated gilts
    b. Buy at a market high.

    These make a loss much more likely particularly if the policy works.....

  • Comment number 81.

    No. 79. John_from_Hendon wrote:
    "Ahead of the curve = Down the pan!!!!"

    I like your idea of the curve being the U-Bend on a lavatory.

    By that measure we are truly well ahead...


  • Comment number 82.

    Are the questions from journalists pre-submitted, with the answers being drafted by technical advisors and merely delivered by the spokesperson? I find it hard to believe that anyone in positions which can so dramatically influence the markets do say anything which is likely to affect the markets.

 

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