Chartalism By The Back Door?

[Traktion]

With the BoE buying gilts, rather than the private sector, and the BoE aiming to hold half of all gilts in total, are we dabbling with Chartalism?

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

Considering that the BoE can provide the money interest free, it will be cheaper for the taxpayer. As money is essentially created the same way in the private sector, with a private bank extending credit from "thin air" in exchange for the gilts, the only difference is that there is no interest (yield) to pay.

As gilts are considered risk free (ie. as good as cash) according to the Basel Accords, the private sector should always pay for the gilts unless they can get better investments elsewhere in the economy. With the BoE setting the base rate so low, this will be causing private banks to look elsewhere for more juicy investments, so the BoE buying the gilts instead makes a certain amount of sense.

If the interest from the government debt is removed, with the money being used to slowly pay off the debt instead, that is £30bn+ a year saved, which could be used to chip away at the national debt. As long as the debt isn't just written off (which is again Maastricht Treaty, I believe), then nothing has changed. Inflation will remain at the same level, whether the money is created by the BoE or the private sector, as the deficit will be the same size. In turn, this will have the same effect of increasing narrow money, until the deficit is repaid.

Sure, the government needs to keep the same attitude towards the national debt, or inflation will get out of control, but the cost savings are obvious. In addition, the power to borrow cannot be dictated by the private bankers/institutions.

I think we also need our governments to balance the budget for stability, but if we are going to borrow, why not do so from the BoE, as Chartalist theory allows?

Edited September 5, 2009 by Traktion

[Authoritarian]

Good post.

As gilts are considered risk free (ie. as good as cash) according to the Basel Accords, the private sector should always pay for the gilts unless they can get better investments elsewhere in the economy. With the BoE setting the base rate so low, this will be causing private banks to look elsewhere for more juicy investments, so the BoE buying the gilts instead makes a certain amount of sense.

I may has misunderstood you but AFAIK there's no relation between the official base rate which is the overnight lending rate and the price of gilts, which is sold on behalf of the Treasury by the Debt Management Office with the price being set by supply and demand.

With both the government and the private banks being strapped for cash this must be causing some interesting dilemma's. I.e BofE gives money to the private banks in exchange for crappy assets the banks then want higher gilt rates from the Treasury to offset all their loses from the years of crappy lending but the government aren't keen on paying these rates due to their own financial predicament. As the BofE can't lend directly to the Treasury I would expect plenty of tension between the various powers in high finance at the mo.

Edited September 5, 2009 by chefdave

[OnlyMe]

The inflation ALREADY created is the problem.

It has destroyed many industries, removed the competitive nature of business and removed the ability of personnel to live and function in those business areas competitively.

Keeping this inflation in place will further undermine the competitive nature of the economy and further worsen the trade deficit and ability of companies to work out of the UK in the world market.

Propping the POS on a stick is going to do no good.

[Traktion]

Good post.

I may has misunderstood you but AFAIK there's no relation between the official base rate which is the overnight lending rate and the price of gilts, which is sold on behalf of the Treasury by the Debt Management Office with the price being set by supply and demand.

With both the government and the private banks being strapped for cash this must be causing some interesting dilemma's. I.e BofE gives money to the private banks in exchange for crappy assets the banks then want higher gilt rates from the Treasury to offset all their loses from the years of crappy lending but the government aren't keen on paying these rates due to their own financial predicament. As the BofE can't lend directly to the Treasury I would expect plenty of tension between the various powers in high finance at the mo.

I think the rates have to be similar or the banks would rather borrow on the overnight rate and lend it out. I'm not sure of the dynamic (I need to think about it some more!), but if they gilt offers 3% and the overnight borrowing rate is 0.5%, maybe they could borrow at 0.5% from the BoE and then buy treasuries yielding 3% causing some sort of feedback loop? I'm sure they are linked in some way... maybe someone else knows more?

With the rate so low, maybe the banks would rather borrow at the over night rate, then loan it out to the private sector? In fact, I think this is one of the reasons why the BoE wants the gilt yield low - banks are encouraged to make loans, to stimulate the economy (rather than buy gilts).

I've had a few drinks, so the brain is a little addled, but the above makes some sense.

The inflation ALREADY created is the problem.

It has destroyed many industries, removed the competitive nature of business and removed the ability of personnel to live and function in those business areas competitively.

Keeping this inflation in place will further undermine the competitive nature of the economy and further worsen the trade deficit and ability of companies to work out of the UK in the world market.

Propping the POS on a stick is going to do no good.

Yes, exactly - property/land prices have inflated to the point that businesses have trouble operating at a profit here, in the global market place.

I think a certain amount of deflation would be very healthy for the economy, which is suffocating with the high costs. However, going back to 70s prices in a total deflationary collapse would also cause a lot of instability too, with businesses failing due to high (inflated) loan costs. The best path seems to be a controlled deflation, over a few years. Giving the banks a helping hand is probably part of this process, but it would be counter productive to help them too much, as then prices will stagnate and business will struggle for years. There has to be a careful balance between encouraging new business, without destroying existing ones.

Of course, any deflation may lead to banks coming under pressure and I think they shouldn't try to do anything to save the banks. Their prerogative should be too help non-financial businesses, not the banks... those banks who can't deflate easily should go to the wall.

[Traktion]

BTW, I found this interesting document: http://www.ucm.es/info/ec/ecocri/cas/Febrero.pdf

[Authoritarian]

I think the rates have to be similar or the banks would rather borrow on the overnight rate and lend it out. I'm not sure of the dynamic (I need to think about it some more!), but if they gilt offers 3% and the overnight borrowing rate is 0.5%, maybe they could borrow at 0.5% from the BoE and then buy treasuries yielding 3% causing some sort of feedback loop? I'm sure they are linked in some way... maybe someone else knows more?

With the rate so low, maybe the banks would rather borrow at the over night rate, then loan it out to the private sector? In fact, I think this is one of the reasons why the BoE wants the gilt yield low - banks are encouraged to make loans, to stimulate the economy (rather than buy gilts).

I've had a few drinks, so the brain is a little addled, but the above makes some sense.

There are limits to overnight lending, I'm saying this because otherwise the BofE wouldn't have opened up the Special liquidity Scheme.

As for the BofE and the price of Gilts I don't think that there's any relation, does the BofE want the gilt yield low? Why would this be their concern when they're only responsible for monetary policy, Gilts are the governments problem. Gilts as a rule are always cheaper than coroporate bonds because apparently the risk is lower, but with the government wanting so much funding this can only help to push the price of yields up - which then pushes up the costs of borrowing for all the other sectors of the economy too.

[porca misèria]

If the interest from the government debt is removed,

... then where does the money for all those annuities come from?

[1929crash]

With the BoE buying gilts, rather than the private sector, and the BoE aiming to hold half of all gilts in total, are we dabbling with Chartalism?

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

Considering that the BoE can provide the money interest free, it will be cheaper for the taxpayer. As money is essentially created the same way in the private sector, with a private bank extending credit from "thin air" in exchange for the gilts, the only difference is that there is no interest (yield) to pay.

As gilts are considered risk free (ie. as good as cash) according to the Basel Accords, the private sector should always pay for the gilts unless they can get better investments elsewhere in the economy. With the BoE setting the base rate so low, this will be causing private banks to look elsewhere for more juicy investments, so the BoE buying the gilts instead makes a certain amount of sense.

If the interest from the government debt is removed, with the money being used to slowly pay off the debt instead, that is £30bn+ a year saved, which could be used to chip away at the national debt. As long as the debt isn't just written off (which is again Maastricht Treaty, I believe), then nothing has changed. Inflation will remain at the same level, whether the money is created by the BoE or the private sector, as the deficit will be the same size. In turn, this will have the same effect of increasing narrow money, until the deficit is repaid.

Sure, the government needs to keep the same attitude towards the national debt, or inflation will get out of control, but the cost savings are obvious. In addition, the power to borrow cannot be dictated by the private bankers/institutions.

I think we also need our governments to balance the budget for stability, but if we are going to borrow, why not do so from the BoE, as Chartalist theory allows?

I had bever heard of chartalism before, so thanks for your post.

It alwasy seemd to me that a more sensible course than bailing out HBOS etc would have been to give everyone and every business their own account at the BOE which could then have been credited with copious quantities of money. Is this what you're arguing?

[The Spaniard]

... then where does the money for all those annuities come from?

Corporate bonds?

[grumpy-old-man-returns]

I had bever heard of chartalism before, so thanks for your post.

me neither.

G20 is pivotol point anyway now.....let's see which way we are really going to go.

[Bloo Loo]

Great post Traktion.

EDIT: I noted this....Bill Still should read. Banks do not create net money, nor do they create net liabilities.

Chartalism states that money is created on a net basis by government deficit spending. Private banks can create money through lending against assets. However, banks do not create net money as each loan creates a liability held against an asset.

shame the "asset" gets its value from prior loans. Banks never created means of exchange...thats the governments job via the central bank.

if banks dont create assets or liabilities....then what use are they?

[Traktion]

... then where does the money for all those annuities come from?

Corporate bonds?

Yes, exactly. Relying on government debt to fund your retirement seems a pretty odd concept to start with, no?

[Traktion]

Great post Traktion.

EDIT: I noted this....Bill Still should read. Banks do not create net money, nor do they create net liabilities.

Chartalism states that money is created on a net basis by government deficit spending. Private banks can create money through lending against assets. However, banks do not create net money as each loan creates a liability held against an asset.

shame the "asset" gets its value from prior loans. Banks never created means of exchange...thats the governments job via the central bank.

if banks dont create assets or liabilities....then what use are they?

in theory, stimulating investment. In practice stealing from the future.

Yes - I think what causes the business cycle was just outlined above. If you steal from the future, investing in bubbles (boom), there will be less money in the future, which causes recession (bust).

[Traktion]

I had bever heard of chartalism before, so thanks for your post.

It alwasy seemd to me that a more sensible course than bailing out HBOS etc would have been to give everyone and every business their own account at the BOE which could then have been credited with copious quantities of money. Is this what you're arguing?

me neither.

G20 is pivotol point anyway now.....let's see which way we are really going to go.

It was new to me too, until Mr B'Stard linked it in one of the monetary reform threads. It pretty much suggests that money is created in a way that a few of us were discussing. It certainly seems to make a lot more sense than the current system to me.

1929crash, no that isn't want I was suggesting, as that is more about fiscal spending than monetary reform. This is just the streamlining of government borrowing to come from the BoE, rather than the private sector, saving the tax payer money on government borrowing.

[AvidFan]

Aren't Chartalism and Monetarism just extensions of loose and tight monetary policy respectively, called into service when the money supply or money transmission mechanism is not functioning as central bankers expect it to?

[Traktion]

Aren't Chartalism and Monetarism just extensions of loose and tight monetary policy respectively, called into service when the money supply or money transmission mechanism is not functioning as central bankers expect it to?

From what I have read, chartalism can be a permanent alternative.

[porca misèria]

Yes, exactly. Relying on government debt to fund your retirement seems a pretty odd concept to start with, no?

Nevertheless, the range of securities that can back annuity payments is very constrained - by law. How many corporate bonds have acceptable credit ratings?

Or am I talking **** here?

[Traktion]

Nevertheless, the range of securities that can back annuity payments is very constrained - by law. How many corporate bonds have acceptable credit ratings?

Or am I talking **** here?

I don't know much about pensions, but the idea of relying on gilts seems rather strange and flawed. Why shouldn't corporate bonds be used instead? On the face of it, it seems more logical and sustainable.

[Traktion]

I found a great article from a bit of accidental googling to backup my initial assertion that private banks can fund unlimited government debt already, which paves the way for the BoE doing it interest free.

On top of this, we also have a problem in the way that the reserve requirements are calculated. Instead of the flat rate of 8% being applied evenly, meaning for every loan, there must be an 8% reserve, Basel I added a system of weighting to different types of lending, such that only certain kinds of loans required the full 8%. This makes the 8% figure entirely notional.

Examples of the weightings can be found below:

* Sovereign debt held in domestic currency, all OECD debt, and all claims on OECD governments - 0%

* Bank debt created by banks within the OECD, loans guaranteed by OECD governments, Short term non-OECD bank debt - 20%

* Residential mortgages - 50%

* Most other loans - 100%

What we have here is a situation in which the amount that needs to be held in reserve has changed to a variable amount, and that does mean a change in the money supply. In particular, as banks alter the shape of their portfolio, it is possible that the amount of money that is really available outside of the banking system will actually change. Furthermore, under these rules, we have a system in which it is possible to lend to governments with no need to hold reserves. They are given no risk whatsover. If we think back to the history of banking, going back to the medieval period, we had a situation in which governments would grant banking privelages in exchange for preferential terms. It all looks painfully familiar.....

Above all else, it is possible for banks to lend to government with no reserves whatsoever. This means that, in principle, a bank can loan to their government without any deposits whatsoever. This is blatant encouragement to lend to the government and it might be considered that it is no coincidence that the debt of many OECD governments continue to grow at a shocking pace. You may be unsuprised to find that the provision of this facility was not changed in Basel II, though the mechanism has changed...

http://cynicuseconomicus.blogspot.com/2009...ng-problem.html (it's a great read in general too)

In a hypothetical world, a bank which only bought sovereign debt, would need no reserves with which to extend credit to the government from. With this in mind, a bank could extend credit to buy an infinite number of gilts, while still remaining solvent. Essentially, the bank could create as much money as the government requested through gilt auctions and still remain solvent.

All of which begs the question - why would we ever have a gilt auction strike these days? While ever the yield is high enough to offset inflation (or index linked are available), the banks would surely be lining up for gilts, especially in a period of credit deflation.

Further more, if the private banks can create an infinite amount of credit for gilts, why not just let the BoE do it and save some interest payments?

Edited September 14, 2009 by Traktion

[huw]

I think a certain amount of deflation would be very healthy for the economy, which is suffocating with the high costs. However, going back to 70s prices in a total deflationary collapse would also cause a lot of instability too, with businesses failing due to high (inflated) loan costs.

Depends how it's managed: sky-rocketing loan costs just mean that debtors lose their assets to creditors, it doesn't mean the assets (such as viable businesses) are necessarily destroyed.

Thanks for the OP in any case, like others I'd not heard of the term "chartalism".

[huw]

In a hypothetical world, a bank which only bought sovereign debt, would need no reserves with which to extend credit to the government from. With this in mind, a bank could extend credit to buy an infinite number of gilts, while still remaining solvent. Essentially, the bank could create as much money as the government requested through gilt auctions and still remain solvent.

But wasn't the Reichsbank/Weimar Treasury living in precisely this hypothetical world?

iirc this is precisely the model they used.

[Traktion]

Depends how it's managed: sky-rocketing loan costs just mean that debtors lose their assets to creditors, it doesn't mean the assets (such as viable businesses) are necessarily destroyed.

Thanks for the OP in any case, like others I'd not heard of the term "chartalism".

Sure, any infrastructure would still exist, but there would be a chaotic unravelling if not managed well. Clearing out the heavily indebted and non-profitable companies is a good thing in the long run anyway. I just wonder if a degree of deflation and a degree of debasement to help prevent a chaotic free fall is a better path?

Glad you and the others liked the OP - I find this stuff fascinating.

[huw]

Sure, any infrastructure would still exist, but there would be a chaotic unravelling if not managed well. Clearing out the heavily indebted and non-profitable companies is a good thing in the long run anyway. I just wonder if a degree of deflation and a degree of debasement to help prevent a chaotic free fall is a better path?

That's the million dollar question.

Or perhaps the one-penny question.

It just depends...

[Traktion]

But wasn't the Reichsbank/Weimar Treasury living in precisely this hypothetical world?

iirc this is precisely the model they used.

Then we should probably be very afraid, unless the government starts showing some self control!

I am amazed that this hasn't been picked up on by commentators already. There is lots of noise about the BoE buying gilts from "thin air", but in reality this has been going on for years in the private banking sector anyway!

On the positive side, if they do manage to cut spending, shrink the deficit and start to manage the deflation, it would give substance to the idea that governments can be trusted to manage the money supply. Time will tell...

P.S. I do think that the government wants perpetual, low, inflation anyway though, to keep us all running to keep up. All hail growth!

[huw]

Then we should probably be very afraid, unless the government starts showing some self control!

I am amazed that this hasn't been picked up on by commentators already. There is lots of noise about the BoE buying gilts from "thin air", but in reality this has been going on for years in the private banking sector anyway!

I think the sole difference with QE is that the intention is to withdraw it.

But yes, self-control would be essential if chartalism were routinely used for money creation. There would still be market discipline in the form of the exchange rate, of course.