Wednesday, February 18, 2009

Possible snag

BoE steps nearer 'quantitative easing'

The BoE is about to embark on a massive buy-back of government debt, gilts. This is a buy-back so of course they are not funding current expenditure (!). Anyway, my snag is this. I posted a while ago that nobody would be mad enough to buy low yield gilts in a declining country when they could put their money outside (as all gilts have lost considerable value against the euro, dollar, yen etc), and that the only buyers -must- be UK pension funds who are forced to hold gilts by government legislation. However, if the pension funds are legally obliged to hold gilts then how will they be able to sell them to the BoE ?!? ...continued in comment...

Posted by stillthinking @ 06:25 PM (2540 views)
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23 thoughts on “Possible snag

  • mountain goat says:

    Sorry in advance because this is near dinner time. But am I the only one who thinks of the BoE buying its own gov Gilts is like a person who drinks his own urine? Its liquidity but doesn’t quench the thirst!

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  • stillthinking says:

    So must be that the only market available to the BoE are those holding gilts without a statutory requirement to hold them. OK. So sterling has collapsed already. Time to go has already passed. Also everybody is fully aware that deflation is on it’s way which has driven the yields down. Also remember that when gilts mature they give back the issuance value. This is the link to the BBC gilts page,

    You can see that yields are very low in the short term.

    Basically, it seems to me that if you want to buy something in a competitive environment you must offer more than the next guy. However, and this is my point, there is no -more- in this context. The price of short term gilts is already extremely close to issuance value!

    Further, like Brown’s pre-announcement of the gold sale driving down the price of gold, the BoE has pre-announced an intention to buy gilts !! This means the price will move up and up until the yield is zero. In fact, this is part of the announcement, ” we will drive yields to zero”.

    Finally my point… 🙂 When the yield is driven to zero, the BoE cannot buy any more gilts. Pension funds can’t sell, and there is no profit in selling for anybody else. In which case to pursue the path of “quantatitive easing” the BoE will have to offer a higher price than the nominal amount at zero yields.

    Basically this is the same as the BoE buying 100 pounds for 120 pounds, because thats the same thing ! So ultimately the snag with free money is that somebody else always gets it….

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  • stillthinking says:

    D*mn, stupid html, the text has changed colour instead of representing my fury with bold type. Also the link to the gilts page is gone. oops.

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  • mountain goat says:
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  • stillthinking:

    That’s why real men don’t use html

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  • mountain goat – how are the gilts the BoE’s? They were issued by the treasury and belong to whoever holds them. In QE the BoE buys the securities (yes, most likely gilts) and credits the institutions account (at the central bank) with newly created money.

    If [that is IF] they then tear up the gilts then they have effectively created even more capital since they have effectively reduced the treasuries existing debts.

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  • It’s in effect early redemption of however much of that issue the treasury purchases. But if it is planning to issue more, will there be any net effect on yields?

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  • mountain goat says:

    51ck-6-51x – I suppose my mental image emerged because I don’t see the BoE and the Treasury as completely independent institutions. Do you regard them as independent institutions?

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  • letthemfall – it’s only early redemption if the holder gives the securities to the treasury – they are being sold to the BoE. Am I missing something here?

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  • mountaingoat – Ahhh I see where you are coming from. Well they are legally separate entities so I do consider them as such, and any gift from one to the other would be questionable, although I suppose it could happen!

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  • mark wadsworth says:

    @ Mountain Goat, exactly. You have hit the nail on the head. Drinking your own urine, pulling yourself up by your own bootstraps.

    To all intents and purposes, the government, the BoE, the Treasury, the Royal Mint and that place where they print bank notes ARE THE SAME THING (how about that for a bit of non-HTML boldening??).

    A bank note is a government backed security, just like a three month Treasury or a ten year gilt (only a bank note is not interest bearing and small denomination). If you take your treasuries to be redeemed when they fall due, the government could redeem them with £50 notes. You just swap one piece of paper for another.

    You could argue that a bank note is not redeemable – of course it is in practice, as you can use it to pay off your income tax or council tax, so when the government gets tax revenue, it would be simultaneously cancelling a receivable (your tax) and a liability (the bank note).

    So 666’s example of the BoE tearing up gilts is nonsense – instead of holding a bit of paper saying “The government will pay you £50,000 in ten years’ time” I’ve now got a thousand £50 notes which I can use to pay my tax bill or buy other gilts. If it were possible to wipe out government debts this way, surely they’d do it? The only way to wipe out government debts is high inflation, and that only works if they can keep interest rates lower than inflation (unlikely but possible). Somebody posted a Martin Wolf article yesterday on Japan’s experience with QE, give it a quick read if you want to know what will happen (short summary = nothing).

    Hope that’s cleared things up. Ultimately QE is printing money, it’s just Emperor’s New Clothes-style printing money.

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  • stillthinking says:

    my humbly made point is there is no window for qe via gilts because they will run up against zero yield and freeze the market. As an side, I don’t draw any distinction between government/BoE/treasury/etc. Possibly there is some advantage in driving the cost of borrowing for the government down. But if gilts are out, and deflation is to be avoided, then what is left? And why mention gilts in the first place?
    They could buy foreign currencies. I can’t see that going well in europe.
    They could buy dodgy bank assets, making a loss and complaints all round from the taxpayer.
    They could start infrastructure development, but takes too long and not sustainable.

    They could could avoid matching taxes to outgoings and use the printed money for current expenditure. Exactly the same as Zimbabwe and precisely what we are all assured is not the case. Or in other words limit their gilt purchases to new issuance. In fact what you said Mark.

    So in short, the long established BoE is not printing money to provide “liquidity” and “encourage lending”, Gordon Mugabe Brown has instead made the move to fund current expenditure with printed money hoping presumably that the economy will recover by itself, and nobody will notice during deflation.

    Thank you mg for restoring black.

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  • 51ck

    Sorry, yes, the BoE, I misread the headline. Although if the govt is going to issue more gilts I still wonder what will happen to yields. And the pound. I suppose that may depend on who else QEs.

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  • But could the BoE just destroy the gilts? A sort of indirect default by the govt.

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  • What does someone with cash in UK banks do now, please?

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  • wiltshire:
    Good question. There are not really that many options. Sit tight is probably the best. Unless you know some clever wheezes.

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  • Wilshire @ 15….. that’s the Big question now……. investing in housing perhaps…. :O(

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  • letthemfall – sure why not – If I lend you a tenner and you write me an IOU, can I not tear it up?

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  • wilshire – If you strongly believe there will be inflation you want assets (as bluebeach said, housing, well maybe choose a better asset class such as wheat, sugar, or some other necessity) or even debt (since inflation erodes that); if, however, you believe there will be deflation you want liabilities (such as the cash in your bank account).

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  • 51ck

    You certainly can. I just wonder what would be the implications for a govt if its central bank did it. A default by another name?

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  • 666 @ 19… that’s the way I’m thinking at the moment…..but which way will it go?… perhaps stick with cash until inflation kicks in… but will there then be a rush for assets later?!?

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  • 666 @ 19… that’s the way I’m thinking at the moment…..but which way will it go?… perhaps stick with cash until inflation kicks in… but will there then be a rush for assets later?!?

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  • bluebeach –

    I am with you there – same boat, but I’m not all that worried about profiting from the situation, just keeping healthy is fine by me!

    To be honest I think we are going to see a dip into worse deflation before we hit inflation.
    (yes I believe we are just about deflating right now, but not much – and the effects on you depend if you drive or own a mortgage [for me neither, so it does not feel like deflation to me])

    All the possible causes – low rates, fiscal stimuli, and capital creation have or are soon to happen, but they take time to feed through, and the fear that grips the capital markets should IMO add extra inertia to the situation.

    The powers that be are desperately laying down fire blankets to stem the start of a deflationary spiral, yet business & consumer confidence are low, and in the end it is consumption that drives the economy.

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