Sunday, November 8, 2009

Sinking into ever more debt

Even more uncomfortable truth

The recent bail out of RBS to the tune of £25.5 bn went barely noticed. Last year it would have been massive news. There was additional QE, of £25, announced that "covered" that news and QE is not seen as government debt. However like a share split QE dilutes the national wealth. We, as the nation, seem to have got used to sinking into ever more massive debt. Pytel’s predictions appear to materialise. Although we all, I guess, wish that he is wrong. (Note the comment of Stephen Herring, Senior Tax Partner at BDO, below the article.)

Posted by ant @ 10:09 AM (1292 views)
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10 thoughts on “Sinking into ever more debt

  • stillthinking says:

    When I was reading this, I read through the other stuff he posted, and one thing struck me. For all the talk of BoE QE being electronically created money, as in, “ho ho ignorant mortal they don’t literally print the money they adjust electronic balances”, in our case, the problem is an underlying lack of treasury notes, so QE must be actually really literally be printing cash, or adjusting values in the financial system that are truly backed in cash. Gilts for example are a proxy for cash, and if the BoE is buying them they must be buying them with cash. What other financial asset can they use?

    So if the BoE isn’t printing cash “yet”, there is a very thin line between current activities and true printing obligations. But if you look at Debden Security Printers (UK money printers), or their parent company De La Rue, there isn’t any news at all.

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  • The printing/electronic issue is quite interesting and cannot be down to merely how one looks at things. It seems to me that QE is not about creating money so much as extending credit lines, principally (at least this is the idea) to business, via BoE gilt purchases from banks. This money, again in theory, goes to producing future wealth and not into immediate consumption. Hence it is not “printing money” in the Bernanke helicopter sense because, regardless of whatever current expenditure it may induce, the future growth outweighs it.

    If, on the other hand, the Govt were to, say, cut the basic rate of tax by 50%, this would immediately put plenty of extra cash into people’s pockets. Then, if the fiscal deficit were made up by creating extra money (to pay for Govt expenditure), this would genuninely be printing, not just because the extra cash would go to net consumption (assuming it wasn’t all used to pay off debts) but because new notes would be produced to provide enough circulating cash to accommodate the extra money supply.

    This is no doubt putting it far too simply – includes no notion of capacity, for example. Any thoughts?

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  • So “money printing” is just adjusting electronic balances, and actual money printing of physical notes merely serves as a means of making those electronic balances accessible to the public ie physical printing says”we shall now include the public in our equation.”

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  • @ant

    “The recent bail out of RBS to the tune of £25.5 bn went barely noticed.”

    I think we’re becoming inured to reports of £1,000,000,000s of pounds of our money being given to failures. I know I am and I ask myself what can I do about it? Revolutionary violence is not my thing and the state is better prepared than ever for dealing with troublemakers.

    The only answer I can come up with is to avoid using the big banks and take more control over my finances.

    The odds of “prosecutions (including wealth confiscation) of all those responsible” seem rather low, unfortunately.

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  • I think Stephen Herring’s comments are a bit fishy.

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  • A coordinated ‘run’ on a “too big to fail” bank will bring the system down.

    But at what cost?

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  • You’ve been stitched up like a kipper, mr g.

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  • 2. letthemfall said…QE is not about creating money so much as extending credit lines…it is not “printing money” in the Bernanke helicopter sense because, … the future growth outweighs it.

    I can see what you are saying ltf, but isn’t this akin to somebody who earns 15,000 a year but owes 250,000 (and who is therefore in deep financial trouble) being leant another half a million in the hope that – although he has proven to be a bad risk in the past – he might somehow magically transform himself into a good credit risk and repay all the money plus interest?

    And on the basis that financials are not productive for the economy your assertion that QE is not money printing in the helicopter sense, while true, suggests that in this particular instance it is exactly that. And also likely to lead to worse problems in the future in addition to hyperinflation.

    Every time they print money, I keep thinking about buying gold.

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  • inbreda
    Well, yes, that may well be true – banks are hardly showing themselves to be chastened, and determined to show their new financial responsibility. At present the QE certainly appears to be causing asset inflation.

    I see this morning that inflation expectations are on the up – linkers’ spreads widening.

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  • As always, it’s pretty complex.

    The vast majority of money that is used is electronic. The “Analysis of bank and building society deposits from and lending to UK residents” from the Bank of England, http://www.bankofengland.co.uk/statistics/abl/current/index.htm, shows £2,308 billion recorded as deposits, and £2,503 billion lent out. Actual physical notes and coins only come to £55 billion (http://www.bankofengland.co.uk/statistics/fnc/current/index.htm). That means that the amount of money in existence, on the books, is around 40 to 50 times as much as the actual amount of paper and coin out there. Therefore, printing more notes and stamping more coins has very little effect. There only need be enough paper and metal to ensure that cash payments can be made, and banks don’t want to hold more than necessary as it would just build up as a stockpile. As electronic payments, through direct transfer and through debit and credit cards, have increased, the amount of cash relative to the economy is reducing.

    When you make a deposit, even if in coins, the bank does not hold that actual coinage for you. They record that you have made the deposit, then, to earn interest on that money, they loan it back out to someone else. (In practice, the coins go back into general circulation.) When they loan it out, it’s typically deposited by the loanee, and loaned out again by the bank that receives that deposit. Looking at a few cycles, you’ll see a problem. Let’s say Andy deposits £1, and the bank loans that £1 out to Bill, who deposits it, and it’s loaned to Charlie, who deposits it, then Dave borrows £1, and deposits it:

    Andy: £1 saved
    Bill: £1 saved, £1 borrowed
    Charlie: £1 saved, £1 borrowed
    Dave: £1 saved, £1 borrowed

    Total, £4 owed by the banks to our small population, £3 owed by the population to the banks, from £1 to start with. You can see that the bank has created £3 of money that never existed. Banks now create the vast majority of all money.

    Getting back to inflation, a definition. Inflation is an increase in prices caused by an excess of money. It follows from the general supply and demand hypothesis, that the price of something will rise if there is more demand than supply, and fall if there is greater supply than demand. With an excess of money, there is greater supply than demand, so the ‘price’ of money, in terms of what it can buy, falls – in other words the price of everything rises. Similarly, with insufficient money, the ‘price’ of money rises, causing prices to fall – deflation. The aim for monetary authorities is to try to closely match supply of money with demand for money. They prefer inflation to deflation so aim for a small amount of inflation, but they’re basically trying to steer a stampede of horses with a very thin piece of string.

    If creating a loan creates money, paying back a loan destroys money. In the current situation, a lot of (electronic) money is being destroyed. Quantitative Easing is creating a bunch of new (electronic) money to compensate for this massive destruction. Unfortunately, QE is putting this money in the wrong hands: it’s going into financial markets, which are in rude health (and still borrowing), and not into the hands of companies who need credit facilities to make payroll and invest in capital equipment. As a result commodity prices are rising (due to the financialisation of commodity futures markets) and share prices are also rising, but the actual productive parts of the economy are crashing.

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