Quantitative Easing, what it is and why it’s not working

Sunday, 7 February 2010

Simon Hinds, WritePublicity Ltd., simongah@blueyonder.co.uk
Will £220bn worth of Quantitative Easing (QE) stimulate growth in the UK economy
?
The Bank of England would like to stimulate the economy, but I don’t believe tha
t is QE’s real purpose. What it was meant to do was to cover a UK debt hole that
most people don’t understand but could push the economy into depression.
The Bank of England has ended QE, at least for the time being. The total amount
it ‘pumped into the economy’ represents around 15% of the value of UK production
or GDP. It has done this with interest rates at 0.5% and a recently announced U
K production (GDP) increase of 0.1%.
Yet, 0.1% doesn’t sound much and there is a good reason that it differs from the
theory.
What you’re told
The theory is that the Bank of England flicks a switch and creates money. The Ba
nk uses this money to buy bonds from investment and high street banks as well as
large companies and therefore deposit money into their coffers. Bonds are contr
acts to pay back a certain amount of borrowed money plus interest.
More money in banks and low interest rates, means that bank managers can lend ou
t more money to businesses, particularly small businesses. But QE is risky. Too
much of it leads to inflation in the medium term and it may also put off global
financiers buying UK government bonds or gilts.
The UK, though, has a good name when it comes to paying debt. Credit rating agen
cies tell global financial markets of the risks of not getting back money loaned
to nations. The UK has a Triple A rating. Its bonds are called gilts because of
this. The financial markets think the idea of the UK settling its debt is unthi
nkable.
Furthermore, the Bank of England can say there are indications that QE’s working
. They also recently announced that provisional November 2009 figures show that
net lending by all UK-resident banks and building societies to businesses was £0
.1 billion. Meanwhile, there has been a more than expected jump in manufacturing
output from December 2009 to January 2010 and QE has, as planned, helped firms
buy more shares.
Yet, the lending numbers is a net figure and incorporates money businesses paid
back to banks and building societies. Indeed, the Bank says that some business b
orrowed money from capital markets in order to pay off their bank debt. Meanwhil
e, the Bank admits that lending over the year remains subdued. As for the manufa
cturing increase, it has been small.
This should not be a surprise. Most of the QE money has not been spent on banks
but rather government gilts. By the end of September 2009, out of £154bn spend o
n QE, £152bn was spent on gilts. Therefore, QE as of yet has not been the succes
s it should have been. So, what is really going on?
What you’re not told
QE is part of the mysterious process of money creation and the purpose that I su
spect it fulfilled is connected to this and to the value of UK sterling.
Money creation is about the money people and organisations spend, have in bank a
ccounts, invest and save. Most of a nation’s money is created by its central ban
k. The government gives certain commercial or investment banks bonds and gilts.
These banks then hands over money to the central bank. The central bank can then
buy more bonds from other banks. The money supply is then swelled. This is why
pound notes are certified by the Bank of England rather than the UK Treasury.
But most central banks are owned by commercial institutions or by private indivi
duals. The same ones to which the government gives its bonds and gilts. The Bank
of England is semi-private in that its shares are held by the Treasury Solicito
r and their board of directors is appointed by the government.
This process helps to create the UK National Debt. From figures published Novemb
er 2009, UK public sector net debt was £870 billion or 61.7% of National GDP (ht
tp://www.statistics.gov.uk/cci/nugget.asp?id=206). Roughly, National Debt is usu
ally represented as the difference between money the government has spent and wi
ll spend that it has financed through tax and the extra spending that it raised
through borrowing that it hasn’t yet paid back. In reality, a substantial propor
tion of that is money owed to the Bank of England when it created money.
In March 2009, the government found that global financial institutions avoided b
uying its gilts. Gilts are regarded as a very safe bet so this was virtually un
precedented. The Bank of England was forced to step in and buy the gilts. I beli
eve this to be the origin of QE.
But government must also pay back with interest the money borrowed from global f
inanciers in the past. Again, this is where QE steps in. I suspect that the main
function of QE is to create money to pay back foreign lenders. Instead to going
into UK banks, much of the money went abroad. It was not intended to substantia
lly stimulate the economy.
What you should be told
So, what does the Bank of England fear? There has been talk that the UK and US m
ight not pay back its debts. This would mean financial Armageddon. But this wha
t Iceland and Greece are going through. So, if the UK did not pay back foreign l
enders then it would lose its high credit rating. The consequence is that foreig
ners would not buy Sterling (through gilts and bonds), its value would fall and
interest rates would go up. The UK would have to go to the IMF and they would ru
n the UK Treasury.
Some analysts suspect that UK national debt is higher than £870bn. The Centre fo
r Policy Studies argue that the real national debt is actually £1,340 billion -
103.5% of GDP. This figure includes all the public sector pension liabilities su
ch as pensions, and Private Finance Initiative contracts Northern Rock liabiliti
es, etc.
The government would say that this debt doesn’t really count because we have a l
ong time to pay it back. And anyway, the UK is a resilient economy. It will over
come these problems and in the meantime why panic people?
Although, financial analysts have said a UK debt default is unthinkable, the moo
d is becoming less optimistic. Consultants McKinsey Global Institute presented a
study of the UK debt situation at the global elite bash, the Davos World Econom
ic Forum. It said that the UK problems is the worst of the major economies and w
ould take up to seven years to get rid of. Add Morgan Stanley, and financier Geo
rge Soros to those agreeing with this bleak picture of the UK and you’ve got som
ething to worry about.
QE has bought some time. We all expect is that coming next is the slashing of pu
blic spending, an increase in taxation and perhaps an increase in interest rates
. But should we also be expecting the IMF to take over the running of the UK Tre
asury?
More information
Bank of England explains Quantitative Easing: http://www.bankofengland.co.uk/mon
etarypolicy/pdf/qe-pamphlet.pdf
Bank of England ends Quantitative Easing: http://www.guardian.co.uk/business/201
0/feb/04/quantitative-easing-bank-of-england
Bank of England buys government gilts:
- http://www.bankofengland.co.uk/publications/other/markets/apf/apfquarterlyrepo
rt1001.pdf
- http://www.marketwatch.com/story/bank-england-buys-uk-gilts-begins
- http://www.guardian.co.uk/business/2010/feb/04/quantitative-easing-bank-of-eng
land
Bank of England’s lending figures: http://www.bankofengland.co.uk/publications/o
ther/monetary/TrendsJanuary10.pdf
What are ‘gilts’: http://www.dmo.gov.uk/index.aspx?page=gilts/about_gilts
UK National Debt: http://www.economicshelp.org/blog/uk-economy/uk-national-debt/
Manufacturing grows more than expected: http://www.guardian.co.uk/business/2010/
feb/01/manufacturing-sector-growth-soars
Banks not lending enough to firms: http://www.thisislondon.co.uk/standard-busine
ss/article-23746139-lack-of-bank-lending-hits-cash-starved-companies.do
Davos World Economic Forum:
www.moneymarketing.co.uk/regulation/news/experts-paint-bleak-picture-of-uk-debt-
crisis/1006057.article
Morgan Stanley: http://www.telegraph.co.uk/finance/economics/6693162/Morgan-Stan
ley-fears-UK-sovereign-debt-crisis-in-2010.html
George Soros: http://www.bbc.co.uk/blogs/thereporters/robertpeston/2010/01/soros
_bleak_outlook_for_uk.html

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