Monday, 17 January 2011

E&Y lay into the Conservatives

Peter Spencer of E&Y has opened up in the normally politically neutral E&Y item Club. First he berates the Prime Minister for daring to comment on Inflation, saying he is cutting across the Bank of England's remit; they are independent after all.

This is an odd argument, as Prime Minister Mr. Cameron should be able to comment how he likes, and the Bank of England are free, due to their Independence, to ignore him if they so wish. The concept of Free Speech here, so long put down under Labour, is clearly troubling for some people. Perhaps the underlying point, that Cameron can see inflation as a problem which the mainstream economists keep denying, is the more important factor.

Building on this comment, Mr Spencer then has harsh words re potential interest rates rises, arguing that with already fiscally conservative VAT hikes, interest rates rises are the last thing we need. Of course, he does not make the point that perhaps not increasing VAT and raising interest rates is the thing to do.

Also ignored by everyone at the moment is what are we going to do with £200 billion of QE bought Gilts? Surely these have to be bought back (or monetised...) before we can contemplate interest rate rises. It is this latter point that personally holds me back from moving to a fixed rate mortgage. Why is this being ignored?

26 comments:

Budgie said...

"Cameron can see inflation as a problem which the mainstream economists keep denying ..."

Oh dear, CU, you know what my opinion of Cameron is. Cameron's comment here is a Bliarism: when our Tony criticised something he had no intention of changing, and/or no power to do so, he did it just to get favourable publicity. That is Cameron too.

Bill Quango MP said...

The MPC seems to be split about 2/3 in favour of low rates. But it cannot last.

Previous post was bang on. I remember the calls {icluding from BQ industries} that rates going up whilst trade was going down was madness.

Is the almost deflationary aspect of America's recovery leading them to believe the same is true here, just masked by out tax rises as opposed to their tax cuts?

Blue Eyes said...

Are there not EU rules on (non-)monetisation which apply here? Even if not the Bank cannot surely countenance it because that would sound the death knell of its fragile credibility and with it the pound's.

My take on the E&Y report, as seen through the prism of the BBC News report, was that it was basically saying to the Bank "hold your nerve, the cuts will be deflationary".

Steven_L said...

The QE money is all in the banks reserve accounts, minus the £60bn or so spent buying bank shares.

Reserve account requirements will be the new monetary policy lever. They might as well just write off the QE gilts and stop paying the coupons, they can always print them again if needs be.

Didn't you say a while back that QE was like morphine? We've become hooked on ZIRP too if you ask me. King (or his replacement)will wait for the nod from Bernanke.

I wouldn't be surprised if the US throw another recession around the world when inflation becomes unpopular stateside and they hike rates a la Reagan.

Budgie said...

I keep thinking I understand then something like this crops up: "The QE money is all in the banks reserve accounts, minus the £60bn or so spent buying bank shares" (Steven_L).

I thought it went like this: the Treasury printed Gilts; the BoE 'printed' the QE money; the BoE gave the money to the Treasury in return for the Gilts. The Treasury spent this extra money, instead of borrowing elsewhere.

At the same time the (retail) banks have been forced to lodge much more capital with the BoE.

So the private sector (banks) have removed a large quantity of money from circulation (which is deflationary), whilst the government has continued to inject money in a profligate manner (inflationary); by chance (or design) about the same amount, so balancing with just a smidgeon too much inflation.

Or has Steven_L said all that but in a rather more succinct manner?

Mark Wadsworth said...

What SL says.

" what are we going to do with £200 billion of QE bought Gilts? Surely these have to be bought back (or monetised...)"

Completely false premise.

Before QE: high street banks (and a few pension funds) held £200 billion in gilts issued by DMO (part of HMG).

QE: BoE (part of HMG) 'buys back' £200 bn of gilts from high st banks etc using electronic balances at BoE to pay for them.

After QE:
a) One part of HMG (the DMO) 'owes' another part of HMG (the BoE) £200 billion. To all intents and purposes, these gilts have ceased to exist. If all the bits of paper now in BoE safe were detroyed by fire, nobody would care.

b) Instead of DMO owing high st banks £200 million long-term at 3% interest, BoE owes high st banks £200 million electronic balances at (currently) 0.5% interest.

Apart from transaction costs (easy profits for high st banks) and a corresponding reduction in average-time-to-maturity of HMG debt (and concomitant reduction in annual interest bill for the time being), nothing has happened that affects the outside world.

e.g. taking husband and wife as one economic unit, if wife withdraws £100 from her savings account and pays it into her husband's savings account, they have become neither richer nor poorer and the bank couldn't care less.

James Higham said...

The concept of Free Speech here, so long put down under Labour, is clearly troubling for some people.

Very much so and this shows how the banks are not all that far removed from the socialists - both wish to rule oligarchically and suppress any criticism of that.

Budgie said...

From the BoE website:
If it [QE] were carried out to finance the budget deficit, it would be a violation of Article 123 of the Treaty on the Functioning of the European Union. Rather, the BoE is undertaking QE in order to meet the inflation target and will sell the government debt back to the private sector once the economy recovers, thus unwinding the original increase in the money supply."

Faisal Islam at Prospect magazine 20-10-2010 said:
"The mechanism by which the Bank bought government debt was convoluted, for operational and legal reasons. On any given morning the debt management office (DMO), an arm of the treasury, sold billions of pounds worth of British gilts to the world. Then in the afternoon, barely 400 metres away, the Bank held a reverse auction where it, in effect, bought up billions of similar government debts. Under EU rules it would have been illegal for the DMO and the Bank to trade with one another. So instead the City stepped in, making profits on trading both sides of this bizarre monetary merry-go-round for over a year.

“I fully admit it does look strange,” said Robert Stheeman, head of the DMO. “On the other hand, we must make the distinction—we are raising money by selling new gilts but the Bank is buying old gilts in the secondary market.”

The end result, though, is that the Bank bought about the same amount of government debt as was issued in a record year. Now it owns a quarter of Britain’s outstanding gilts, and points to falls in interest rate on gilts of about 1 percentage point as evidence of QE’s positive impact.

Some of the commercial banks saw it another way. Appearing before the treasury select committee in January, Stephen Hester, the chief executive of Royal Bank of Scotland, was asked how RBS had been boosted by QE. He replied: “Quantitative easing so far has taken the form of the government effectively funding its deficit by printing money.”"

In essence therefore, the BoE did finance the government deficit by 'printing' money. But did so in a convoluted way to avoid the EU. And that money did get into the general economy. And the BoE has a load of Gilts to sell in the future.

Electro-Kevin said...

Cuts may be deflationary but people in secure employment (and many who aren't) will borrow if necessary in order to maintain a standard of living; so long as borrowing remains cheap.

I know a few people who are paying utilities and mortgages on credit cards.

CityUnslicker said...

Budgie many thanks, as I was really busy today and had not the time to respond to SL and Mark W. Guys, the BOE has assets it needs to sell in the market cancelling them is Weimar, selling them in the market is going to push down the price of gilts and so push up interest rates.

When I do get a chance though a proper post on undoing QE is coming up!

Mark Wadsworth said...

CU: "Guys, the BOE has assets it needs to sell in the market..."

That's the point. If BoE holds IOUs issued by the DMO and they are both parts of the same government department (HM Treasury), those 'assets' (on the part of the BoE) and the corresponding 'liablities' (on the part of the DMO) have ceased to exist!! They are already cancelled!

Imagine they were bearer bonds and were detroyed in a fire. The BoE 'loses' £200 bn and the DMO 'gains' £200 bn because it no longer has to repay them. The government as a whole loses or gains nothing.

If you know about company law, the general rule is that when a company buys back its own shares, those shares are then cancelled because they cease to exist (ignore extra rules on 'Treasury stock').

Or, another analogy, the Royal Mint makes £100 million in new ten pence piece and 'buys back' £50 notes from the commercial banks for £50 each (in ten pence pieces). Those notes were originally issued by the BoE. The commercial banks are no better or worse off for this. Would you honestly claim that 'money was printed'? Or that the Royal Mint 'needs to' re-issue those crumpled notes?
------------
QE in the USA was quite different, as the Fed really did buy/overpay for crappy residential mortgage assets, separate topic, I am talking specifically about the UK.

Budgie said...

Mark, the government has gained something: £200bn of cash which it has spent already.

The avowed purpose of QE was to offset the contraction of the money supply (occurring because of the credit crunch), by injecting the extra £200bn into the economy. In this way a depression was avoided.

But this is temporary; at some future date when the economy recovers, the BoE intends to sell the Gilts back to the public, thereby soaking up the excess £200bn.

If the BoE instead shredded the Gilts it would lose a ready made future anti-inflation tool, and it would look like (and be) Zimbabwe style money printing (so annoying foreign holders of Sterling - and us too).

Anonymous said...

Mark. So you are saying that QE in Britain didn't do anything real at all?


unslicker, you mentioned fixed rate mortgage, some of my family are needing to borrow a lot of money cause of buying out a business partener.
I am concerned that although not in the short term but in the medium term interest rates could be a lot higher.
My dad thinks this is impossible because the country couldn't cope so the government wouldn't risk it.

How is this gonna play out over the next 15-20 years? we can't remain so low for long surely?

Steven_L said...

Weimar, shmeimar!

Weimar only happens when loads of freshly printed money ends up in the hands of the masses. Like it did via 100% self cert mortgages to house prices.

There is no mechanism by which the money the banks are holding in their reserve accounts ends up doing Wayne and Waynetta's weekly shop at Asda.

It might get drawn down from time to time and see its way inti inflating London property, Ferrari and yacht prices, but that's about it.

Anonymous said...

Ernst & Young

Auditors to Anglo Irish Bank

CityUnslicker said...

MW - no, the gilts that the Bank of England bought are not the same ones that the DMOP sold in the market. If I own a buy one house and sell another house it does not mean net net that nothing has changed - I have a different house altogether.

The Government has sold bonds to the marker under a normal programme, also the DMO has bought bonds. It still owns these bonds and needs to sell them .A ll the Government has done is finance itself temporarily which in turn has stopped the banks from having to do it at a time of poor liquidity - plus they made a take on the arbitrage of the buy and sell.

When the Bank has to sell these bonds to the market it will compete with other new DMO issues - which will reduce the price of the gilts and so raise the yield. Pushing up interest rates. Currently UK interest rates are estimated at -3%; this will return to 0.5% if we ended QE tomorrow as gilt prices would fall substantially.

Anon re interest rates, I am not a person able to given credible or legal financial advice. However I can point out that there are major banks like HSBC who offer the chance to switch between tracker and fixed for quite low costs- allowing the opportunity of some heding should things get tricky in the years ahead.

Budgie said...

Well, I have learned something. I originally said: "the BoE gave the money to the Treasury in return for the Gilts". Whilst I corrected myself in the next comment, I did not acknowledge my original statement as an error. Thanks, CU.

Mark Wadsworth said...

CU, I am an old fashioned accountant and economist, not a politician and I have looked at the figures and followed all the book-keeping entries, and what I say is simply true (for the UK at least). Do not believe a word of what the newspapers or politicians or bankers say as they are all pathological liars (or maybe just stupid).

"MW - no, the gilts that the Bank of England bought are not the same ones that the DMOP sold in the market. If I own a buy one house and sell another house it does not mean net net that nothing has changed - I have a different house altogether."

Government bonds are fungible, it's about as thrilling as the difference between having a £50 note or 500 x 10p pieces.

"The Government has sold bonds to the marker under a normal programme, also the DMO has bought bonds. It still owns these bonds and needs to sell them.

Well that is not true, it does not need to 'sell' those particular bonds, or even sell them at all. Please address the issue of what would happen if these were bearer bonds and were destroyed by fire. The BoE no longer has an asset and the DMO no longer has a liability.

They could painstakingly work out which phsyical bits of paper were destroyed and lovingly reprint and reinstate them, or they might just not bother.

Or please address my other thought experiment - the Royal Mint produces £100m in 10p pieces, and the BoE has £100 million in new notes printed, and they exchange one for the other - the BoE puts the coins in a safe and the RM puts the notes in a safe.

Have the RM or the BoE (both parts of the government) become one penny richer or poorer by doing this? Nope, clearly not.

Anonymous said...

Then why did they do it Mark?

Steven_L said...

Another one, is the US going to go 'Weimar' or are the Fed going to flog all that Fanny/Freddie paper they overpaid for?

Steven_L said...
This comment has been removed by the author.
Anonymous said...

The Bank of England is not "independent", nor has it been since it was nationalised by the Labour Government in 1946.

The Labour Government of 1997 gave the Bank of England's MPC the task of determining base interest rates, with instructions to hold inflation within a narrow band.

Not too long afterwards, the Labour Government started to rig the standard measurement of inflation, and also the membership personnel of the MPC, in order to carry on squandering public money on its own supporters and voters, and to maintain the illusion of increasing prosperity.

The current BoE programme of watering the currency (otherwise known as Quantative Easing), and of recklessly-low interest rates, merely perpetuates that illusion.

Reality is about to arrive.

Anonymous said...

It's now been over 6 hours since anonymous's question to Mark Wadsworth, a man who thinks that a hundred acres of improved pasture planted with trees in nice straight lines is preferable to 50 acres of ancient woodland.

Martin

CityUnslicker said...

Mark, if thr BOE gets rid of the bonds, i.e. by fire, then we lose all credibility and become Zimbabwe. It is called monetising the debt - it is an option but rather a nuclear one as then Government has just printed £200 billion and paid people out of thin air.

I rather think the world would sit up at that point and the UK would reap a financial shitstorm that would make icleandic experience equate to a gentle walk in the park. The game of fiat currencies is to keep belief in the paper. if the Government itself undermines this then all the paper becomes worthless - perhaps instantaenesouly. After all if the Government cancels some gilts why not others, why pay any gilt holders interest at all?

The idea of QE is to get more money into the economy (to recapitliase banks and asset prices) but in a semi-legitimate fashion, that is credible and believable without being a total dodge of the responsibility to pay market rate interest on debt issued.

I don't understand your position that the banks et al have not benefited from the arbitrage effect and made use of the extra cash provided by the liquidity - you are considering the fractional leverage they obtain by holding such AAA rated assets in terms of their own ability to create money? The bank of england is not the sole creator of money in our financial system.

Mark Wadsworth said...

CU: "Mark, if the BOE gets rid of the bonds, i.e. by fire, then we lose all credibility and become Zimbabwe."

Well no, why would it? On paper, one branch of govt (Debt Mgt Office) owes another branch of govt (BoE) about £200 billion. There is no pressing need to repay it, why would they bother?

In theory, the two branches of govt could agree that the bonds held by BoE will simply be cancelled. The net effect of this on the outside world is absolutely nothing.

As a separate issue, what the UK commercial banks did was sell £200 billion of UK govt bonds (issued by DMO) to the BoE, so instead of having assets £200 bn govt bonds, it has assets £200 bn balance with BoE. In either case, the banks are owed money by branches of the UK govt. To the banks, it makes precious little difference.

I strongly recommend that instead of relying on newspaper reports written by people who don;t understand what they are talking about, you do a crash-course in bookkeeping; look up the actual facts and figures; and then try and reconstruct the actual cash flows of all this - apart from a per cent free easy profit for the banks, not much money really changed hands at all.

The situation is quite different in the USA of course where the Fed was buying 'mortgage backed securities', that is a whole different topic.

Mark Wadsworth said...

Martin has described me as " a man who thinks that a hundred acres of improved pasture planted with trees in nice straight lines is preferable to 50 acres of ancient woodland."

I can't remember ever saying that, and in any event, 'preferable' to whom? I'm sure nature lovers and ramblers prefer 'ancient woodland' and farmers prefer 'improved pasture with trees in straight lines'. So it's up to whoever owns the land to decide what to do, I think.