FTSE 100
Dow Jones

Friday, 13 March 2009

Quantitative Easing: follow the money

Sometimes, the government's economy with the truth and its unfamiliarity with common sense can leave the man in the street a little flustered. The term Quantitative Easing, and its practice, is a good example. If the government wanted to devalue the currency as a way out of its problems all it would have to do is print money, which in essence is what it is doing, but to see how it works you just have to follow the money.

The way it works is simple. The Government needs to raise money through the issue of bonds, but it looks as though the Chinese and others will be less willing to bale out GB plc, so it gets the Bank of England to offer to buy existing gilts from the banks. On Monday the Bank bought in £2 billion and paid for them by crediting each bank’s account for the sales price in cash. The next day the Treasury issues £3 billion of new gilts to the market, so the banks use the £2 billion they have on deposit at the BOE and a further billion of cash that they have on deposit. That process repeats daily for say 200 business days until the BOE has bought in £200 billion of gilts and the Treasury has issued £300 billion of new gilts.

Of course the banks have a great time. They sell their old gilts to the bank at the offer price and buy the new gilts at the bid price, thereby making a good bid-offer spread every other day. So the government is being taken for an expensive ride? Wouldn’t it be easier for the Treasury to cut out the middle man and sell the gilts straight to the bank. After all the difference between a newly issued 5 year gilt and a 10 year gilt with the same coupon and 5 years to redemption is ... nothing. The banks are having a free ride at the taxpayers expense. After all, if they weren’t making money at it, they wouldn’t be buying and selling.

Mark that one up as incompetence dressed to impress.


Demetrius said...

It all sounds so simple, but it never is, there are unknowns, uncertainties, and unpredictable consequences of any move of this kind. Moreover, it assumes a degree of control that does not exist. Try Systemic Risk, Quantative Easing, and Digging for Victory to explain.

Anonymous said...

Now my head really begins to hurt. According to The Independent (sorry only reference found) some £190 billion of gilts are held by foreign banks or 36% of total, which would give you C £527.7 for 100% of gilts, which means the issue of £150 billion QE gilts represents some 28% added to this debt. The Independent fears this may end up in foreign banks anyway.
France and Germany are looking very askance at us now, I feel more than ever that we must remove Brown with all haste to stand any chance of staying in the game.

http://www.gopetition.co.uk/online/25648.html before it's too late.