Some Thoughts on QE

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As Ben Dyson notes in his submission to the Treasury Committee on QE, Mervyn King is rather vague about exactly how the QE money enters into general circulation. One possible but politically sensitive explanation is that the pension funds and insurance companies in receipt of the QE money promptly use that money to buy newly issued gilts from the DMO (Debt Management Office). The QE money issued by the BoE is thus acquired quickly by the Treasury and then used to finance the usual government spending programmes.

This is a plausible route by which much of the QE money might enter into the general economy, but to acknowledge its reality is to admit that the UK is finding it difficult to finance its public spending commitments from taxation plus the conventional methods of selling gilts. As a nation we might be less credit worthy than we appear to be. There might be very little actual commercial demand for new UK gilts at current low interest rates, and QE might be a way to avoid, at least for the time being, that uncomfortable fact. If and when QE stops, we might see that purchasers of gilts via the DMO auctions then demand substantially higher interest rates. If this is indeed what is going on then the government is effectively monetizing its debt to fund its spending programmes, action from which it is prohibited explicitly by Maastricht, but which might be facilitated indirectly within the rules if those institutions which sell their old gilts under QE agree to buy new gilts with the money received.

An interesting date is fast approaching – I have read that 7 March 2013 is the earliest maturity date for those gilts purchased by the BE under QE. Will the Treasury pay the principal redemption values of these gilts to the BoE? If so, then where will the money come from? Or will the gilts simply be cancelled? One clue might be that so far the dividends (approximately £35 billion) nominally payable by the Treasury to the BoE on the gilts purchased through QE have been cancelled. The stated intention that the BoE will one day sell the old gilts back into the market might turn out to be so much window dressing to make QE more acceptable.

Another direct effect of QE has been vastly to increase the amount of the electronic central bank money in circulation between the commercial banks – the medium they use for their inter-bank settlement. Hence post QE there is now much less need for inter-bank lending and the mutual trust necessary for that. Inter-bank liquidity has been eased enormously by QE.

Interestingly, from the perspective of monetary reform, the fundamental superfluity of our two-tier money system becomes ever clearer as the ratio of central bank money to commercial bank money increases under QE. The more that real economy transactions in expensive and ephemeral bank-credit money are directly settled by inter-bank transfers of publicly issued and persistently circulating central bank money, the more we can see the common sense of changing to a unitary publicly issued money system .

I emphasize that the above are my personal speculations and not those of Positive Money. They are presented for discussion.

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  • Gareth Jones

    There is speculation, in the USA, that QE money has gone to pay off toxic debt as well as buying gilts. What are your thoughts on this?

  • Rory Short

    Nobody should be allowed to issue money that has not the backing of the intrinsic value in specific goods or services, clear and simple. Money that has that backing is sound money. Money that does not have such backing is fraudulent even if it is officially sanctioned like QE.

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