Between March 2009 and July 2012, through the program known as Quantitative Easing (QE), £375bn of newly created money has been spent by the Bank of England (BoE) to buy UK gilts, mainly from non-banks such as pension funds and insurance companies, institutions that together constitute much of the gilts market. Over the same time period a substantially larger quantity of new gilts has been issued by HM Treasury (HMT) and sold through the usual DMO auctions (DMO – UK Debt Management Office), giving ample scope for the QE money to be reinvested into newly issued gilts. Given the (sometimes mandatory) nature of their portfolios, it seems to me highly likely that the financial institutions involved have reinvested much of the QE money into new gilts.
Two precedents have been set concerning the stock of gilts acquired by the BoE through QE. First, the coupon payments, paid from HMT to the BoE, and so far in total approximately £35bn, have been returned to HMT, and so effectively waived. Second, the redemption money received by the BoE from HMT for the first batch of QE gilts to reach their maturity date (£6.6bn in March 2013) has been used by the BoE to buy other gilts, presumably from much the same group of QE gilt sellers.
These two precedents, if continued, indicate that the BoE will hold a rolling stock of at least £375bn of gilts and will forego the coupon payments on this stock. For as long as the gilt redemption payments are rolled over to buy replacement gilts, and assuming that QE itself is not reversed, the BoE’s stock of gilts will not decrease. If further new QE money is issued to buy gilts, then the stock will increase accordingly.
However, should the QE gilt redemption monies flowing to the BoE not be spent by the BoE on replacement gilts, then the BoE’s present £375bn stock of gilts will decrease, all else equal. For example, the NEF’s recent proposal to spend the gilt redemption monies on national infrastructure projects rather than on replacement gilts would entail HMT (on behalf of the UK taxpayer) making coupon payments on a greater proportion of its extant gilts than would otherwise be the case. This is how the cost to the taxpayer of the well-intentioned NEF program would manifest, though many might consider it a cost worth paying.
From HMT’s point of view the rolling gilt stock owned by the BoE has effectively been annulled. HMT pays no coupon on it. As the BoE gilts mature the redemption monies are passed on from the BoE to the sellers of the replacement gilts. If these sellers buy new gilts from the DMO to at least the same value, then in effect HMT is rolling over the stock of ‘coupon-free’ gilts held by the BoE. This rollover may proceed indefinitely as further BoE owned gilts reach maturity and are replaced.
Since QE began the total UK national debt – that is, all extant gilts – has increased by the aggregate of the government’s annual deficits. However, because of QE, the stock of gilts not owned by the BoE, that is all those gilts that continue to cost HMT the requisite coupon payments, has increased by £375bn less than this cumulative deficit. This is functionally very close to the government funding £375bn of its excess spending not by the usual method of additional net borrowing, but by issuing new debt-free money.
The debt-free QE money has countered the potential deflation of the commercial bank money supply, which occurs when new bank lending fails to keep pace with the repayment of old bank loans. Mervyn King has stated recently in an interview with Martin Wolf that one purpose of QE is to bolster the broad money supply by injecting QE broad money in place of the diminishing commercial bank money:
“I’ve always seen this as a way of increasing the broader money supply. And the thing that’s so extraordinary is that, for the past few years, the banking system, which is normally responsible for creating 95 per cent of broad money has been contracting its part of the money supply. And since we at the bank only supply about 5 per cent of it, the proportional increase in our bit has to be massive to offset the contraction of the rest.”
Had the QE money merely stayed in circulation between the financial institutions that received it initially, as is often assumed, then such counter deflationary effects would not be apparent. In general, pension funds and insurance companies are not indebted to the commercial banks – they tend to be bank creditors with money on deposit. To satisfy Mervyn King’s intention, the QE money must move into the loan re-paying sectors of the economy. The primary way for money so to move from the financial institutions to the indebted general economy is through the purchase of new gilts by those institutions. The money then quickly finds its way into the general economy through the usual government spending programs.
Inside the banking system, the amount of central bank money, the banks’ medium of inter-bank settlement has also increased through QE by £375bn. This has greatly facilitated inter-bank liquidity. Banks can now rely far more on each other’s ability to meet their settlement obligations and not to expose or aggravate fears of bank insolvency by baulking at inter-bank lending.
Arguably then, QE has enabled the UK economy so far to avert a major deflationary recession, has kept the dysfunctional banking system liquid and ostensibly solvent, and has allowed the government to fund its deficit – to increase the national debt – without proportionately increasing the coupon payments on that national debt. It has bought time.
In the context of possibly the early death throes of our commercially issued, debt-based money system, even the awkward and contrived special measure that is QE has demonstrated some of the potential utility of debt-free, publicly issued money – that is, of monetary reform.