The new report from Ritchie and friends. In the intro, how\’s this for a great piece of logic?
3. There was a shortage of gilts available for investment purposes as a result of the Bank
of England buying so many in the market. Large quantities of funds were invested
instead in other financial assets including the stock market and commodities such as
food stuffs and metals. The USA also undertook quantitative easing at the same time
as the UK, which meant that despite near recessionary conditions commodity prices
for coffee and basic metals such as copper have risen enormously. This has impacted
on inflation, which has stayed above the Bank of England target rate;
4. Deflation has been avoided, although the relative role of quantitative easing in this
versus the previous government’s reflation policies is unclear;
Got that? Quantitative easing caused inflation but we don\’t know whether it avoided deflation?
This is fun:
To explain this mathematically, suppose that the current gilt rate is 4%. In other words, new £100
gilt pays £4 of interest per annum. There are, however, gilts out there which were issued at 5% per
annum. The bond market does not ignore this difference, instead it adjusts the price of the gilt
already issued to reflect the current prevailing interest rate. As a result the price of the gilt already in
issue which is paying £5 a year is adjusted so that the effective rate of interest it plays is reduced to
the current 4% and rate of interest. It can do this by increasing the value of that gilt from £100, at
which it was issued, to £125. £5 is 4% of £125. The result is that the bank or pension funds that now
owns that gilt makes a profit of £25 on the original purchase price, if it can sell the gilt it owns that
has now gone up in value back to the Bank of England under the quantitative easing programme.
Err, no. For a start, they\’re assuming that the BoE has been buying up perpetuals (of which I think there are only Consols left). I\’m not sure, but I think that the BoE has been mainly buying up 10 year gilts. Meaning that the price change to effect the yield change will be much lower.
But even then they\’ve cocked the calculation, haven\’t they? Because 1% is 20% of 5%, not 25% (although now that we\’re playing with numbers I could well be wrong).
But where they\’ve really gone wrong is that they\’ve assumed (further up the report) that the banks made a huge profit by selling their old gilts to the BoE. And thus, given that old gilts were issued at lower prices (higher yields) the banks have made a huge profit by doing so.
That explanation, just like almost everything else in this report, revolves around money, and in this
case how the High Street and investment banks can make money out of the Treasury. The technical
explanation of this process is in Appendix 2 to this report. Suffice to say here that because the Bank
of England has pushed interest rates on gilts to their lowest level for many decades they have, as a
direct consequence, pushed gilt prices to record highs. That means that the banks and pension funds
that have sold government gilts to the Bank of England as part of the quantitative easing programme
have made profits since they would have bought these gilts previously at a lower price.
How much profit as being made in this way is hard to guess. It would be of enormous benefit to
know. What we suspect is that a significant part of the £200 billion of spending on QE was turned,
almost immediately into profit by UK based banks and we in turn suggest that it was this fact, and
little else that restored bank profitability and bank bonuses in 2009.
Well, no, for as we discussed earlier, the banks have been increasing their holdings of gilts, not reducing them. But even if they had been decreasing their holdings it would still be a load of cockammammie Ritchiebollocks.
Because the surge in gilt prices is only very marginally anything to do with QE. What\’s really caused the surge is the BoE lowering the interest rate. Of which most of it has been the BoE saying \”interest rates are now lower\”, not their QE through open market operations.
People more informed than me say that the profit to the banks from lower interest rates has been substantial (just as their losses when interest rates rise will be, assuming they\’re long gilts) but the profits from QE are around £nil.
Interesting little note: the cover photo is from R. Murphy: my, those rectories in Norfolk do need some maintenance, don\’t they?
Finally, and the most important point, they\’ve got horribly and terminally confused between monetary activities (of which QE is one) and fiscal or spending activities.
Monetary stuff is bits like lowering interest rates: and when you cannot do that then you print money (QE) to lower them even further. You do this because you want to lower interest rates. Further, you do it because you know it is reversible. Inflation starts soaring away and you can sell the gilts back to the banks/market/pension funds, stick the money back in the BoE and cancel said money\’s existence. It is a temporary thing you see?
They\’ve now run off and said \”Look! Free money! Now, what would we like to spend it on?\”
Squeal like a piggie! Windmills! Insulation! Solar Cells!
But this isn\’t temporary: this isn\’t reversible. This is not QE in effect: this is printing new money in order to go spend it on real assets. You know, Zimbabwenomics?
And here we come back to our old problem with Ritchie and his friends. They\’re quite simply too ignorant of economics, the basic nuts and bolts of the subject, to understand the difference. Printing up some money to lower interest rates a few points is one thing: printing up some money to go spend it is quite a different thing.