Idiot is idiot

So, the cure for QE is a permanent gilt. A Consol in other words, a couple of years after they were paid off.

Well done.

And those pointless arguments about QE having to be repaid would end: the QE debt could be held in perpetuity, neither redeemed or cancelled, but just sitting there like the double entry book-keeping which is all that it now really represents.


I had one of the boring ‘but QE will have to be repaid one day’ conversations that have been a part of my life for some time now towards the end of last week. The argument of those putting forward this idea is that it’s all well and good the Bank of England buying up government debt and holding it under the QE programme but one day (they say) the Bank will either have to sell it back into the market (the reason why they ‘have to’ is never specified, largely because it does not exist) or it will become impossible to roll the debt over one day at the same interest rate. This is another non-argument: if the Bank of England replaces one government bond with another for the sake of QE the rate does not matter: interest is not paid on QE debt. Let me however suggest a way in which this argument could be put to bed for good.

It would help if Spud actually understood the reason that the QE bonds do have to go back into said market at some point.


Money times velocity of circulation is equal to prices and quantities. PQ is also roughly equivalent to GDP. Money here is base money (it is V which multiplies it up to broad money, so, not quite but about, P is M0 and MV is M4). Please note these descriptions are wrong, inaccurate, but useful to explain what is going on.

The essential QE point is that V sank like a stone in the crisis. To avoid P doing so (deflation) or Q, or even PQ, a Depression, we needed to do something. So, increase the amount of M in order to keep PQ up and thus not see horrible fall in PQ. Again, not accurate, but useful enough.

M0 is notes and coins in circulation which is about £70 billion these days. QE money isn’t M0 but we can usefully, if inaccurately, think of it as being an addition to it. QE money is around £500 billion at present (or will be by the time the latest extension ends).

Some day, who knows when, V will return to something like normal. We’ll then have £570 billion of M0 as the M in our MV. That will lead to a considerable – to be mild about it – increase in P. Inflation that is.

Which is why QE has to be reversed. Because we must take that created base money out of the economy and destroy it. At some point. The alternative is a massive jolt of inflation. Not to reverse QE would be what Zimbabwe and Venezuela have both done, those terribly successful economies, the monetisation of government spending.

Which is why Ritchie’s magic money tree doesn’t exist. It can exist for a time, that time being when V is depressed. But we need to reverse it when V recovers.

We also know how it will be done when the time comes. As bonds mature currently the Bank buys more. At some point it will stop doing that and the Treasury will have to issue more bonds to the market to cover the repayments to the Bank. Yes, we do know this because the Fed has stated very clearly that that is the way they will do it.

Spud’s just getting this wrong.

14 thoughts on “Idiot is idiot”

  1. What a fucking mess. That whole piece is up there with his best / worst.

    By his own admission, he suggests the BofE offer private sector holders of Gilts an exchange into another bond bearing a much less attractive yield (and unlimited duration risk). Take up from existing holders ? I’m guessing Zero.

    The only sort of world that might work (which admittedly I’m sure would fall into the Professor’s definition of ‘Courage’) is if the government step in to say the exchange is compulsory. At which point the Gilt market tanks, the government becomes a pariah issuer, and can whistle for any private sector or foreign buying of any new gilts, and the government runs out of cash sharpish as they fail to rollover existing debt.

    But don’t worry. The professor then goes on to say that this new class of low cost gilt could then be issued (I’m not sure why it isn’t ‘issued’ when he gets his first exchange underway) to ‘fund the investment this country really needs’.

    I’m guessing guns and ammo to restore order when people realise the govt is out of money, or inflation suddenly ramps up to 300% as the only available way to pay your public sector workforce is to run the presses 24/7.

    Any chance that somebody knows anybody at City Uni who might have a look at the professor’s output ?

  2. Mind you, low interest rates are wreaking havoc everywhere. The car insurance industry is using it as an excuse to raise premiums/premia. Rates need to rise to a normal situation otherwise the whole finance industry gets bent right of shape yet again. Finance needs to serve an economy rather than drive it.

  3. I’m with Richard on this one. Stopped clock and all that. Murray Rothbard wrote convincingly demolishing mv=pq imho. In particular the v concept. Monetarism is up their with Keynesianism imo.

  4. Tim said: “We also know how it will be done when the time comes. As bonds mature currently the Bank buys more. At some point it will stop doing that and the Treasury will have to issue more bonds to the market to cover the repayments to the Bank. Yes, we do know this because the Fed has stated very clearly that that is the way they will do it.”

    As has the Bank of England. Initially they said once the Labour Force Survey showed an unemployment figure of 7% they would consider whether to stop rolling over the purchases. When it looked like the LFS would report an unemployment figure of less than 7% the BoE preempted it. They decided there was still too much slack in the economy and would consider reducing the asset purchase program once interest rates were above 0.5%.

    This change is described in th BoE’s Asset Purchase Facility quarterly report for Q1 2015. (pdf)

    I expect the Fed is similarly flexible in defining when it will or won’t take action.

  5. James G… Look at Simon Wren Lewis… Mainly macro… Every serious economist is keynsian…. He makes me laugh.. The archetypal out of touch intellectual, deploring the attitudes of the worsocrat

  6. One day 3%war loan will again become a worry factor. In the 1980s, trusts were benchmarked against that!! Eventually the law changed when trust beneficiaries asked why

  7. I recall reading the Forsyte Saga in the 1970s, and the idea of living off the income from 2% consols seemed so weird that I asked my merchant banking father about it. He said they needed a 35% account to survive. And gave me a book about economics

  8. I don’t get the idea that V “sank like a stone” and has yet to recover. Yes, people slowed down their spending a bit; but it has since caught up with, and even surpassed pre-recession levels.

    House prices would certainly suggest as much; and the NPV of a house is closely tied to the buyer’s expectation of V.

  9. I’m with James G on this. I can’t find much in the Richie quote to criticise (I’ve not read the full piece nor do I intend to).

    I suspect much of the money has just gone to prop up asset prices and marginal economic ventures – I don’t expect a huge surge in inflation. It’s not like it is just sitting there waiting to be used.

    Also, there are more than 1 trillion in sterling private sector pension fund liabilities out there, not all of which are invested in gilts. The government doesn’t need to worry about finding a buyer. In a pinch they could pass some regulation mandating ‘low risk’ government bond investment.

  10. Lpt why should a pension fund invest in gilts at 1%? The inflation behind the QE expansion of the money supply is hidden because it seems to be going into gilts, housing and bond – proxy securities. The inflation is there and it is distorting the economy. Houses are expensive. Assets are expensive. Insurance premiums are ratcheting up more than ever. Yields are hard to find. A crash is inevitable.

  11. LPT: …they could pass some regulation mandating ‘low risk’ government bond investment.

    There’s a cracking idea.

    Indeed, the government could stipulate that half of all benefits (old age, disability, jobless – the lot) be paid in government bonds renewable at, say, 180 days. I bet a whole new discount market would spring up overnight and secondary traders would park multiple Porsches in front of their villas just on the strength of it.

  12. Diogenes,

    Only the government issues long dated, inflation linked debt, with low risk of default (there is some private sector supply but it is extremely limited). These are exactly the characteristics of defined benefit pension scheme liabilities and as so very attractive assets for pension schemes. Yields are very expensive but regardless almost all pension schemes have an ambition to be 100% invested in gilts as soon as they can afford to, which in most cases is between 10 and 20 years from now. If yields go up faster than expected then all that will happen is that the flow into gilts will accelerate (indeed many pension schemes have put in place frameworks that do this automatically), which will then push down yields again.

    Virtually the only thing that has the potential to severely disrupt the gilt market is a sovereign credit crisis of Greek proportions. It’s a bit different for nominal gilts than for index linked gilts, as the supply is greater for the former and the market is less dominated by pension funds/insurers.

    I agree with you that a crash is more likely than an inflationary boom. Still plenty of households and companies out there that couldn’t cope with a 2% real yield (i.e. up 4% from the current level, as linkers currently trade at c. -2%)

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