Excellent summary which I’m sharing with friends who have an interest in esoteric matters like this. I say in substance it is cancelled. The Houblons, one of whom had been out there at the same time as Downing, actually managed to get the CB going, probably because unlike Downing they applied to do so at a time of war when monarchs were traditionally scratching for readies. Money creation is a be duty of any Sovereign power. Second, it helped to stabilize the U.S. economy, providing the funds and the confidence to pull out of the recession. However, without quantitative easing, the recession may have been even deeper. The tallies issued by government departments in payment for goods and services were, in effect, cheques drawn on the farmers of those taxes which had been hypothecated for the supply of those goods and services, which the farmers of those taxes were obliged to honour from the cash they were holding in revenues from those taxes. Primarily for simplicity. By suggesting prepayment (which is just hopelessly wrong, I’m afraid) you would also mean then that the opposite is true. After quantitative easing was introduced in 2009, there was a partial recovery. Firstly it is worth saying in full what the BoE say about how QE works in the link you gave. For example, the 5% bond with a yield of 0% and price of 150 does not mean any prepayment has occurred. UK unemployment was lower than Eurozone where quantitative easing didn’t take place. They are cancelled at par: the premium is properly accounted for as prepaid interest over the life of the cancelled giilt: the one remaining accounting function it has when considering substance and not form, b) The BoE does not have to pay interest in the reserve account balances – it chooses to – at base rate right now, d) MtM is a red herring – and it is not paid to the Treasury (not that it need be anyway, as it is already in the APF which is part of the Treasury) and that is because there is no means to make payment. You twice use the phrase “for various reasons”. So still a net loss of £25m. The first thing you would see if all excess reserves being placed into other return seeking assets – which would promote instability in markets as asset prices would be linked closely to the availability of money market liquidity. There is also the suspicion that this will also allow the BoE to keep pretending that it cannot on its own resources sustain gov spending by the Treasury(via Ways and Means) as this risks awkward questions about where the BoE is getting its reserves from we can’t have people seeing that money can be created out of thin air! Bonds will show profits and losses depending on the path of interest rates, which makes the purchae price (and time) important. The BoE could allow the government to spend without borrowing by just granting it an “overdraft” (Ways and Means account) but, for various reasons, chooses to buy gilts. This is the second post in a three-part series on the use of quantitative easing as a monetary policy tool over the past decade. e) Bonds do not prepay interest. But my point is – in reality QE does result in the BoE replacing gilts with money – and its choice that they pay interest on this. Yes there is money(reserves) created here but what kind of liability is national currency? The coupons cancel each other out, as you suggest, but you have still lost money on the bond. You have to look at all of this from a psychological viewpoint. If the bonds rise in value they show a profit. The accounts specifically separate out the interest payments and MtM value gained, and the amount passed back to HMT is the sum of these less the costs. All Right Reserved. Great article Richard, really interesting. The Federal Reserve pays for the bonds by inventing new money electronically and paying for the securities with this new money. It uses credit it creates out of thin air. At its core, quantitative easing is the attempt by a central bank to inject more money into the economy and to keep long-term interest rates low through the purchase of large amounts of assets, often held by financial institutions. That will be true irrespective if the bond is never re-sold to the market – the loss will be locked in. Our Website uses cookies to improve your experience. We then use it to buy things like government debt in the form of bonds. Perhaps such a diagram would be too complex to be useful? There is another advantage to the accounting method used, which is at arms length. You could consolidate everything but that would not give you the answer you are looking for – as I pointed out in my example. There is nothing untoward about this: this is how fixed interest bond markets work. HMT will lose money in the example I gave you. Their assets are the Gilts they purchased. Higher debt service costs for the 10y years. I much refer the informed opinions who live and work in the real world. But established economists are taking me on on twitter this morning to say otherwise. HMT receives £100m from the sale of the bond. If they weren’t currently holding any cash, the tally holders had to wait until they were. Historically UK governments used to use tally sticks to create money without a national bank. So QE works by making it cheaper for households and businesses to borrow money – encouraging spending. Trying to follow Keith.s line That same loan is, of course, an asset on the balance sheet of the Bank of England, and the two sums do balance each other out. The Treasury cannot lose on the assets it now owns: they are not longer traded and will be held to redemption. Way out of my depth with this particular ding-dong. a) This is not correct. The two sums should be offset to present a true and fair view of the interest cost that the government actually incurs. In that case the proceeds have been reinvested in the purchase of replacement gilts acquired in exactly the same way as other reacquired gilts, as already noted. We should be very much aware what better than to set up phoney debt obligations than insist a country needs a national bank! There is no prepayment on Gilts. However in the Govts. This is not so. It is interesting the govt. For security reasons, credit card donations require Javascript. You may also hear it called ‘QE’ or ‘asset purchase’ – these are the same thing. What does QUANTITATIVE EASING mean? This is a massive benefit from HMT’s viewpoint, which would not be possible if the bonds were cancelled. Quantitative easing is a monetary policy instituted by central banks in an effort to stimulate the local economy. “Quantitative Easing Explained: Putting More Money into Our Economy to Boost Spending,”by the Bank of England, 2010. The BoE gained control over the issue of banknotes. As a consequence of this pretence, successive governments have been able to claim that the cost of government debt servicing has been more onerous than has actually been the case, and have claimed that this has prevented it from undertaking other forms of spending. g) See above. The only possible explanation for this misrepresentation has been that it has suited government purposes to make it. Quantitative easing can take several forms, depending on the assets the central bank buys, from whom it is purchased, and in what amounts. ~And the APF can make neither profit nor loss: by definition. When you mention QE into the economy, I take it to mean at the top end of the economy. Read my “Understanding Quantitative Easing” white paper at SSRN. The UK entered a double-dip recession in 2012. Where the Fed is not purchasing short-term debt, but is starting to buy longer term debt, things further down the yield curve. Please don’t but their lies. Far better to have everyone see and that the BoE needs an actual asset (gilts)to justify all this money creation. You still get your 5% coupons, but the increase in price is solely due to the current level of interest rates. Why would the establishment, which is dominated by the rich and their gofers, want to set up a phoney debt obligation or obligations and the answer is they hate uncertainty. Until you get your head around that your comementary is worthless, b) Wrong: the short term rate would be zero. Before the great financial crisis, 10y bond yields are at 5% and HMT issues a £100m 10y bond with a 5% coupon. The APF clearly states where it’s profit and loss comes from. It answers my basic questions/misunderstandings. The government kept some as their fee for coining. We need to bear in mind a few things here. HMT has made it’s money back – as well as front-loading the £25m to today and spreading it’s cost over 10 years. Tell me how the gain is passed back to the Treasury? Understanding the basics of QE: A quick QE primer. Politically it has suited the government’s narrative to maintain this pretence that interest is owing on these gilts. But I thought your point was that that government and the BoE aren’t acknowledging this reduction in debt service costs, when they vry clearly are doing so. I think you are looking at things purely on a static basis and assuming fixed coupon bonds also have a fixed value, which leads you to your mistake. Thank you Richard. Point 13 isn’t quite true either. To have the new money created sitting opposite gilts looks better than an a straight up overdraft from certain points of view I suppose, but it’s really only aesthetic.. Ways and means never covered these kinds of figures in the past either, its like having an overdraft as opposed to a taking out a mortgage. You claim the treasury makes a loss on purchase, which rather bizarrely means you think the bond is legally cancelled; it could not do so otherwise. QE expands the money supply and stimulates growth. OBR, government and BoE all acknowledge that QE has reduced debt servicing costs through lower rates and netting off with APF. Jonathan Portes says I am wrong because there is a new liability – the new money, Along with his claim that they are equal and opposites. Here’s the rub. First, I know exactly how this bond is priced. The true value of the £2trn of government debt is much higher than £2trn at the moment – were government to buy it all back today. In a nutshell politically motivated “smoke and mirrors” is being used to deny all the citizens of the UK an equitable Integrated Supply and Demand Policy. The mechanics of a QE transaction. The APF liability is the loan from the BoE, which is essentially a fixed amount with a floating interest rate cost. The Crown also borrowed heavily from private citizens, and most of the plethora of finance bills enacted in the seventeenth century specified the amounts to be borrowed from willing lenders and established new customs tariffs, or extended existing ones, to generate the revenue to service these debts. The price paid may not have been the price at which the gilts were originally issued by the government. Copyright © 2018 US Represented. The BoE starts QE and the APF buys the bonds from the market, at market prices, so pays £125m for the £100m face value. Take a £5 note to the BoE for redemption and they will give you another £5 (or maybe 5 x £1 coins). The present value of 5% coupons is worth more over the 10 years when discounted at 0% than at 5%. Don’t Give Up: The Legacy of Franklin Macon, Quantitative Easing: A Simple Explanation, Women’s Bean Project: Smart Assistance for Those in Need, On the Road: The Life and Times of an American Trucker. I gather to improve his chances Downing put considerable effort into trying to get a war going between England and the Low Countries, this against the specific written orders of his king. You can see this on page 12 of the following APF accounts. It also tries to make borrowing cheaper in order to help an economy grow again. He failed, and was rewarded only with a spell in the Tower for his efforts. Tax farmers then periodically submitted redeemed tallies in lieu of cash in settlement of their obligations to the Exchequer. This is called quantitative easing. We can tell from the accounts that the MtM gains ARE DEFINITELY passed back to HMT. If it didn’t pay interest, as you claim it could choose to, there would be serious implications and the BoE would lose the ability to maintain short term interest rates – which it does by paying interest on deposits primarily. Businesses can borrow money more easily. The treasury bought a bond at a premium. Using a pure MtM method, on both sides (WGA and APF) you would see the APF with an asset (bond) worth £125m and liability (borrowing from BoE) of £125m, so not net profit and loss. This is because the coupons are worth more, when discounted back by lower rates. If interest rates move lower to 0%, that bond will trade at 150. Quantitative easing is a sneaky way to make everyone dealing in U.S. dollars pay off the U.S. debt. There have been significant mark to market gains from the bonds held by the APF and these have already been passed back to HMT, as well as losses in a couple of years. Although the nature of this transaction would imply that the reacquired gilts are cancelled, because it is immediately apparent that the Treasury cannot owe itself money, the legal form in which the gilts were created, and the nature of the loan structure used for their repurchase has meant that legally the gilts have not been cancelled as a consequence of their repurchase. The new money swells the size of bank reserves in the economy by the quantity of assets purchased—hence "quantitative" easing. The accounts of the APF and WGA are not prepared on the same accounting basis, so you can’t just consolidate them in the manner you suggest. The loss is still very real though – HMT has simply repurchased the bond it issued at a higher price. Tallies were thus acceptable in payment not because they served to redeem recipients from their personal liabilities to taxation (as MMT accounts imply) but because they served as negotiable claims on tax revenues intended for the Exchequer. The U.S. central bank engages in quantitative easing to influence the economic activity and increase cash in order to stimulate the economy as a whole. our bond now has a value of 125, the extra 25 coming from the present value of 5% coupons and bullet repayment at a lower discount rate of 2.5%. I hope that much at least is not controversial. "https://secure." It is becoming apparent you don’t understand how bonds are priced or function. Can’t see the EU ever wanting to get into a bun fight over this with the UK ,they have had enough trouble to cope with within the EZ as it is. There is no prepaid interest, there is only present value, and what you are saying is simply totally wrong. The coronavirus pandemic has been a … Quantitative Easing Explained A number of subscribers forwarded this video to me and it’s making the rounds in financial circles. The point about accounting you make, saying that the Gilts are shown to be cancelled, is also not true. a) You are wrong: only the premium at the time of reacquisition matters: that is fixed. Quantitative easing is a tool that central banks, like us, can use to inject money directly into the economy. The central banking system, the Federal Reserve in America, buys bonds from private or commercial banks. When I can find time I will do another Mythbuster to explain the economic consequences of this: The Bank of England says that quantitative easing (QE) is[1]: Quantitative easing is a tool that central banks, like us, can use to inject money directly into the economy. [5] There is nothing surprising about this change in the price of gilts after their issue. However, many argue that quantitative easing only compounds economic problems by triggering a dangerous inflationary spiral. • Credit Easing Policy Tools Interactive chart of the assets on Federal Reserve's balance sheet. Now, with quantitative easing, the Federal Reserve buys bonds at a slightly higher price than anyone else in the market is willing to pay. So, in short, QE could cancel bonds, but there would be a cost associated with doing so – and quite a substantial one. has decided to go down the QE route rather than the Ways and means one. Even if you account for the APF and HMT in exactly the same manner, if you issue a bond at 100 and buy it back at 150 you will likely have lost money. https://www.bankofengland.co.uk/monetary-policy/quantitative-easing, https://beta.companieshouse.gov.uk/company/06806063, https://obr.uk/forecasts-in-depth/tax-by-tax-spend-by-spend/debt-interest-central-government-net/, Richard Murphy - Mythbuster: What is quantitative easing and how does it work? Of course it is not at arm’s length. If you those bonds were cancelled when bought at £125m, that £25m loss is locked in. I have been asked to explain how quantitative easing works, given how important it is within our economy and managing the coronavirus crisis right now. If you do it the way things are currently done, you get a distinct advantage. These values have been generated by the mark to market value of the Gilts held changing with interest rates (bond yields, specifically) and not the coupon payments from the bonds. As I mention in my other post, another major reason for the WGA being prepared in the manner they are is to eliminate the fluctuation of Gilt prices on the value of government debt outstanding – effectively simplifying the situation. The English were the forerunners in the evolution of money over the last 300 odd years:-, https://books.google.com/books?id=kMwCoQEACAAJ&pg=PA1&source=gbs_toc_r&cad=4#v=onepage&q&f=false. You need an accountant to get these things right. HMT itself now shows assets of £125m (£100 from sale of bond, £25m from APF) and liabilities marked to book of £100m, but the ammortised cost of repurchasing the bond is still £25 over the life (because they have locked in a sale at 5% and repurchase at 2.5%). The premium is prepaid interest to be unwound over the remaining life of the gilt previously contractually arranged, and still paid but with this cancelling the income on return to the treasury, so stating interest cost at originally contracted price. Banks are all about creating debt. I’ll be the first to admit that the mechanics of quantitative easing can be hard to wrap your head around. They explained this process in the Spring 2014 edition of their Quarterly Bulletin, The vast majority of the money created in this way was used by the APF to buy government gilts from the financial institutions that owned them. Either way, you are still left with a cost to government and QE not being free. This is another reason you can’t simply cancel bonds in the manner which you suggest. Why would the Govt. The EU fiscal pact rules have also been generally ignored/eased by the EU since their creation . The government stopped charging for creating coins at the Royal Mint. muddies the water by pretending that the gilts are not cancelled As I note – the premium is an asset representing interest prepaid. QE is kind of like the open market operations that I mentioned earlier where the Fed buys bonds to influence interest rates. If anything, the structure in place means HMT doesn’t have to crystallize losses upfront and can ammortise them over the life of the bond – though those losses don’t disappear. They pay interest to the BoE of £3.5bn and the remaining £43.5bn is paid back to HMT. The loan from the Bank of England to fund the purchase of the reacquire gilts is a liability on the APF balance sheet. The GFC happens and markets price interest rate lower – to 2.5%. As Kimberly Amadeo explains in the balance: make money personal, during the Great Recession that began in around 2007, Quantitative Easing “removed toxic subprime mortgages from banks’ balance sheets, restoring trust and therefore banking operations. You really need to learn to read and understand accounts. document.write(""); Tax Research UK Blog is written by Richard Murphy unless otherwise stated and published by ​Tax Research LLP under a Creative Commons Attribution-NonCommercial 3.0 Unported License. The word which comes to mind is obfuscation! As described by Robert Ashton in “The Crown and the Money Market 1603-1640” (OUP 1960), the Crown farmed out to consortia of private individuals collection of certain taxes and customs revenues hypothecated for specific purposes. those of the APF, still show transactions being undertaken with regard to these gilts, does not alter this economic substance that the transactions in question net out on consolidation for the government as a whole, and as such have no real economic substance to them, clearly indicating that the gilts in question are effectively cancelled. ( ignoring the interest element ) After that there is no risk because the Treasury owns both sides of the arrangement. Tweets by @RichardJMurphy Please don’t think mark to market accounting reflects reality – it assumes a sale that will never take place. Money is either physical, like banknotes, or digital, like the money in your bank account. Agreed, the BoE has only recently started paying interest on its reserves. d) I know the APF accounts inside out: you fail to read them as being internal accounts of the Trteasury which is what they actually are, and so the double entry is wholly within the Treasury. The government doesn’t MtM their borrowings. I’ve seen this argument before, seems a rather academic one to me. What follows is part of a larger piece of work that is in development, and is a bit technical in nature, but I hope it is of use to those who are looking for a bigger understanding of this issue. Bonds are loans, or IOUs, but you serve as the bank. Rationally that is the discounted value of the future income stream payable with the discount rate being the difference between issued and prevailing rates to equate these over bond life. Any way you look at it though, and however you consolidate the accounts buying Gilts back at higher prices than they we issued at is still going to mean HMT has lost money. This is important to note for the later points you make, where you only consider the interest (coupon) payments of the Gils, but not their mark to market value. I hope we can all agree that this bond will issue at par – 100. e) A premium on a bond price is due to the present value of the coupons and bullet being higher than when issued, because interest rates are lower. This influx of cash is supposed to stimulate the economy. ” the whole of the Govts.basis ” the gilts are indeed shown as cancelled. Point 14 is also incorrect I’m afraid. Please visit our Private: Data Protection & Cookie Policy page for more information about cookies and how we use them. The bond premium will change as interest rates change – which is why you see bond mark to markets change. A visual guide to endogenous money and the failure of QE. The coupons cancel out, as you suggest, but they have still paid 150 for an asset which will redeem at 100. So it is not a sham that the APF is at arms length. For it to be any other way, there would have to be a finite supply of money. The premium is porep[aid interest not now due. I’ve got so much stuff to get my head round!!!! image caption Quantitative easing aims to support the economy by encouraging people to save less and spend a bit more. “Oh look the government’s already in debt can’t afford to do what you oiks want!”. Quantitative easing involves us creating digital money. A lot of what you describe is correct, but you have made some important omissions and at the end you start to get things wrong. It also clearly states that any profits are returned to HMT, and and losses are made whole by the HMT indemnity guarantee. Who wins ? This claim has been disingenuous. Although “quantitative easing” sounds complex, the idea is relatively simple in economic terms. Any surplus tax legitimately collected by them over and above this amount belonged to them. Yesterday’s post discussed central banks’ use of quantitative easing … The result has been that the income in question has been returned to HM Treasury, as a matter of fact. Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. To date none have ever been sold back to the financial markets although some have been redeemed by HM Treasury at the end of their lives. f) I’m not sure where the fraud is coming from. I have already explained why you are wrong on this, And the Treasury did not lose on repurchasing these gilts, It saved paying future interest to third parties – and that was what the premium represented, And now your posts will be deleted, because I bet bored after a while with people who can’t understand macro issues. Better that, than sitting in the dark though!!!! Any excess liquidity would then go seeking any place to be parked, even at negative yields. 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