How Banks Create Money out of Thin Air

Darling’s latest rescue plan for the economy is to print fresh money.

By GEORGE PASCOE-WATSON
Political Editor


CHANCELLOR Alistair Darling’s latest rescue plan for the economy is to print fresh money.
The Treasury and the Bank of England will agree this week on a £100billion injection of cash which currently doesn’t exist. Economists call the highly risky strategy “quantitative easing”.

Here is The Sun’s guide to modern-day printing money:


Why is it happening?
The Bank of England’s main weapon against a slump is interest rates. It has cut them down to one per cent already to put more cash in people’s pockets.

But that still hasn’t done the trick and once interest rates fall to zero per cent, it must find a new way of kick- starting the economy.


Does this literally mean fresh bank notes, i.e fivers and tenners, being printed?
No.


So why is it called printing money?
Quantitative easing means flooding the economy with more money than currently exists. But the cash injected is not new bank notes. It is done electronically by the Bank of England, our central bank.


How does it happen?
High Street banks will “sell” their assets to the Bank of England. These can be mortgage deals they have with customers, Government bonds and other debt. The Bank of England will then pay the banks for these assets with money that currently doesn’t exist. It won’t be hard cash — it will be electronic transfers of money.

In fact, the Bank of England will merely increase the size of commercial banks’ accounts held there. All banks must keep reserves of cash at the Bank of England.

So the commercial banks’ assets will be swapped for more cash reserves by the Bank of England.


What happens next?
Commercial banks will have more money to use — and lend. Printing money will also keep long-term interest rates down — meaning banks will be more likely to lend to each other.

This will encourage them to give credit to firms and individuals who will start spending money.


How much cash is there in the money supply?
We currently have £1.95trillion in the UK money supply. Only £50billion is cash — or £850 per person. The rest is in banks as savings and investments.


Are there risks?
There is a risk of hyper-inflation if printing money is done too rapidly.


Has it ever been done before?
Yes. Most recently the Japanese government did it for six years, only ending the practice in 2006. But experts believe the move did not make a significant difference to their long-term slump.


What about disasters?
Money was printed and pumped into the economy in Zimbabwe under Robert Mugabe and in pre-Second World War Germany. Both actions led to the economies’ collapse as banknotes became worthless.

In Germany people carried cash in wheelbarrows because each note was worth so little. The barrows were soon stolen because they were worth more than the cash due to hyperinflation.

http://www.thesun.co.uk/sol/homepage/news/money/article2262459.ece

The market gives a thumbs-up to printing money

The market gives a thumbs-up to printing money
Posted By: Edmund Conway at Feb 18, 2009 at 19:58:27 [General]

What would you expect a currency to do when a central bank admits it is about to start printing money imminently? The answer you'll find in the textbooks is pretty clear: it will fall, and fall fast. Just look at Zimbabwe.

But that's precisely the opposite of what happened this morning when the Bank of England said that within weeks it will have the printing presses roaring away. In fact, as you can see from the graph here, after the Bank announced this in its Monetary Policy Committee minutes at around 9.30, people started buying, rather than selling, sterling. Why? What on earth has happened in the topsy-turvy world of currencies that makes traders believe a good investment is a currency that is about to become all the more plentiful? Has everyone lost their senses?



The answer is intriguing, and helps underline precisely how counterintuitive is the policy challenge we face in this economic crisis. People are buying sterling not out of economic ignorance or bloody-mindedness but as a vote of confidence in the Bank of England's economic policy. In other words, they believe quantitative easing - the technical term for printing money - will, in the long run, bring the economy back to health, even if in the short run it could devalue sterling.

Meanwhile, the market is punishing the euro (against which I plotted the pound in this chart) because of the European Central Bank's neanderthal approach to monetary policy. Of all the central banks they are the most reluctant to slash interest rates and start up the presses. This could be a big mistake.

The explanation for this, by the way, goes back to the genesis of each continent's respective central bank. The ECB is the spawn of the German Bundesbank. Its history was shaped by the horrific experience of Weimar Germany's hyperinflation of the 1920s, so it is naturally inclined to fear the worst about inflation. The Federal Reserve's big bugbear, on the other hand is deflation, since that was what afflicted the US in the 1930s.

Anyway, the point is that the market believes (today anyway) that the Federal Reserve, which is already well down the road towards money-printing, and the Bank of England are right, and that the ECB is wrong. I happen to agree.

Quantitative easing is a hard sell - I know that from your comments whenever I write approvingly about it! But if handled properly I genuinely believe it could help prevent this from turning into the recession to end all recessions.

Whether you agree with me or not about that, the one thing we can surely all agree on is that, should the Bank of England pursue this course, it must, must be ready to raised interest rates and pull money back out of the economy when it looks as if deflation has really been averted.

You can count on us at the Telegraph to do our best to make sure it does.

http://blogs.telegraph.co.uk/edmund_conway/blog/2009/02/18/the_market_gives_a_thumbsup_to_printing_money

Bank of England to buy bonds and loans in first step towards quantitative easing

The iconic columns of the Bank of England in London. Photo: EPA

Bank of England to buy bonds and loans in first step towards quantitative easing
The Government has taken the first step towards quantitative easing by authorising the Bank of England to buy up to £50bn of private sector assets as part of a wider drive to get banks lending again.

By Angela Monaghan Last Updated: 2:52PM GMT 19 Jan 2009

Under the scheme the Bank will be able to buy corporate bonds and consumer loans under the Government's new credit guarantee scheme.
Mervyn King, the Bank's Governor, said the new facility would "provide an important additional tool to improve financing conditions in the economy."
The move is not quantitative easing as it does not involve an increase in the money supply, but some said it could mark the beginning of a shift in that direction.
"This framework could readily evolve into full-blown quantitative easing - we would expect it to do so given the proximity of Bank Rate a de facto zero bound and deteriorating economic conditions, perhaps as soon as March/April," said Ross Walker, economist at Royal Bank of Scotland.
Quantitative easing, also known as printing money, is a more unconventional tool available to the Bank beyond interest rates as it attempts to halt the pace of economic decline in the UK.
The programme announced by the Treasury today comes into effect on February 2, before the next vote on interest rates by the Bank's Monetary Policy Committee on February 5.
"In effect one can argue that this makes the Bank of England the UK's 'bad bank', even if there are some limits to the risk that is being transferred," said Marc Ostwald, strategist at Monument Securities. "Cynics could also argue that Brown and Darling are merely passing the buck to the MPC in terms of exit strategy."
It is part of a broader programme announced by the Treasury this morning allow banks to exchange cash or shares for a Government guarantee on their "toxic" debts. As part of the rescue package, the taxpayer has taken an even bigger stake in Royal Bank of Scotland
The package comes before the first official confirmation on Friday that the UK is in recession. The Office for National Statistics is expected to reveal a sharp decline in gross domestic product in the final quarter of 2008, following a 0.6pc contraction in the third quarter. A technical recession occurs when the economy shrinks for two successive quarters.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/4288754/Bank-of-England-to-buy-bonds-and-loans-in-first-step-towards-quantitative-easing.html