Pound and gilt yields slide as Bank of England pledges to buy £50bn more
Money and currency markets were sent reeling after the Bank of England surprised the City by unexpectedly extending its programme of Quantitative Easing (QE) by £50bn.
By Edmund Conway, Economics Editor
Published: 5:54AM BST 07 Aug 2009
Far from bringing its programme of bond-buying to an end, the Bank's Monetary Policy Committee has extended it beyond the initial £150bn ceiling agreed with the Chancellor.
The Bank said it planned to increase the scale of its programme to £175bn over the next three months, buying up a further chunk of the UK sovereign debt market. As expected, it also left the Bank rate on hold at 0.5pc. The move sent the pound more than a cent and a half lower against the dollar to $1.6801, although sterling strengthened against the euro, whose guardian, the European Central Bank, also left its key rate on hold at 1pc.
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The announcement caused a further flurry in gilt market, where yields dropped at one point by more than 20 basis points, before settling at just above 3.7pc.
So much of the gilts market does the Bank now own that, in a landmark move, it also agreed that it would temporarily lend out gilts through the Debt Management Office to ensure that banks are able to close out positions as necessary.
The Bank has also suspended its purchases of four particular maturities of gilts after it emerged that it had bought as much as 70pc of their total issue. In a further sign of the rate at which it is exhausting the gilt market, the Bank will also start buying gilts of both shorter and longer maturities than the 5 to 25 year set it was originally buying.
Danny Gabay of Fathom Consulting said the news "reflects the fact that the Bank has to all intents and purposes 'cornered' the market for certain Gilts or bonds, to which market participants may still need to have access. Innocent enough - but it makes the charge that the whole [scheme] is an elaborate smokescreen for monetising the government's ballooning deficit even harder to refute.
"So, while we welcome the news of an extension to the asset programme, we would once again urge the MPC to consider a much wider range of assets to purchase than government bonds."
Yesterday's decision means that the Bank will soon own almost half of the entire gilts market, currently worth around £400bn, raising further questions about the Government's reliance on the QE programme to keep its financing under control.
Former Bank policymaker Sushil Wadhwani said he suspected the Bank's enthusiasm for QE could store up problems next year as attention focuses on the creditworthiness of various countries around the world.
"It seems to me that with the economic indicators bouncing they didn't need to take the risk [of extending QE], though I don't think it will do a lot of harm at this stage."
http://www.telegraph.co.uk/finance/financetopics/recession/5984999/Pound-and-gilt-yields-slide-as-Bank-of-England-pledges-to-buy-50bn-more.html
Showing posts with label quantitative easing. Show all posts
Showing posts with label quantitative easing. Show all posts
Friday 7 August 2009
Sunday 29 March 2009
It's time to admit inflation is going to be a major problem
It's time to admit inflation is going to be a major problem
I don't wish to be smug. But can we now agree that, despite repeated warnings from ministers and the City, the UK won't get caught in a "deflationary spiral" and inflation is a much greater danger?
By Liam Halligan
Last Updated: 5:11AM BST 29 Mar 2009
Comments 0 Comment on this article
For months, this column has argued that the spectre of deflation has been conjured up by those whose hubris and incompetence caused this crisis.
It's given Gordon Brown an excuse to indulge the Keynesian wet-dreams of his political adolescence, spending our money willy-nilly, with absolutely no regard for the impact on future generations.
Our economy is being held to ransom by deflation fear
Even before this sub-prime debacle, his borrowing was far too high.
But having failed to put the UK's fiscal house in order during the good years, Brown has now set fire to the whole shebang.
The reason, we're told, is that because deflation is imminent, "the danger of doing too little is greater than the danger of doing too much".
"Deflation is coming" has been the mantra of the City economists too.
Could their views be influenced by the institutions employing them?
Hyped-up deflationary fears have certainly led to an awful lot of taxpayer-funded "soft credits" being chucked towards the Square Mile.
Meanwhile, the supposed cure, "quantitative easing" (sic), is allowing banks that should fail, that need to fail, to rebuild balance sheets they themselves destroyed by years of wild risk-taking. So, if you're a washed-up, spendthrift Prime Minister, or a banking executive desperate to cover up past mistakes, "look out, deflation" is a useful message to get into the mind of the public.
Barely pausing to look at the evidence or question WHY our so-called leaders are saying this, the press has too easily obliged.
The UK economy contracted 1.6pc during the final three months of 2008 and 0.7pc the quarter before.
This is now a deep downturn – the worst since the early 1980s and counting. Retail sales growth was a perky 3.8pc in January, but slumped to 0.4pc last month.
Despite that slowdown, and the "deflation is nigh" warnings, CPI inflation ROSE in February – to 3.2pc, up from 3pc the month before.
So grave is the deflationary danger that the Bank of England has just written a letter to the Treasury explaining why inflation remains ABOVE its 2pc target – as it has been for 17 months.
RPI inflation fell marginally last month, to 0.0pc. But that measure stresses house prices – which, of course, have dropped sharply.
Desperate to drum up more free taxpayers' cash, City economists were only last week forecasting the February RPI number would be minus 0.7pc. How wrong can you be?
The RPIX – similar to RPI, but excluding housing costs – also rose last month and, while the deflationists tried to attribute February's CPI number to rising food prices, "core inflation" – which excludes items with volatile prices such as food – shot up too.
Why? Because, weighed down by lax fiscal and monetary policy, the pound has lost a third of its value in just over a year.
That pushes up import prices and overseas goods account for a very high share of UK household spending.
In my view, inflation will get much worse in the medium term.
By the time "quantitative easing" is over, the UK will have more than doubled its monetary base.
Deflationists say low lending offsets that but M4 – the broadest monetary measure, which includes bank lending – is still growing by 16pc a year.
Lending to households is 5pc down on last year. Lending to firms is still expanding but only by 4pc, compared with 15pc average annual corporate credit growth since 2005.
But credit to OFIs – other financial institutions – is now growing at a colossal 45pc annual rate, so banks are "still lending", as they say, but mostly to their own off-balance sheet vehicles
which they set up in previous years to take crazy risks.
That lending will find its way into the economy and is still inflationary – even if ordinary punters are "credit crunched".
So, both base and broad money are now expanding rapidly – storing up huge future inflation, despite the slowdown.
I accept that, during the early summer, the RPI may go negative for a month or two. Oil prices were up above $140 in May and June last year, and will this year be much lower – weighing heavily on the index. But such "base effects" will be short-lived and very quickly reversed.
Oil was $40 a barrel in December 2008 and, as explained below, could easily be at $60 by the end of this year – 50pc higher.
That will send the inflation indices into orbit, just as the vast monetary expansion starts feeding through.
So, please, let's stop pretending deflation is a problem.
We need an honest, robust debate about fiscal meltdown, bank balance sheets and future inflation – the genuine problems we face.
West set for a crude awakening
AS THE G20 denizens battle to save the global economy, one positive they can point to is the price of oil. Since soaring last summer, the cost of crude has collapsed.
That lowers fuel bills and helps Western oil importers cut their (often gaping) trade deficits. How bad would things be if, as well as financial meltdown, we had high oil prices too?
Well, that could easily happen. Oil prices moved firmly above $50 last week – almost 40pc up from their February low. Until now, most economists have accepted the "demand destruction" story – assuming a slowing world economy would use less oil, keeping a lid on prices.
But crude has recently rocketed, despite the prospects for global growth being worse than at any time during this crisis. Across the Western world, GDP growth forecasts are being scythed. The US, the world's biggest oil importer, is now contracting at its fastest rate for three decades. In Japan, the world's second largest economy, oil imports are at a 20-year low.
So why is oil going up? Well, "demand destruction" was never as big a deal as economists in oil-importing countries wanted to believe.
The big emerging markets now account for a large share of world-wide oil use. Their population growth, and on-going economic expansion, is keeping global oil demand firm.
At the same time, recent low crude prices have caused production cutbacks. In the past six months, the number of active oil rigs in the US – still a major crude producer – has dropped nearly 50pc.
Even worse, high credit costs have led to much lower spending on future production capacity.
In Saudi, UAE, Russia and other leading producers, numerous oil infrastructure projects have lately been mothballed or axed.
That's one reason why oil markets are showing such a steep "contango" – with futures contracts way above today's "spot" price. Oil for delivery in December 2009 is now more than $60 a barrel, rising beyond $70 a year later.
Something else is going on too. Across the world, many sophisticated investors and money-managers have never believed the self-serving "deflation is coming" mantra being pumped-out of London and Washington. And as Western governments lose control and central bank printing presses crank-up, the "inflation not deflation" crowd is growing.
That's why oil prices are rising. As a tangible, scarce asset like gold, crude is increasingly being used as an easily tradable anti-inflation hedge.
http://www.telegraph.co.uk/finance/comment/liamhalligan/5066497/Its-time-to-admit-inflation-is-going-to-be-a-major-problem.html
Related Articles
Right, not bonkers
Economy could sink Gordon Brown in snap poll
To cut rates would harm the Bank's reputation
Inflation is the greatest danger to the British economy
Our economy is being held to ransom by deflation fear
I don't wish to be smug. But can we now agree that, despite repeated warnings from ministers and the City, the UK won't get caught in a "deflationary spiral" and inflation is a much greater danger?
By Liam Halligan
Last Updated: 5:11AM BST 29 Mar 2009
Comments 0 Comment on this article
For months, this column has argued that the spectre of deflation has been conjured up by those whose hubris and incompetence caused this crisis.
It's given Gordon Brown an excuse to indulge the Keynesian wet-dreams of his political adolescence, spending our money willy-nilly, with absolutely no regard for the impact on future generations.
Our economy is being held to ransom by deflation fear
Even before this sub-prime debacle, his borrowing was far too high.
But having failed to put the UK's fiscal house in order during the good years, Brown has now set fire to the whole shebang.
The reason, we're told, is that because deflation is imminent, "the danger of doing too little is greater than the danger of doing too much".
"Deflation is coming" has been the mantra of the City economists too.
Could their views be influenced by the institutions employing them?
Hyped-up deflationary fears have certainly led to an awful lot of taxpayer-funded "soft credits" being chucked towards the Square Mile.
Meanwhile, the supposed cure, "quantitative easing" (sic), is allowing banks that should fail, that need to fail, to rebuild balance sheets they themselves destroyed by years of wild risk-taking. So, if you're a washed-up, spendthrift Prime Minister, or a banking executive desperate to cover up past mistakes, "look out, deflation" is a useful message to get into the mind of the public.
Barely pausing to look at the evidence or question WHY our so-called leaders are saying this, the press has too easily obliged.
The UK economy contracted 1.6pc during the final three months of 2008 and 0.7pc the quarter before.
This is now a deep downturn – the worst since the early 1980s and counting. Retail sales growth was a perky 3.8pc in January, but slumped to 0.4pc last month.
Despite that slowdown, and the "deflation is nigh" warnings, CPI inflation ROSE in February – to 3.2pc, up from 3pc the month before.
So grave is the deflationary danger that the Bank of England has just written a letter to the Treasury explaining why inflation remains ABOVE its 2pc target – as it has been for 17 months.
RPI inflation fell marginally last month, to 0.0pc. But that measure stresses house prices – which, of course, have dropped sharply.
Desperate to drum up more free taxpayers' cash, City economists were only last week forecasting the February RPI number would be minus 0.7pc. How wrong can you be?
The RPIX – similar to RPI, but excluding housing costs – also rose last month and, while the deflationists tried to attribute February's CPI number to rising food prices, "core inflation" – which excludes items with volatile prices such as food – shot up too.
Why? Because, weighed down by lax fiscal and monetary policy, the pound has lost a third of its value in just over a year.
That pushes up import prices and overseas goods account for a very high share of UK household spending.
In my view, inflation will get much worse in the medium term.
By the time "quantitative easing" is over, the UK will have more than doubled its monetary base.
Deflationists say low lending offsets that but M4 – the broadest monetary measure, which includes bank lending – is still growing by 16pc a year.
Lending to households is 5pc down on last year. Lending to firms is still expanding but only by 4pc, compared with 15pc average annual corporate credit growth since 2005.
But credit to OFIs – other financial institutions – is now growing at a colossal 45pc annual rate, so banks are "still lending", as they say, but mostly to their own off-balance sheet vehicles
which they set up in previous years to take crazy risks.
That lending will find its way into the economy and is still inflationary – even if ordinary punters are "credit crunched".
So, both base and broad money are now expanding rapidly – storing up huge future inflation, despite the slowdown.
I accept that, during the early summer, the RPI may go negative for a month or two. Oil prices were up above $140 in May and June last year, and will this year be much lower – weighing heavily on the index. But such "base effects" will be short-lived and very quickly reversed.
Oil was $40 a barrel in December 2008 and, as explained below, could easily be at $60 by the end of this year – 50pc higher.
That will send the inflation indices into orbit, just as the vast monetary expansion starts feeding through.
So, please, let's stop pretending deflation is a problem.
We need an honest, robust debate about fiscal meltdown, bank balance sheets and future inflation – the genuine problems we face.
West set for a crude awakening
AS THE G20 denizens battle to save the global economy, one positive they can point to is the price of oil. Since soaring last summer, the cost of crude has collapsed.
That lowers fuel bills and helps Western oil importers cut their (often gaping) trade deficits. How bad would things be if, as well as financial meltdown, we had high oil prices too?
Well, that could easily happen. Oil prices moved firmly above $50 last week – almost 40pc up from their February low. Until now, most economists have accepted the "demand destruction" story – assuming a slowing world economy would use less oil, keeping a lid on prices.
But crude has recently rocketed, despite the prospects for global growth being worse than at any time during this crisis. Across the Western world, GDP growth forecasts are being scythed. The US, the world's biggest oil importer, is now contracting at its fastest rate for three decades. In Japan, the world's second largest economy, oil imports are at a 20-year low.
So why is oil going up? Well, "demand destruction" was never as big a deal as economists in oil-importing countries wanted to believe.
The big emerging markets now account for a large share of world-wide oil use. Their population growth, and on-going economic expansion, is keeping global oil demand firm.
At the same time, recent low crude prices have caused production cutbacks. In the past six months, the number of active oil rigs in the US – still a major crude producer – has dropped nearly 50pc.
Even worse, high credit costs have led to much lower spending on future production capacity.
In Saudi, UAE, Russia and other leading producers, numerous oil infrastructure projects have lately been mothballed or axed.
That's one reason why oil markets are showing such a steep "contango" – with futures contracts way above today's "spot" price. Oil for delivery in December 2009 is now more than $60 a barrel, rising beyond $70 a year later.
Something else is going on too. Across the world, many sophisticated investors and money-managers have never believed the self-serving "deflation is coming" mantra being pumped-out of London and Washington. And as Western governments lose control and central bank printing presses crank-up, the "inflation not deflation" crowd is growing.
That's why oil prices are rising. As a tangible, scarce asset like gold, crude is increasingly being used as an easily tradable anti-inflation hedge.
http://www.telegraph.co.uk/finance/comment/liamhalligan/5066497/Its-time-to-admit-inflation-is-going-to-be-a-major-problem.html
Related Articles
Right, not bonkers
Economy could sink Gordon Brown in snap poll
To cut rates would harm the Bank's reputation
Inflation is the greatest danger to the British economy
Our economy is being held to ransom by deflation fear
Tuesday 24 March 2009
Q&A: How will quantitative easing affect me?
From Times Online
March 5, 2009
Q&A: How will quantitative easing affect me?
David Budworth
The Bank of England voted today to begin quantitative easing — effectively printing money — to drag the UK out of recession. Here we explain how this radical decision could impact on your finances in the months and years to come.
Q: Who is going to benefit directly from the extra money printed?
A: Banks, other big institutional investors and possibly large companies, but not the average person.
When a central bank like the Bank of England embarks on quantitative easing it has to find a way of pumping the extra money created into the economy. The Bank is expected to offer to buy government bonds, called gilts, from institutional investors and the corporate treasury departments of large companies using the billions created. It might also offer to buy corporate bonds from the same investors but private individuals will not be part of the buy-back programme.
Q: How will this cash makes its way into the wider economy?
A: The investors who get their hands on the money are expected to deposit this cash in the banking system, helping to boost bank reserves.
Q: If banks have more money in their coffers, will it become easier to borrow money?
A: Anxious banks are still reluctant to lend money to individuals and businesses despite historically low rates. However, if quantitative easing works, it will become easier to take out a mortgage or loan and here is how it could work.
Quantitative easing will flood the UK banks with hard cash, but because the base rate is only 0.5 per cent they will earn hardly anything by sitting on that money.
Hopefully this will persuade the banks that it will be more profitable to lend the money out, ending the lending freeze that has crippled the economy and exacerbated the house price slump.
Q: What will that mean for economic growth?
A: If households and businesses are able to borrow more, they will have extra money in their pockets. This should increase spending helping to stimulate economic growth, boost employment prospects and even drag us out of recession.
Q: Will it work?
A: No one can be sure.
Ian Kernohan, the chief economist at Royal London Asset Management, said: "It is still not clear why banks have been so anxious about lending. If it is because they haven't had access to enough funds then it could work. But if they are worried about lending at a time when we are in recession and house prices are falling they may not want to boost lending."
There is a danger that the banks will simply sit on the money rather than increase lending.This is what happened in Japan at the early part of this decade. Because the money wasn't dispersed into the wider economy Japan suffered from a long-term recession.
Q: How long will it be before we know if it has worked?
A: Months not weeks.
Q: Are there any downsides to central banks creating money through quantitative easing?
A: There is a risk that the extra money will encourage too much growth and ignite inflation. The Bank could then have to raise interest rates aggresively.
However, it could be several years before this becomes apparent as deflation — falling prices — is the most serious risk in today's environment. And if the Bank makes the right decisions in the coming months it should be able to control inflation before it gets out of hand.
Q: Isn't the Bank of England being reckless by encouraging more borrowing?
A: Reckless lending sparked the financial crisis, but most economists think that we have gone too far in the other direction and are not borrowing enough to keep the economy running smoothly.
Kernohan said: "We have gone from feast to famine and need to get back to a more normal situation where businesses and individuals can have access to credit. At the moment we are in a vicious circle and the bank is aiming to change that into a virtuous circle."
Q: Will I be affected if I am invested in gilts?
A: Martin Gahbauer, a senior economist at Nationwide Building Society, said: "In the short term, this could push gilt yields down. Yields have already fallen quite significantly in expectation that the Bank was going to do this."
Bond yields are one of the main influences on annuity rates so this could be bad news for those approaching retirement.
http://www.timesonline.co.uk/tol/money/property_and_mortgages/article5851508.ece
Related Links
Mortgage rates rise to beat the Bank of England
Inflation explained
March 5, 2009
Q&A: How will quantitative easing affect me?
David Budworth
The Bank of England voted today to begin quantitative easing — effectively printing money — to drag the UK out of recession. Here we explain how this radical decision could impact on your finances in the months and years to come.
Q: Who is going to benefit directly from the extra money printed?
A: Banks, other big institutional investors and possibly large companies, but not the average person.
When a central bank like the Bank of England embarks on quantitative easing it has to find a way of pumping the extra money created into the economy. The Bank is expected to offer to buy government bonds, called gilts, from institutional investors and the corporate treasury departments of large companies using the billions created. It might also offer to buy corporate bonds from the same investors but private individuals will not be part of the buy-back programme.
Q: How will this cash makes its way into the wider economy?
A: The investors who get their hands on the money are expected to deposit this cash in the banking system, helping to boost bank reserves.
Q: If banks have more money in their coffers, will it become easier to borrow money?
A: Anxious banks are still reluctant to lend money to individuals and businesses despite historically low rates. However, if quantitative easing works, it will become easier to take out a mortgage or loan and here is how it could work.
Quantitative easing will flood the UK banks with hard cash, but because the base rate is only 0.5 per cent they will earn hardly anything by sitting on that money.
Hopefully this will persuade the banks that it will be more profitable to lend the money out, ending the lending freeze that has crippled the economy and exacerbated the house price slump.
Q: What will that mean for economic growth?
A: If households and businesses are able to borrow more, they will have extra money in their pockets. This should increase spending helping to stimulate economic growth, boost employment prospects and even drag us out of recession.
Q: Will it work?
A: No one can be sure.
Ian Kernohan, the chief economist at Royal London Asset Management, said: "It is still not clear why banks have been so anxious about lending. If it is because they haven't had access to enough funds then it could work. But if they are worried about lending at a time when we are in recession and house prices are falling they may not want to boost lending."
There is a danger that the banks will simply sit on the money rather than increase lending.This is what happened in Japan at the early part of this decade. Because the money wasn't dispersed into the wider economy Japan suffered from a long-term recession.
Q: How long will it be before we know if it has worked?
A: Months not weeks.
Q: Are there any downsides to central banks creating money through quantitative easing?
A: There is a risk that the extra money will encourage too much growth and ignite inflation. The Bank could then have to raise interest rates aggresively.
However, it could be several years before this becomes apparent as deflation — falling prices — is the most serious risk in today's environment. And if the Bank makes the right decisions in the coming months it should be able to control inflation before it gets out of hand.
Q: Isn't the Bank of England being reckless by encouraging more borrowing?
A: Reckless lending sparked the financial crisis, but most economists think that we have gone too far in the other direction and are not borrowing enough to keep the economy running smoothly.
Kernohan said: "We have gone from feast to famine and need to get back to a more normal situation where businesses and individuals can have access to credit. At the moment we are in a vicious circle and the bank is aiming to change that into a virtuous circle."
Q: Will I be affected if I am invested in gilts?
A: Martin Gahbauer, a senior economist at Nationwide Building Society, said: "In the short term, this could push gilt yields down. Yields have already fallen quite significantly in expectation that the Bank was going to do this."
Bond yields are one of the main influences on annuity rates so this could be bad news for those approaching retirement.
http://www.timesonline.co.uk/tol/money/property_and_mortgages/article5851508.ece
Related Links
Mortgage rates rise to beat the Bank of England
Inflation explained
Friday 20 March 2009
Federal Reserve is now playing a high-risk game with inflation
Federal Reserve is now playing a high-risk game with inflation
The US Federal Reserve is increasing its balance sheet by another $1 trillion, including $300bn of Treasury bonds, the Federal Open Market Committee said on Wednesday.
By Martin Hutchinson, breakingviews.com
Last Updated: 8:55AM GMT
19 Mar 2009
Yet the pace of US economic decline seems to be slowing, while deflation is nowhere visible. Fed policy is now high-risk, and resurgent inflation may strike sooner than expected.
The FOMC said it expects inflation to remain subdued with some risk it could "persist for a time below rates that best foster economic growth”. Notably, the Fed is not now forecasting actual deflation.
Related Articles
Inflation to fall to lowest in nearly 50 years
Inflation expected to fall as oil retreats and VAT cut kicks in
The week ahead
UK inflation falls to lowest in almost 50 years
Cheaper bills and coats keep wrap on inflation
That’s not surprising, since February’s top-line consumer price index rose 0.4pc, equivalent to 4.8pc annually, while core consumer prices also rose, by 0.2pc. The Cleveland Fed’s median CPI was 2.8pc above the previous year. February’s producer price inflation was marginally lower, with the headline index rising at 1.2pc annually and the core measure at 2.4pc.
Meanwhile, last week’s unexpectedly strong February retail sales and Institute for Supply Management index readings suggest that economic decline is slowing.
The experience of the 1970s in both the United States and Britain demonstrates that the Fed’s theory that inflation won't co-exist with economic slack is wrong. Thus an over-inflationary monetary or fiscal policy could quickly produce accelerating inflation even while recession persists.
The Fed’s proposed purchase of $300bn of long-term Treasury bonds, when combined with the Obama administration’s record budget deficits, is particularly risky. Running large budget deficits and monetising them through central bank purchases of debt is a highly inflationary policy that has got plenty of emerging markets into trouble.
Broad money growth, whether by the M2 metric or by the St. Louis Fed’s MZM figure, has been running at over 15pc annually since last September. The $1trillion further expansion of the Fed’s balance sheet is very likely to accelerate this. The effect may not be obvious in the short term. But at some point, it is almost inevitable inflation will return, probably with force.
The Fed will then need to reverse policy with the speed and verve of a racing driver. Unfortunately, the odds are against it doing so before inflation has taken hold.
For more agenda-setting financial insight, visit www.breakingviews.com
http://www.telegraph.co.uk/finance/breakingviewscom/5014284/Federal-Reserve-is-now-playing-a-high-risk-game-with-inflation.html
The US Federal Reserve is increasing its balance sheet by another $1 trillion, including $300bn of Treasury bonds, the Federal Open Market Committee said on Wednesday.
By Martin Hutchinson, breakingviews.com
Last Updated: 8:55AM GMT
19 Mar 2009
Yet the pace of US economic decline seems to be slowing, while deflation is nowhere visible. Fed policy is now high-risk, and resurgent inflation may strike sooner than expected.
The FOMC said it expects inflation to remain subdued with some risk it could "persist for a time below rates that best foster economic growth”. Notably, the Fed is not now forecasting actual deflation.
Related Articles
Inflation to fall to lowest in nearly 50 years
Inflation expected to fall as oil retreats and VAT cut kicks in
The week ahead
UK inflation falls to lowest in almost 50 years
Cheaper bills and coats keep wrap on inflation
That’s not surprising, since February’s top-line consumer price index rose 0.4pc, equivalent to 4.8pc annually, while core consumer prices also rose, by 0.2pc. The Cleveland Fed’s median CPI was 2.8pc above the previous year. February’s producer price inflation was marginally lower, with the headline index rising at 1.2pc annually and the core measure at 2.4pc.
Meanwhile, last week’s unexpectedly strong February retail sales and Institute for Supply Management index readings suggest that economic decline is slowing.
The experience of the 1970s in both the United States and Britain demonstrates that the Fed’s theory that inflation won't co-exist with economic slack is wrong. Thus an over-inflationary monetary or fiscal policy could quickly produce accelerating inflation even while recession persists.
The Fed’s proposed purchase of $300bn of long-term Treasury bonds, when combined with the Obama administration’s record budget deficits, is particularly risky. Running large budget deficits and monetising them through central bank purchases of debt is a highly inflationary policy that has got plenty of emerging markets into trouble.
Broad money growth, whether by the M2 metric or by the St. Louis Fed’s MZM figure, has been running at over 15pc annually since last September. The $1trillion further expansion of the Fed’s balance sheet is very likely to accelerate this. The effect may not be obvious in the short term. But at some point, it is almost inevitable inflation will return, probably with force.
The Fed will then need to reverse policy with the speed and verve of a racing driver. Unfortunately, the odds are against it doing so before inflation has taken hold.
For more agenda-setting financial insight, visit www.breakingviews.com
http://www.telegraph.co.uk/finance/breakingviewscom/5014284/Federal-Reserve-is-now-playing-a-high-risk-game-with-inflation.html
Thursday 12 March 2009
The dangers of printing money: four lessons from history
March 05, 2009
The dangers of printing money: four lessons from history
The Bank of England voted today to begin quantitative easing — printing money to you and me — in a last ditch attempt to save the UK from the twin threats of depression and deflation.
It is a decision that is fraught with risks.
The hope is that the money pumped into the economy will encourage banks to become more relaxed about lending to individuals and businesses.
Flush with extra cash we will all rush out to spend it, kickstarting the economy and dragging it out of recession. Governor of the Bank of England, Mervyn King, will get a well deserved knighthood, and the rest of us will all breathe a sigh of relief and carry on as before, a little poorer, a little wiser, but generally OK.
But, none of the above is certain.
Banks might prefer to sit on the cash resulting in continued gridlock in the borrowing market. Impact: a big fat zero.
If too much money is pumped into the economy inflation or even hyper-inflation becomes a real threat. Impact: an unwelcome return to the 1970s.
Have you got high hopes that it will work, or are you worried that it could dig us deeper into depression? Post your comments below.
In the meantime take heed of three examples from history - and one from current times- where printing money to get the economy out of a pickle has failed, sometimes spectacularly.
1. Weimar Republic (1923)
Following the the First World War, Germany, was forced to pay massive amounts of compensation to the Allies. By 1923, the Weimar Republic as it had become known, was buckling because of the huge cost and in 1923 it stopped payments.
France promptly invaded the Rhineland, Germany's most productive region, to force the reparation payments from Germany. Strikes were called and production ground to a near halt in the region.
The German Government resorted to printing money to pay its bills sparking a hyper inflation that destroyed the value of the currency and the savings of ordinary Germans as money lost all value. The rest, as they say, is history and an ugly one at that.
2. Zimbabwe (now)
There are many reasons for the sorry state that the Zimbabwean economy is in today. High on the list is the Zanu PF Government's tendency to print money like it is water to finance state spending.
As in Weimar Germany this has unleashed the horror of hyper-inflation - Zimbabwe has the highest inflation rate in the world, a terrifying 230 million per cent.
3. Revolutionary France (1789)
The revolutionary French government that seized control in 1789 printed money quicker than it chopped off the heads of the hated aristocracy. It seemed the obvious means of paying off the massive debts racked up under the final years of the ancien regime.
All might have been well, if the government hadn't yielded to cries for more to be printed - and more, and even more - as soon as the freshly printed money was used.
The massive printing sparked inflation immediately - not something that is expected in the UK since the economy is so stagnant. Seven years later the French economy was in ruins, opening the door for Napolean to seize control and wage war across Europe. Vive la Revolution, I don't think.
4. Japan (2001)
Japan's attempt to flush itself out of recession by printing yen didn't lead to disaster - in fact, it didn't really lead to anything, which was its main problem. It did little to encourage Japanese banks to increase lending. Instead the banks, simply sat on the cash or lent it to overseas borrowers.
The dangers of printing money: four lessons from history
The Bank of England voted today to begin quantitative easing — printing money to you and me — in a last ditch attempt to save the UK from the twin threats of depression and deflation.
It is a decision that is fraught with risks.
The hope is that the money pumped into the economy will encourage banks to become more relaxed about lending to individuals and businesses.
Flush with extra cash we will all rush out to spend it, kickstarting the economy and dragging it out of recession. Governor of the Bank of England, Mervyn King, will get a well deserved knighthood, and the rest of us will all breathe a sigh of relief and carry on as before, a little poorer, a little wiser, but generally OK.
But, none of the above is certain.
Banks might prefer to sit on the cash resulting in continued gridlock in the borrowing market. Impact: a big fat zero.
If too much money is pumped into the economy inflation or even hyper-inflation becomes a real threat. Impact: an unwelcome return to the 1970s.
Have you got high hopes that it will work, or are you worried that it could dig us deeper into depression? Post your comments below.
In the meantime take heed of three examples from history - and one from current times- where printing money to get the economy out of a pickle has failed, sometimes spectacularly.
1. Weimar Republic (1923)
Following the the First World War, Germany, was forced to pay massive amounts of compensation to the Allies. By 1923, the Weimar Republic as it had become known, was buckling because of the huge cost and in 1923 it stopped payments.
France promptly invaded the Rhineland, Germany's most productive region, to force the reparation payments from Germany. Strikes were called and production ground to a near halt in the region.
The German Government resorted to printing money to pay its bills sparking a hyper inflation that destroyed the value of the currency and the savings of ordinary Germans as money lost all value. The rest, as they say, is history and an ugly one at that.
2. Zimbabwe (now)
There are many reasons for the sorry state that the Zimbabwean economy is in today. High on the list is the Zanu PF Government's tendency to print money like it is water to finance state spending.
As in Weimar Germany this has unleashed the horror of hyper-inflation - Zimbabwe has the highest inflation rate in the world, a terrifying 230 million per cent.
3. Revolutionary France (1789)
The revolutionary French government that seized control in 1789 printed money quicker than it chopped off the heads of the hated aristocracy. It seemed the obvious means of paying off the massive debts racked up under the final years of the ancien regime.
All might have been well, if the government hadn't yielded to cries for more to be printed - and more, and even more - as soon as the freshly printed money was used.
The massive printing sparked inflation immediately - not something that is expected in the UK since the economy is so stagnant. Seven years later the French economy was in ruins, opening the door for Napolean to seize control and wage war across Europe. Vive la Revolution, I don't think.
4. Japan (2001)
Japan's attempt to flush itself out of recession by printing yen didn't lead to disaster - in fact, it didn't really lead to anything, which was its main problem. It did little to encourage Japanese banks to increase lending. Instead the banks, simply sat on the cash or lent it to overseas borrowers.
Q&A: How will quantitative easing affect me?
From Times Online
March 5, 2009
Q&A: How will quantitative easing affect me?
David Budworth
The Bank of England voted today to begin quantitative easing — effectively printing money — to drag the UK out of recession. Here we explain how this radical decision could impact on your finances in the months and years to come.
Q: Who is going to benefit directly from the extra money printed?
A: Banks, other big institutional investors and possibly large companies, but not the average person.
When a central bank like the Bank of England embarks on quantitative easing it has to find a way of pumping the extra money created into the economy. The Bank is expected to offer to buy government bonds, called gilts, from institutional investors and the corporate treasury departments of large companies using the billions created. It might also offer to buy corporate bonds from the same investors but private individuals will not be part of the buy-back programme.
Q: How will this cash makes its way into the wider economy?
A: The investors who get their hands on the money are expected to deposit this cash in the banking system, helping to boost bank reserves.
Q: If banks have more money in their coffers, will it become easier to borrow money?
A: Anxious banks are still reluctant to lend money to individuals and businesses despite historically low rates. However, if quantitative easing works, it will become easier to take out a mortgage or loan and here is how it could work.
Quantitative easing will flood the UK banks with hard cash, but because the base rate is only 0.5 per cent they will earn hardly anything by sitting on that money.
Hopefully this will persuade the banks that it will be more profitable to lend the money out, ending the lending freeze that has crippled the economy and exacerbated the house price slump.
Q: What will that mean for economic growth?
A: If households and businesses are able to borrow more, they will have extra money in their pockets. This should increase spending helping to stimulate economic growth, boost employment prospects and even drag us out of recession.
Q: Will it work?
A: No one can be sure.
Ian Kernohan, the chief economist at Royal London Asset Management, said: "It is still not clear why banks have been so anxious about lending. If it is because they haven't had access to enough funds then it could work. But if they are worried about lending at a time when we are in recession and house prices are falling they may not want to boost lending."
There is a danger that the banks will simply sit on the money rather than increase lending.This is what happened in Japan at the early part of this decade. Because the money wasn't dispersed into the wider economy Japan suffered from a long-term recession.
Q: How long will it be before we know if it has worked?
A: Months not weeks.
Q: Are there any downsides to central banks creating money through quantitative easing?
A: There is a risk that the extra money will encourage too much growth and ignite inflation. The Bank could then have to raise interest rates aggresively.
However, it could be several years before this becomes apparent as deflation — falling prices — is the most serious risk in today's environment. And if the Bank makes the right decisions in the coming months it should be able to control inflation before it gets out of hand.
Q: Isn't the Bank of England being reckless by encouraging more borrowing?
A: Reckless lending sparked the financial crisis, but most economists think that we have gone too far in the other direction and are not borrowing enough to keep the economy running smoothly.
Kernohan said: "We have gone from feast to famine and need to get back to a more normal situation where businesses and individuals can have access to credit. At the moment we are in a vicious circle and the bank is aiming to change that into a virtuous circle."
Q: Will I be affected if I am invested in gilts?
A: Martin Gahbauer, a senior economist at Nationwide Building Society, said: "In the short term, this could push gilt yields down. Yields have already fallen quite significantly in expectation that the Bank was going to do this."
Bond yields are one of the main influences on annuity rates so this could be bad news for those approaching retirement.
http://www.timesonline.co.uk/tol/money/property_and_mortgages/article5851508.ece
Related Links
Mortgage rates rise to beat the Bank of England
Inflation explained
March 5, 2009
Q&A: How will quantitative easing affect me?
David Budworth
The Bank of England voted today to begin quantitative easing — effectively printing money — to drag the UK out of recession. Here we explain how this radical decision could impact on your finances in the months and years to come.
Q: Who is going to benefit directly from the extra money printed?
A: Banks, other big institutional investors and possibly large companies, but not the average person.
When a central bank like the Bank of England embarks on quantitative easing it has to find a way of pumping the extra money created into the economy. The Bank is expected to offer to buy government bonds, called gilts, from institutional investors and the corporate treasury departments of large companies using the billions created. It might also offer to buy corporate bonds from the same investors but private individuals will not be part of the buy-back programme.
Q: How will this cash makes its way into the wider economy?
A: The investors who get their hands on the money are expected to deposit this cash in the banking system, helping to boost bank reserves.
Q: If banks have more money in their coffers, will it become easier to borrow money?
A: Anxious banks are still reluctant to lend money to individuals and businesses despite historically low rates. However, if quantitative easing works, it will become easier to take out a mortgage or loan and here is how it could work.
Quantitative easing will flood the UK banks with hard cash, but because the base rate is only 0.5 per cent they will earn hardly anything by sitting on that money.
Hopefully this will persuade the banks that it will be more profitable to lend the money out, ending the lending freeze that has crippled the economy and exacerbated the house price slump.
Q: What will that mean for economic growth?
A: If households and businesses are able to borrow more, they will have extra money in their pockets. This should increase spending helping to stimulate economic growth, boost employment prospects and even drag us out of recession.
Q: Will it work?
A: No one can be sure.
Ian Kernohan, the chief economist at Royal London Asset Management, said: "It is still not clear why banks have been so anxious about lending. If it is because they haven't had access to enough funds then it could work. But if they are worried about lending at a time when we are in recession and house prices are falling they may not want to boost lending."
There is a danger that the banks will simply sit on the money rather than increase lending.This is what happened in Japan at the early part of this decade. Because the money wasn't dispersed into the wider economy Japan suffered from a long-term recession.
Q: How long will it be before we know if it has worked?
A: Months not weeks.
Q: Are there any downsides to central banks creating money through quantitative easing?
A: There is a risk that the extra money will encourage too much growth and ignite inflation. The Bank could then have to raise interest rates aggresively.
However, it could be several years before this becomes apparent as deflation — falling prices — is the most serious risk in today's environment. And if the Bank makes the right decisions in the coming months it should be able to control inflation before it gets out of hand.
Q: Isn't the Bank of England being reckless by encouraging more borrowing?
A: Reckless lending sparked the financial crisis, but most economists think that we have gone too far in the other direction and are not borrowing enough to keep the economy running smoothly.
Kernohan said: "We have gone from feast to famine and need to get back to a more normal situation where businesses and individuals can have access to credit. At the moment we are in a vicious circle and the bank is aiming to change that into a virtuous circle."
Q: Will I be affected if I am invested in gilts?
A: Martin Gahbauer, a senior economist at Nationwide Building Society, said: "In the short term, this could push gilt yields down. Yields have already fallen quite significantly in expectation that the Bank was going to do this."
Bond yields are one of the main influences on annuity rates so this could be bad news for those approaching retirement.
http://www.timesonline.co.uk/tol/money/property_and_mortgages/article5851508.ece
Related Links
Mortgage rates rise to beat the Bank of England
Inflation explained
Wednesday 11 March 2009
Pound Falls Against Euro as Housing Sales Slide to Record Low
Pound Falls Against Euro as Housing Sales Slide to Record Low
By Matthew Brown
March 10 (Bloomberg) -- The pound fell to its weakest in more than five weeks against the euro after Britain’s housing sales slipped to the lowest level since at least 1978 and manufacturing shrank the most in four decades.
The U.K. currency dropped for a third day versus the 16- nation currency as the Bank of England prepared to print money to buy assets as part of a quantitative easing policy. The average number of transactions in a survey of real-estate agents and surveyors fell to 9.5 per respondent in the quarter through February, the least since the data began three decades ago, the Royal Institution of Chartered Surveyors said today.
“Investors are saying we don’t like the banking situation in the U.K., the housing data was bad, and we’re nervous about the economy,” said Jeremy Stretch, a senior currency strategist in London at Rabobank International. “Quantitative easing is about to begin, and all these factors tell us to stand aside and wait until it gets cheaper.”
The pound weakened to 92.33 pence per euro by 5:20 p.m. in London, from 91.53 yesterday. It slipped to 92.48 pence earlier, the lowest level since Jan. 29. Against the dollar, the currency was little changed at $1.3784.
Factory production dropped 2.9 percent in January from December, the Office for National Statistics in London said. Economists in a Bloomberg survey predicted a 1.4 percent decline. Manufacturing shrank 6.4 percent in the three months through January, the most since records began in 1968.
Quantitative Easing
The Bank of England will seek to buy 2 billion pounds of gilts in an operation for its asset-purchase facility on March 11, it said last week. Policy makers said March 5 they will acquire as much as 150 billion pounds of government and corporate assets, the first central bank to adopt quantitative easing since the Bank of Japan in the 1990s.
“With the Bank of England taking far more aggressive steps than any other central bank, bar possibly the Federal Reserve, the pound remains vulnerable to the downside,” Derek Halpenny, the London-based European head of global currency research at Bank of Tokyo-Mitsubishi UFJ Ltd., wrote in a note today.
Policy makers cut the nation’s benchmark interest rate 4.5 percentage points to an all-time low of 0.5 percent since October as the economy headed for its worst recession since World War II. Gross domestic product contracted 1.5 percent in the fourth quarter, the most since 1980, a report on Feb. 25 showed.
The pound may still strengthen to 89 pence per euro in the next three months as the recession in the euro region economy deepens, Stretch said. For Merrill Lynch & Co., the euro’s gain against the pound may have gone to far.
Gilts Rise
“We will probably look to fade the move higher in the euro- pound if and when the short-term interest-rate spread-compression trend resumes,” wrote Steven Pearson, a London-based strategist at Merrill Lynch. “It is worth noting that with the Bank of England bank rate having likely reached its terminal level, pound-euro may now start to trade well during risk aversion.”
U.K. government bonds rose, with the yield on the 10-year gilt falling one basis point to 3.11 percent. The 4.5 percent security due March 2019 advanced 0.09, or 90 pence per 1,000- pound face amount, to 111.82. Two-year gilt yields slipped one basis point to 1.32 percent. Bond yields move inversely to prices.
The U.K. Treasury today sold 3 billion pounds of 4.5 percent bonds maturing in 2019. The sale received bids 2.06 times the amount offered, the Debt Management Office said, compared with an average 1.9 times at the last three auctions of the securities.
‘Carried Away’
“Investors are getting carried away with the euphoria surrounding quantitative easing,” said Ian Williams, chief executive officer of Charteris Portfolio Managers in London. “The Bank of England is a buyer of gilts, but the U.K. government is still a net seller of gilts. The compression in yields when the penny drops is going to be difficult to maintain, and the implications of quantitative easing are inflationary.”
The yield on the 10-year gilt may rise to 3.25 percent by the end of April, said Williams, whose U.K. government-bond fund beat all its competitors in January, according to data from Lipper and given to Bloomberg by Charteris.
Ten-year gilts may keep gaining, according to technical strategists at Barclays Plc.
“Bigger picture, the secular bull trend remains intact, particularly following the recent failure to overcome 3.82 percent-area support,” Barclays Capital analysts including Jordan Kotick in New York wrote in a report. The yield may move toward 2.70 percent “medium term,” they said.
To contact the reporter on this story: Matthew Brown in London at mbrown42@bloomberg.net Last Updated: March 10, 2009 13:43 EDT
http://www.bloomberg.com/apps/news?pid=20601102&refer=uk&sid=adCmriDF1wc8
By Matthew Brown
March 10 (Bloomberg) -- The pound fell to its weakest in more than five weeks against the euro after Britain’s housing sales slipped to the lowest level since at least 1978 and manufacturing shrank the most in four decades.
The U.K. currency dropped for a third day versus the 16- nation currency as the Bank of England prepared to print money to buy assets as part of a quantitative easing policy. The average number of transactions in a survey of real-estate agents and surveyors fell to 9.5 per respondent in the quarter through February, the least since the data began three decades ago, the Royal Institution of Chartered Surveyors said today.
“Investors are saying we don’t like the banking situation in the U.K., the housing data was bad, and we’re nervous about the economy,” said Jeremy Stretch, a senior currency strategist in London at Rabobank International. “Quantitative easing is about to begin, and all these factors tell us to stand aside and wait until it gets cheaper.”
The pound weakened to 92.33 pence per euro by 5:20 p.m. in London, from 91.53 yesterday. It slipped to 92.48 pence earlier, the lowest level since Jan. 29. Against the dollar, the currency was little changed at $1.3784.
Factory production dropped 2.9 percent in January from December, the Office for National Statistics in London said. Economists in a Bloomberg survey predicted a 1.4 percent decline. Manufacturing shrank 6.4 percent in the three months through January, the most since records began in 1968.
Quantitative Easing
The Bank of England will seek to buy 2 billion pounds of gilts in an operation for its asset-purchase facility on March 11, it said last week. Policy makers said March 5 they will acquire as much as 150 billion pounds of government and corporate assets, the first central bank to adopt quantitative easing since the Bank of Japan in the 1990s.
“With the Bank of England taking far more aggressive steps than any other central bank, bar possibly the Federal Reserve, the pound remains vulnerable to the downside,” Derek Halpenny, the London-based European head of global currency research at Bank of Tokyo-Mitsubishi UFJ Ltd., wrote in a note today.
Policy makers cut the nation’s benchmark interest rate 4.5 percentage points to an all-time low of 0.5 percent since October as the economy headed for its worst recession since World War II. Gross domestic product contracted 1.5 percent in the fourth quarter, the most since 1980, a report on Feb. 25 showed.
The pound may still strengthen to 89 pence per euro in the next three months as the recession in the euro region economy deepens, Stretch said. For Merrill Lynch & Co., the euro’s gain against the pound may have gone to far.
Gilts Rise
“We will probably look to fade the move higher in the euro- pound if and when the short-term interest-rate spread-compression trend resumes,” wrote Steven Pearson, a London-based strategist at Merrill Lynch. “It is worth noting that with the Bank of England bank rate having likely reached its terminal level, pound-euro may now start to trade well during risk aversion.”
U.K. government bonds rose, with the yield on the 10-year gilt falling one basis point to 3.11 percent. The 4.5 percent security due March 2019 advanced 0.09, or 90 pence per 1,000- pound face amount, to 111.82. Two-year gilt yields slipped one basis point to 1.32 percent. Bond yields move inversely to prices.
The U.K. Treasury today sold 3 billion pounds of 4.5 percent bonds maturing in 2019. The sale received bids 2.06 times the amount offered, the Debt Management Office said, compared with an average 1.9 times at the last three auctions of the securities.
‘Carried Away’
“Investors are getting carried away with the euphoria surrounding quantitative easing,” said Ian Williams, chief executive officer of Charteris Portfolio Managers in London. “The Bank of England is a buyer of gilts, but the U.K. government is still a net seller of gilts. The compression in yields when the penny drops is going to be difficult to maintain, and the implications of quantitative easing are inflationary.”
The yield on the 10-year gilt may rise to 3.25 percent by the end of April, said Williams, whose U.K. government-bond fund beat all its competitors in January, according to data from Lipper and given to Bloomberg by Charteris.
Ten-year gilts may keep gaining, according to technical strategists at Barclays Plc.
“Bigger picture, the secular bull trend remains intact, particularly following the recent failure to overcome 3.82 percent-area support,” Barclays Capital analysts including Jordan Kotick in New York wrote in a report. The yield may move toward 2.70 percent “medium term,” they said.
To contact the reporter on this story: Matthew Brown in London at mbrown42@bloomberg.net Last Updated: March 10, 2009 13:43 EDT
http://www.bloomberg.com/apps/news?pid=20601102&refer=uk&sid=adCmriDF1wc8
Saturday 7 March 2009
Why should printing money succeed here when it failed in Japan?
Why should printing money succeed here when it failed in Japan?
Posted By: Edmund Conway at Mar 5, 2009 at 20:13:00 [General]
Posted in: Business
Tags:
Bank of England, Interest rates, Japan, quantitative easing
Why on earth will Britain succeed where Japan failed?
It is the big question which no-one in the Bank of England - or for that matter the Federal Reserve, or other central banks around the world that have pledged to embark on policies of overt money creation - is particularly comfortable answering.
There is nothing new about what the Bank has announced it will do. Japan tried very similar tactics around a decade ago after most of its other deflation-aversion tactics failed. As we all know, it failed to pull Japan out of the rut it still lies in (though the hyperinflationists among you may be reassured that neither did it spark a Weimar Germany style rise in prices).
So what have we got on our side that Japan hasn't?
Here are the big differences.
1. Time. Japanese policymakers took a good few years to get round to Quantitative Easing (let's call it QE from hereon). The old adage in monetary policy is that the sooner you act the more effect it will have, and the Bank definitely has this on its side, having reduced interest rates all the way down from 5pc to 0.5pc in barely more than a year, and now getting on with QE pretty much instantly. On the other hand, the size and immediacy of the economic slowdown we're facing is far greater.
2. Size. The Japanese (and for that matter the Americans) spent around 5pc of their GDP on QE, printing money to buy up assets. The Bank of England, on the other hand, has committed to spending just over 10pc of GDP. This is a hell of a lot of money. A terrifying amount. To put it into context, the total size of the 5 year to 25 year government bond market in the UK is around £250bn; the amount the Bank is proposing to spend on these government bonds through magicked-up money is around £100bn (the remaining £50bn will go on corporate bonds, the market for which is even smaller). Anyway, with QE, the bigger, so they say, is better.
3. Savings culture. Quantitative easing is designed to encourage people to save less and spend more. The Japanese, however, had a 15pc or more (I forget) savings ratio at the start of their recession. As a result they had a massive bed of savings to eat into (rather than borrowing) over the years. We have little or no savings ratio and a culture of high borrowing and spending. In the long run that needs to change, but it may mean the switch to frugality may be slightly less fast and aggressive than it was there.
4. Application. This is important but mildly technical. The Japanese may have pumped this newly-created money into the wrong bit of the financial system. They did a very similar thing to what the Bank is planning, printing money (electronically) and using it to buy up government debt. This will certainly mechanically increase the amount of cash floating around the system. It will also push down the yields on government debt, which should in turn reduce the cost of borrowing throughout the economy. However, this is only one half of the objective for QE. The other is to try to encourage companies and investors to get out there and spend more.
The Japanese tended to buy most of these assets off banks. Unfortunately, the banks then hoarded the cash, because their balance sheets had been so damaged by the financial crisis. The Bank, on the other hand, intends to buy most of the gilts off institutional investors - pension funds, insurers and the like. The theory - or hope - is that they will be less keen to hoard the cash and will spend it elsewhere.
This will, so the theory goes, set off a snowball effect whereby they buy extra stuff, which in turn encourages other sellers to go out and buy, and which eventually causes the economy to start growing again. So the £150bn that is poured into the economy eventually generates two or three or four times that in economic output and in money growth. We hope.
***
The problem, as you'll have guessed, is that although all of these arguments seem very rational, we have no idea whether they will work in practice. Sure, the Japanese made mistakes, but there could easily by another mistake we'll make. Likewise, even if we fulfil all the preconditions necessary, will this actually have the desired effect of bringing economic growth back up to trend? And if it does, how will we ensure we don't then generate a tidal wave of inflation which creates another dangerous bubble five years hence?
No-one knows, of course. All of which is why this new topsy-turvy world is so terrifying. However, the one counterfactual I am pretty sure about is this: for all that it is disturbing for savers now to see interest rates down at absolute zero, the economy would be in a far, far worse state if interest rates had been any higher over the past year. Then we truly would have been staring economic armageddon in the face.
In the meantime, we must try to get to grips with the remoulded economic and monetary landscape thrown up by quantitative easing. Many thanks for all your comments and questions in my last blog. Please keep them coming (either at the bottom here or by twitter) and I'll try to address them tomorrow and thereafter. I'm going home now to watch trashy television and briefly expunge words like quantitative easing from my brain.
[ 33 comments ]
Monday 23 February 2009
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
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
Thursday 19 February 2009
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]
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
Wednesday 21 January 2009
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: EPABank 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.
Tuesday 23 December 2008
Splitting between quantitative and qualitative easing
23-12-2008: Splitting between quantitative and qualitative easing
Special report by DBS Group Research
Email us your feedback at fd@bizedge.com
WHEN the Fed cut its interest rate target to between zero and 0.25% last week it marked the end of interest rate easing and the beginning of what most people refer to as quantitative easing - the outright purchase of assets to influence liquidity conditions in financial markets.
In fact, even an interest rate policy is really a quantitative policy when you get right down to it. The only way the Fed controlled its policy rate, Fed funds, was by buying and selling assets, mainly repos and reverse repos, in the market.
(The day-to-day conduct of monetary policy is not typically done via buying/selling US Treasuries in what are called open market operations but rather by buying repos or reverse repos. A repo (repurchase agreement) is a temporary loan to a securities dealer, often overnight and usually for a few days or less.
The Fed credits the dealer's bank with an increase in reserves at the Fed and the borrower places high quality collateral (government or agency securities) with the Fed. At the end of the period, the collateral is returned to the borrower and the bank's reserves are appropriately debited.
The repo is thus a temporary injection of liquidity into the market. A reverse repo works the other way. The Fed temporarily drains liquidity from the market by debiting the account (reserves) of a security dealer's bank and replacing the reserves a few days later.) Buying repos injected liquidity and lowered the Fed funds rate. Buying reverse repos did the reverse. By hook or by crook, quantitative policy has been the reality all along.
Still, there's a perception that with short-term rates at zero, we've now entered a new phase of monetary easing. A quantitative phase. The Fed is going to buy large quantities of assets and continue to expand its balance sheet.
Quantitative versus qualitative easing Isn't this expansion of the Fed's balance sheet - this quantitative easing - just printing money? The answer over the past year has been yes, mostly, but not entirely.
Fed purchases of troubled assets or loans to troubled firms injects liquidity into the system and raises the monetary base. But that rise could be offset by sales of other assets like government bonds.
How much offsetting (sterilising) the Fed does when it buys a chunk of dubious assets determines whether its purchases are translated into quantitative easing (monetary expansion), or qualitative easing - an extension of liquidity to a firm, which does not raise the monetary base but dilutes the assets' quality on the Fed's books.
In the past three months, the Fed's balance sheet has grown by US$1.25 trillion (RM4.38 trillion) or 2.5 times and the monetary base has doubled. With the Fed planning to buy another US$800 billion of assets, how it pays for these assets will influence the monetary base and could have important consequences for inflation and the value of the dollar. The quality/quantity split is key.
Splitting the cake How has the Fed chosen to split the cake so far? Very inconsistently. Between August 2007 (when the crisis erupted) and Sept 3, 2008, the Fed injected some US$339 billion into markets, sterilising 93% of its purchases of troubled assets with sales of government bonds. Seven percent (US$28 billion) was paid for with an increase in the monetary base. In September, though, the Fed's balance sheet grew by a whopping 50%, or US$428 billion.
About US$157 billion (37%) of that was financed by a rise in the monetary base. Then things went wild. Between Oct 1 and Dec 17, the Fed bought US$841 billion of troubled assets, growing its balance sheet by another two-thirds. Eighty percent of that expansion (US$672 billion) was financed by an expansion in the monetary base - by printing money.
Since Sept 3, the Fed's balance sheet has expanded 2.5 times thanks to US$1.6 trillion of new credit extended loans to illiquid firms. Some 53% (US$857 billion) has been paid for via quantitative easing (an expansion in the monetary base) and 47% via qualitative easing (sterilising, or swapping good bonds for bad).
Back to qualitative easing? The Fed's Dec 16 FOMC statement that large scale quantitative easing was on the cards raised a lot of eyebrows. After all, the monetary base has already doubled since September.
So at a subsequent press conference, "senior Fed officials" hastened to add that the split going forward would favour qualitative easing (sterilised asset swaps) over quantitative easing (money printing á la Japan).
But that would be a big U-turn after the past two months of rolling the printing presses. How can you know for sure? You can't. The best you can do is to watch the data week by week.
The Fed's balance sheet - up close and technical Below, we discuss the evolution of the Fed's balance sheet since August 2007 and the present. Amongst it is the mechanics of some typical and, more recently, non-typical Fed transactions so that readers may see their effects on the monetary base and the quantitative/qualitative split in Fed policy. Readers familiar with the Fed's balance sheet and its mechanics may wish to skip ahead to the final section.
The good old days and Fed funds: Back in the good old days, the Fed's balance sheet was a pretty simple thing. On the asset side, the Fed held a lot of government bonds and not much else. Repos and reverse repos, used to fine-tune monetary policy on a day-to-day basis, were small. On Aug 8, 2007, reverse repos outnumbered repos by US$13 billion. Use of the discount window was extremely tiny and the Fed held US$40 billion of miscellaneous assets.
On the liability side were two items: currency in circulation and reserve balances, or simply reserves. Reserves are the deposits that banks must hold at the Fed. Minimum levels must be maintained on a daily basis. Banks which hold excess reserves may lend to banks temporarily short. The interest rate on these loans is called the Fed funds rate. As most are aware, this rate is the Fed's policy rate and through it the Fed controls, or used to anyway, other short-term market rates.
Open market operations: The most generic way to increase the money supply is called an open market operation (OMO). The first step is not necessary but typically begins with the Treasury issuing say a US$100 bond to a securities dealer in return for cash that it uses to cover its deficit. The Fed purchases the bond from the dealer, crediting the dealer's bank's account at the Fed for US$100. The bank may withdraw the funds from its reserve account at any time and since, in the past, reserves did not pay interest, it would typically do so fairly quickly. The US$100 bond issue has led to a US$100 increase in currency in circulation. If the Fed wanted to tighten liquidity, it would do the reverse, selling a Treasury bond into the market. The Fed would debit the dealer's bank reserves for US$100 and this would soon result in a reduction in the amount of currency in circulation. As member banks may always demand currency for reserves, the monetary base is the sum of these two Fed liabilities.
Repo injection: The Fed would typically engage in open market operations when it had heavy lifting to do, such as when it had changed the target for policy rates, Fed funds. For day-to-day fine-tuning of the Fed funds rate, repos and reverse repos would typically be used. Repos are loans extended for very short durations, usually a few days or less, secured with high quality collateral (UST or agency debt). As one would expect, a syphoning of liquidity via reverse repos would simply reverse the signs in the balance sheet entries. Interest rates on Fed funds would rise and would be transmitted out to the rest of the market.
Term Auction Facility (TAF) injections: By June 25, 2008, the Fed had extended US$150 billion of loans via the Term Auction Facility, or TAF. Other things equal, those TAF loans would have increased the monetary base just like the OMO or repo injections shown. But the Fed was worried that the TAF loans (and other injections that, between August 2007 and June 2008, amounted to US$339 billion) would have inflationary consequences. The Fed decided to offset these injections with sales of government bonds. Total assets have remained the same, as have total liabilities. This is, in effect, a simple asset swap. Again, the purpose is to provide liquidity to the TAF party in need without increasing the monetary base. The Fed's balance sheet becomes too small? Contrary to much market talk back in October, there are no constraints on the size of the Fed's balance sheet. The Fed can print money, which means it can buy any amount of assets. The sky's truly the limit. But the Fed's balance sheet can be constrained if it tries to buy too many assets without printing money. Once the Fed runs out of Treasuries, the sterilised asset swap can no longer occur. By September 2008, the Fed's supply of Treasuries had fallen by nearly half, thanks to sterilised asset swaps. In fact, it had fallen far lower than that because the Fed had already swapped another US$250 billion of Treasuries more formally in its Term Securities Lending Facility (TSLF) which the Fed records as an off-balance sheet item. In reality, 70% of the Fed's supply of Treasuries had been swapped by Sept 3, 2008. Unless the Fed could come up with some additional Treasuries, its rapidly growing portfolio of loans made through the TAF, the Primary Dealer Credit Facility (PDCF) and eight other programmes listed in the balance sheet would soon have to be financed by printing money alone.
On Oct 7, the Fed and the Treasury announced the Supplementary Financing Programme. What this amounted to, in effect, was a joint effort whereby the Fed would purchase the dubious assets as it had been and, since it was out of Treasuries, the Treasury would do the mopping up. A sterilised asset swap still obtained the result of two agencies being better than one.
There are various ways of viewing this from a balance sheet perspective. The most transparent way is probably to view the joint transaction in three distinct steps.
In step 1, the Treasury sells US$100 of bonds directly to the Fed. The Fed pays for the bonds by crediting the Treasury's supplementary reserve account. The Treasury promises not to withdraw or lend these funds so they do not affect the monetary base or the Fed funds rate.
In step 2, the Fed loans US$100 to a primary dealer, as per before, which leads a monetary base increase of US$100. In step 3, the monetary increase is sterilised by the sale of the newly acquired government bond. In net terms, primary dealers have received US$100 of new liquidity but the monetary base has not changed. In this case, the Fed's balance sheet has grown by US$100 but there is no monetary impact.
A more straightforward way of accomplishing the same thing would be for the Fed to issue its own bonds. The Fed's US$100 loan to a primary dealer broker leads to a rise in the monetary base of the same amount.
The Fed sterilises this injection with the sale of a Federal Reserve bond. This would be a pure asset swap although new Fed bonds would be issued (the size of the Fed's balance sheet would grow). If the Fed needs to expand its balance sheet to finance the acquisition of "large quantities" of assets without monetary consequences, then, in practical terms, it would seem to make little difference whether the Fed issued its own bonds for sterilisation purposes or bought them from the Treasury for onward sale to the market.
Why the quantity/quality split? And will it work? Besides avoiding the monetary consequences of large purchases of troubled assets, the Fed's qualitative easing is aimed at lowering the spread of various interest rates over the risk-free Treasury rate.
The Fed apparently feels that risk-free rates are low enough (10Y UST yields are currently at 2.13%). The hope is that by buying troubled assets and selling Treasury's, the yields on the two securities would come closer together.
Whether it will work remains unclear. Many consider the spread to be a function mainly of the probability of default on the part of the troubled borrower, not on the relative amounts of the securities bought and sold.
On this view, unless Fed loans actually lower the probability of default, the credit spread will remain. What matters to the borrower, though, and for that matter to the economy more generally, is not the spread he has to pay over the risk-free rate, but the actual rate at which he can borrow.
If the Fed wants to lower that rate, it may have to content itself with lowering the risk-free rate, for example, pursuing quantitative easing over qualitative.
Second, one cannot not forget the adage that leading a horse to water does not make it drink. The Fed can buy assets and credit the reserves of the banks. But unless the banks withdraw those funds and lend them onward in the market, it's all for naught.
This is currently a problem. The monetary base on Dec 17 was US$1.67 billion but half of that comprised reserves. Banks are not withdrawing the funds and putting them to use. This may be good from an inflation perspective but plainly not from a get-the-economy-going perspective.
Finally, one must not forget that many financial institutions have reported large losses and it is reasonable to assume that some, perhaps many, are insolvent. In such cases, Fed easing will not solve the problem but only postpone the day of reckoning. When it comes to putting off until tomorrow what can be done today, there is no quantity/quality split.
http://www.theedgedaily.com/cms/content.jsp?id=com.tms.cms.article.Article_62478269-cb73c03a-53897400-a8659b88
Special report by DBS Group Research
Email us your feedback at fd@bizedge.com
WHEN the Fed cut its interest rate target to between zero and 0.25% last week it marked the end of interest rate easing and the beginning of what most people refer to as quantitative easing - the outright purchase of assets to influence liquidity conditions in financial markets.
In fact, even an interest rate policy is really a quantitative policy when you get right down to it. The only way the Fed controlled its policy rate, Fed funds, was by buying and selling assets, mainly repos and reverse repos, in the market.
(The day-to-day conduct of monetary policy is not typically done via buying/selling US Treasuries in what are called open market operations but rather by buying repos or reverse repos. A repo (repurchase agreement) is a temporary loan to a securities dealer, often overnight and usually for a few days or less.
The Fed credits the dealer's bank with an increase in reserves at the Fed and the borrower places high quality collateral (government or agency securities) with the Fed. At the end of the period, the collateral is returned to the borrower and the bank's reserves are appropriately debited.
The repo is thus a temporary injection of liquidity into the market. A reverse repo works the other way. The Fed temporarily drains liquidity from the market by debiting the account (reserves) of a security dealer's bank and replacing the reserves a few days later.) Buying repos injected liquidity and lowered the Fed funds rate. Buying reverse repos did the reverse. By hook or by crook, quantitative policy has been the reality all along.
Still, there's a perception that with short-term rates at zero, we've now entered a new phase of monetary easing. A quantitative phase. The Fed is going to buy large quantities of assets and continue to expand its balance sheet.
Quantitative versus qualitative easing Isn't this expansion of the Fed's balance sheet - this quantitative easing - just printing money? The answer over the past year has been yes, mostly, but not entirely.
Fed purchases of troubled assets or loans to troubled firms injects liquidity into the system and raises the monetary base. But that rise could be offset by sales of other assets like government bonds.
How much offsetting (sterilising) the Fed does when it buys a chunk of dubious assets determines whether its purchases are translated into quantitative easing (monetary expansion), or qualitative easing - an extension of liquidity to a firm, which does not raise the monetary base but dilutes the assets' quality on the Fed's books.
In the past three months, the Fed's balance sheet has grown by US$1.25 trillion (RM4.38 trillion) or 2.5 times and the monetary base has doubled. With the Fed planning to buy another US$800 billion of assets, how it pays for these assets will influence the monetary base and could have important consequences for inflation and the value of the dollar. The quality/quantity split is key.
Splitting the cake How has the Fed chosen to split the cake so far? Very inconsistently. Between August 2007 (when the crisis erupted) and Sept 3, 2008, the Fed injected some US$339 billion into markets, sterilising 93% of its purchases of troubled assets with sales of government bonds. Seven percent (US$28 billion) was paid for with an increase in the monetary base. In September, though, the Fed's balance sheet grew by a whopping 50%, or US$428 billion.
About US$157 billion (37%) of that was financed by a rise in the monetary base. Then things went wild. Between Oct 1 and Dec 17, the Fed bought US$841 billion of troubled assets, growing its balance sheet by another two-thirds. Eighty percent of that expansion (US$672 billion) was financed by an expansion in the monetary base - by printing money.
Since Sept 3, the Fed's balance sheet has expanded 2.5 times thanks to US$1.6 trillion of new credit extended loans to illiquid firms. Some 53% (US$857 billion) has been paid for via quantitative easing (an expansion in the monetary base) and 47% via qualitative easing (sterilising, or swapping good bonds for bad).
Back to qualitative easing? The Fed's Dec 16 FOMC statement that large scale quantitative easing was on the cards raised a lot of eyebrows. After all, the monetary base has already doubled since September.
So at a subsequent press conference, "senior Fed officials" hastened to add that the split going forward would favour qualitative easing (sterilised asset swaps) over quantitative easing (money printing á la Japan).
But that would be a big U-turn after the past two months of rolling the printing presses. How can you know for sure? You can't. The best you can do is to watch the data week by week.
The Fed's balance sheet - up close and technical Below, we discuss the evolution of the Fed's balance sheet since August 2007 and the present. Amongst it is the mechanics of some typical and, more recently, non-typical Fed transactions so that readers may see their effects on the monetary base and the quantitative/qualitative split in Fed policy. Readers familiar with the Fed's balance sheet and its mechanics may wish to skip ahead to the final section.
The good old days and Fed funds: Back in the good old days, the Fed's balance sheet was a pretty simple thing. On the asset side, the Fed held a lot of government bonds and not much else. Repos and reverse repos, used to fine-tune monetary policy on a day-to-day basis, were small. On Aug 8, 2007, reverse repos outnumbered repos by US$13 billion. Use of the discount window was extremely tiny and the Fed held US$40 billion of miscellaneous assets.
On the liability side were two items: currency in circulation and reserve balances, or simply reserves. Reserves are the deposits that banks must hold at the Fed. Minimum levels must be maintained on a daily basis. Banks which hold excess reserves may lend to banks temporarily short. The interest rate on these loans is called the Fed funds rate. As most are aware, this rate is the Fed's policy rate and through it the Fed controls, or used to anyway, other short-term market rates.
Open market operations: The most generic way to increase the money supply is called an open market operation (OMO). The first step is not necessary but typically begins with the Treasury issuing say a US$100 bond to a securities dealer in return for cash that it uses to cover its deficit. The Fed purchases the bond from the dealer, crediting the dealer's bank's account at the Fed for US$100. The bank may withdraw the funds from its reserve account at any time and since, in the past, reserves did not pay interest, it would typically do so fairly quickly. The US$100 bond issue has led to a US$100 increase in currency in circulation. If the Fed wanted to tighten liquidity, it would do the reverse, selling a Treasury bond into the market. The Fed would debit the dealer's bank reserves for US$100 and this would soon result in a reduction in the amount of currency in circulation. As member banks may always demand currency for reserves, the monetary base is the sum of these two Fed liabilities.
Repo injection: The Fed would typically engage in open market operations when it had heavy lifting to do, such as when it had changed the target for policy rates, Fed funds. For day-to-day fine-tuning of the Fed funds rate, repos and reverse repos would typically be used. Repos are loans extended for very short durations, usually a few days or less, secured with high quality collateral (UST or agency debt). As one would expect, a syphoning of liquidity via reverse repos would simply reverse the signs in the balance sheet entries. Interest rates on Fed funds would rise and would be transmitted out to the rest of the market.
Term Auction Facility (TAF) injections: By June 25, 2008, the Fed had extended US$150 billion of loans via the Term Auction Facility, or TAF. Other things equal, those TAF loans would have increased the monetary base just like the OMO or repo injections shown. But the Fed was worried that the TAF loans (and other injections that, between August 2007 and June 2008, amounted to US$339 billion) would have inflationary consequences. The Fed decided to offset these injections with sales of government bonds. Total assets have remained the same, as have total liabilities. This is, in effect, a simple asset swap. Again, the purpose is to provide liquidity to the TAF party in need without increasing the monetary base. The Fed's balance sheet becomes too small? Contrary to much market talk back in October, there are no constraints on the size of the Fed's balance sheet. The Fed can print money, which means it can buy any amount of assets. The sky's truly the limit. But the Fed's balance sheet can be constrained if it tries to buy too many assets without printing money. Once the Fed runs out of Treasuries, the sterilised asset swap can no longer occur. By September 2008, the Fed's supply of Treasuries had fallen by nearly half, thanks to sterilised asset swaps. In fact, it had fallen far lower than that because the Fed had already swapped another US$250 billion of Treasuries more formally in its Term Securities Lending Facility (TSLF) which the Fed records as an off-balance sheet item. In reality, 70% of the Fed's supply of Treasuries had been swapped by Sept 3, 2008. Unless the Fed could come up with some additional Treasuries, its rapidly growing portfolio of loans made through the TAF, the Primary Dealer Credit Facility (PDCF) and eight other programmes listed in the balance sheet would soon have to be financed by printing money alone.
On Oct 7, the Fed and the Treasury announced the Supplementary Financing Programme. What this amounted to, in effect, was a joint effort whereby the Fed would purchase the dubious assets as it had been and, since it was out of Treasuries, the Treasury would do the mopping up. A sterilised asset swap still obtained the result of two agencies being better than one.
There are various ways of viewing this from a balance sheet perspective. The most transparent way is probably to view the joint transaction in three distinct steps.
In step 1, the Treasury sells US$100 of bonds directly to the Fed. The Fed pays for the bonds by crediting the Treasury's supplementary reserve account. The Treasury promises not to withdraw or lend these funds so they do not affect the monetary base or the Fed funds rate.
In step 2, the Fed loans US$100 to a primary dealer, as per before, which leads a monetary base increase of US$100. In step 3, the monetary increase is sterilised by the sale of the newly acquired government bond. In net terms, primary dealers have received US$100 of new liquidity but the monetary base has not changed. In this case, the Fed's balance sheet has grown by US$100 but there is no monetary impact.
A more straightforward way of accomplishing the same thing would be for the Fed to issue its own bonds. The Fed's US$100 loan to a primary dealer broker leads to a rise in the monetary base of the same amount.
The Fed sterilises this injection with the sale of a Federal Reserve bond. This would be a pure asset swap although new Fed bonds would be issued (the size of the Fed's balance sheet would grow). If the Fed needs to expand its balance sheet to finance the acquisition of "large quantities" of assets without monetary consequences, then, in practical terms, it would seem to make little difference whether the Fed issued its own bonds for sterilisation purposes or bought them from the Treasury for onward sale to the market.
Why the quantity/quality split? And will it work? Besides avoiding the monetary consequences of large purchases of troubled assets, the Fed's qualitative easing is aimed at lowering the spread of various interest rates over the risk-free Treasury rate.
The Fed apparently feels that risk-free rates are low enough (10Y UST yields are currently at 2.13%). The hope is that by buying troubled assets and selling Treasury's, the yields on the two securities would come closer together.
Whether it will work remains unclear. Many consider the spread to be a function mainly of the probability of default on the part of the troubled borrower, not on the relative amounts of the securities bought and sold.
On this view, unless Fed loans actually lower the probability of default, the credit spread will remain. What matters to the borrower, though, and for that matter to the economy more generally, is not the spread he has to pay over the risk-free rate, but the actual rate at which he can borrow.
If the Fed wants to lower that rate, it may have to content itself with lowering the risk-free rate, for example, pursuing quantitative easing over qualitative.
Second, one cannot not forget the adage that leading a horse to water does not make it drink. The Fed can buy assets and credit the reserves of the banks. But unless the banks withdraw those funds and lend them onward in the market, it's all for naught.
This is currently a problem. The monetary base on Dec 17 was US$1.67 billion but half of that comprised reserves. Banks are not withdrawing the funds and putting them to use. This may be good from an inflation perspective but plainly not from a get-the-economy-going perspective.
Finally, one must not forget that many financial institutions have reported large losses and it is reasonable to assume that some, perhaps many, are insolvent. In such cases, Fed easing will not solve the problem but only postpone the day of reckoning. When it comes to putting off until tomorrow what can be done today, there is no quantity/quality split.
http://www.theedgedaily.com/cms/content.jsp?id=com.tms.cms.article.Article_62478269-cb73c03a-53897400-a8659b88
Sunday 21 December 2008
Why the Bank of England must fight the economic Blitz in a battle for Britain
From The Times
December 8, 2008
Why the Bank of England must fight the economic Blitz in a battle for Britain
Gary Duncan: Economic view
It is the 64-trillion-dollar question. As a fearful nation battens down the hatches, the question that everyone wants an answer to is: just how bad is this recession going to get?
After the Bank of England’s latest dose of economic “shock and awe” with last week’s landmark cut in interest rates to 2 per cent, a level last seen in 1951, a colleague asked me why so much commentary on the new recession harks back to Britain’s last one, in the early Nineties. Having closely tracked the misfortunes of business in that episode, his point was that this downturn already feels much worse.
You can see the point. As dire news piles up, it really does seem like the economy is going into freefall. And that feeling matters, as it saps sentiment and drains away confidence. None of us can be certain how fast, or how far, the economy will slide. So, in trying to weigh the true scale of the danger, it is worth peering back at the lessons of history. Sadly, there are plenty of recessions to ponder.
About 20 recessions in Britain since the mid-19th century and at least 255 across 17 developed economies since 1870 are examined in recent papers by Paul Ormerod, highlighted in research by David Owen, of Dresdner Kleinwort. The findings offer a little comfort – although mainly of the cold variety.
First, the good news. Most recessions have tended to be relatively short and afflicted economies have been able to bounce back quickly. Only 33 of the 255 recessions lasted more than two years and, while nine were calamitous, with GDP dropping by more than 30 per cent, three of those related to the First World War and six to the Second World War. The conclusion is that, with the exception of the two world wars and the Great Depression, developed economies have generally revived fairly rapidly from recessions.
That, though, is where the reassurance ends. Tellingly, wars aside, episodes of recession in Britain since the Seventies have been much more severe than in the 19th and early 20th centuries. Crucially, Professor Ormerod finds that the deeper and longer a recession is, the more feeble the recovery then is. As Mr Owen observes, this takes us straight back to the role of confidence. The faster and more viciously recession tightens its grip, the more confidence evaporates and the more elusive recovery becomes as what John Maynard Keynes called the economy’s “animal spirits” are killed off.
It is just this peril that, more and more clearly, confronts Britain. The new recession has taken hold with brutal speed and severity and the immediate, acute danger is that it will, indeed, prove to be markedly worse than that of the early Nineties. That is why the only thing wrong with last week’s drastic interest rate cut was that it was not drastic enough.
The Bank itself admits that “the downturn has gathered pace”, with “a weaker outlook for activity in the near-term”. It is worth remembering that it was already forecasting that the economy would shrink next year by 1.3 per cent or more – more or less matching the 1.4 per cent slump suffered in 1991, at the nadir of the last recession.
There are at least two powerful factors that leave us at grave risk of enduring something still harsher and which threaten to mean that the economy’s slump accelerates still farther.
The first is the global nature of this downturn, with all the leading Western economies now in a synchronised slump. This is bound to aggravate the toll from recession, with no big economy left immune and able to act as a locomotive to pull the others out of the mire. As Mr Owen notes, global trade is close to collapsing.
The second factor is the pivotal role of the banks, the bogeymen of this crisis, and their continuing failure to play their proper role in the economy and provide a steady flow of lending to businesses and households.
While the banks’ behaviour in curbing lending to safeguard their own financial strength is individually rational, it is collectively crazy and will mean a far deeper and more painful recession unless it is quickly reversed. Certainly, interest rate cuts will help to limit the toll from recession, but, as Philip Shaw, of Investec, observed last week, there is no point in having very cheap money if nobody will lend it to you. While the banks insist that they are keeping up the flow of lending, the data tells a different story.
Taken together, these aspects of the present crisis make Professor Ormerod’s conclusions compelling. The swifter, more radical and more aggressive the action taken now by the Bank and the Treasury to nip recession in the bud, the more the danger will diminish, the smaller the eventual toll will be and the bigger the chances of an eventual, potent return to growth.
The Bank has already taken two giant leaps with the successive 1.5 and 1 percentage point cuts in interest rates over the past four weeks. It can no longer be accused of timidity. Another step will take it into uncharted territory and rates to a level not seen seen in the Bank’s 316-year history. It should take this step soon and make it another big one.
Yet it must be bolder still and steel itself quickly to follow the US Federal Reserve in deploying more unorthodox weapons from the armoury of monetary policy, such as large-scale direct lending to the banks, the buying-up of credit products and other forms of so-called “quantitative easing”. It is vital that it acts now to jump-start stalled activity and to get the lifeblood of bank lending flowing once more.
The historical parallels remain resonant. The last time that rates were cut to 2 per cent was in 1939, a month after the outbreak of the Second World War. Now, as then, the country confronts an economic Blitz. It is time for the Bank to wage a battle for Britain.
December 8, 2008
Why the Bank of England must fight the economic Blitz in a battle for Britain
Gary Duncan: Economic view
It is the 64-trillion-dollar question. As a fearful nation battens down the hatches, the question that everyone wants an answer to is: just how bad is this recession going to get?
After the Bank of England’s latest dose of economic “shock and awe” with last week’s landmark cut in interest rates to 2 per cent, a level last seen in 1951, a colleague asked me why so much commentary on the new recession harks back to Britain’s last one, in the early Nineties. Having closely tracked the misfortunes of business in that episode, his point was that this downturn already feels much worse.
You can see the point. As dire news piles up, it really does seem like the economy is going into freefall. And that feeling matters, as it saps sentiment and drains away confidence. None of us can be certain how fast, or how far, the economy will slide. So, in trying to weigh the true scale of the danger, it is worth peering back at the lessons of history. Sadly, there are plenty of recessions to ponder.
About 20 recessions in Britain since the mid-19th century and at least 255 across 17 developed economies since 1870 are examined in recent papers by Paul Ormerod, highlighted in research by David Owen, of Dresdner Kleinwort. The findings offer a little comfort – although mainly of the cold variety.
First, the good news. Most recessions have tended to be relatively short and afflicted economies have been able to bounce back quickly. Only 33 of the 255 recessions lasted more than two years and, while nine were calamitous, with GDP dropping by more than 30 per cent, three of those related to the First World War and six to the Second World War. The conclusion is that, with the exception of the two world wars and the Great Depression, developed economies have generally revived fairly rapidly from recessions.
That, though, is where the reassurance ends. Tellingly, wars aside, episodes of recession in Britain since the Seventies have been much more severe than in the 19th and early 20th centuries. Crucially, Professor Ormerod finds that the deeper and longer a recession is, the more feeble the recovery then is. As Mr Owen observes, this takes us straight back to the role of confidence. The faster and more viciously recession tightens its grip, the more confidence evaporates and the more elusive recovery becomes as what John Maynard Keynes called the economy’s “animal spirits” are killed off.
It is just this peril that, more and more clearly, confronts Britain. The new recession has taken hold with brutal speed and severity and the immediate, acute danger is that it will, indeed, prove to be markedly worse than that of the early Nineties. That is why the only thing wrong with last week’s drastic interest rate cut was that it was not drastic enough.
The Bank itself admits that “the downturn has gathered pace”, with “a weaker outlook for activity in the near-term”. It is worth remembering that it was already forecasting that the economy would shrink next year by 1.3 per cent or more – more or less matching the 1.4 per cent slump suffered in 1991, at the nadir of the last recession.
There are at least two powerful factors that leave us at grave risk of enduring something still harsher and which threaten to mean that the economy’s slump accelerates still farther.
The first is the global nature of this downturn, with all the leading Western economies now in a synchronised slump. This is bound to aggravate the toll from recession, with no big economy left immune and able to act as a locomotive to pull the others out of the mire. As Mr Owen notes, global trade is close to collapsing.
The second factor is the pivotal role of the banks, the bogeymen of this crisis, and their continuing failure to play their proper role in the economy and provide a steady flow of lending to businesses and households.
While the banks’ behaviour in curbing lending to safeguard their own financial strength is individually rational, it is collectively crazy and will mean a far deeper and more painful recession unless it is quickly reversed. Certainly, interest rate cuts will help to limit the toll from recession, but, as Philip Shaw, of Investec, observed last week, there is no point in having very cheap money if nobody will lend it to you. While the banks insist that they are keeping up the flow of lending, the data tells a different story.
Taken together, these aspects of the present crisis make Professor Ormerod’s conclusions compelling. The swifter, more radical and more aggressive the action taken now by the Bank and the Treasury to nip recession in the bud, the more the danger will diminish, the smaller the eventual toll will be and the bigger the chances of an eventual, potent return to growth.
The Bank has already taken two giant leaps with the successive 1.5 and 1 percentage point cuts in interest rates over the past four weeks. It can no longer be accused of timidity. Another step will take it into uncharted territory and rates to a level not seen seen in the Bank’s 316-year history. It should take this step soon and make it another big one.
Yet it must be bolder still and steel itself quickly to follow the US Federal Reserve in deploying more unorthodox weapons from the armoury of monetary policy, such as large-scale direct lending to the banks, the buying-up of credit products and other forms of so-called “quantitative easing”. It is vital that it acts now to jump-start stalled activity and to get the lifeblood of bank lending flowing once more.
The historical parallels remain resonant. The last time that rates were cut to 2 per cent was in 1939, a month after the outbreak of the Second World War. Now, as then, the country confronts an economic Blitz. It is time for the Bank to wage a battle for Britain.
**Desperate times: how the Fed plans to save the world
Economic policy
Desperate times: how the Fed plans to save the world
Larry Elliott, economics editor
The Guardian, Thursday 18 December 2008
The unusual measures unveiled this week by the Federal reserve chairman, Ben Bernanke, promise to usher in an era of free money unprecedented in the history of financial markets. They include tools designed to lower long-term interest rates and boost growth in the world's biggest economy. Here we look at what the measures are, what they mean for you, and what will happen if they don't work.
Why has the Fed been forced to take such drastic steps?
After 18 months in which they have cut interest rates sharply, nationalised leading banks and provided tax rebates for consumers, US policymakers are now desperate to halt America's slide into a deep and painful recession. For historical reasons, fear of a slump runs as deep in the US as does fear of inflation in Germany, but all the conventional policy tools have so far failed. Non-farm jobs fell by more than 500,000 in November, the biggest drop since the mid-1970s, and the housing market is in freefall. Ben Bernanke is a former academic who specialised in the lessons of the Great Depression, one of which is that policymakers have to act fast and decisively to prevent a deflationary spiral setting in.
So what is the Fed proposing?
There are various forms of interest rates. Policy, or short-term, rates are set by central banks and affect the cost of money to the financial system. In the UK, the policy, or bank rate, is 2%. In the US, after Tuesday's cut, the Fed has set a target range of 0% to 0.25% - an all-time low. In normal circumstances, ultra-low policy rates make it easier for banks to lend money to their business and personal customers but these are not normal circumstances. The supply of credit has dried up as banks repair the damage to their balance sheets caused by losses on their ill-judged investments during the boom. Real borrowing rates for households and firms have fallen but not nearly so rapidly as have policy rates. The Fed's actions this week are aimed at cutting real borrowing costs.
How does it do this?
The Federal Reserve has already bought up mortgage-backed securities and the debts of Fannie Mae and Freddie Mac, the two giant state-owned mortgage finance companies. This week it said this programme would be stepped up and perhaps extended to purchases of longer-term treasury securities. Buying treasury bonds, the remedy proposed by Keynes in the 1930s and taken up by Franklin Roosevelt, is a radical step and as yet only being "evaluated" by the US central bank. But its aim is to drive down the long-term interest rates, normally set by buying and selling in the financial markets, through large-scale purchases of bonds. The interest rate - or yield - on bonds goes down as the price goes up, and buying bonds makes them more attractive by reducing the supply. Bringing down the interest rate on long-term bonds also brings down all other long-term interest rates, on fixed-rate mortgages, for example. It also gives the banks more money to lend because they exchange their bonds for money from the central bank.
So what's the drawback?
This process, known as quantitative easing, involves a huge expansion of the central bank's balance sheet so it can buy the bonds. It is not "printing money" since it no extra banknotes are churned out, but it gives the commercial banks more capital to lend on to their customers. To be effective, the central bank has to reassure financial markets that it will hold down long-term interest rates for as long as it takes to get credit markets working again. This means expanding the money supply, with the risk of re-igniting inflation once growth picks up. Bond markets are traditionally terrified by inflation and if investors start to believe that the central bank has lost control, a bond market bubble could potentially turn into a bond market bust.
What happens if it doesn't work?
In those circumstances, the next step will be wholesale use of fiscal policy. Keynes said in his General Theory that there might be cases when spirits in the private sector were so low that there would be no desire to borrow at any level of short-term or long-term interest rates. The state would then try to boost activity itself, either by public works or tax cuts. President-elect Barack Obama's plan for a fiscal boost worth 4% of GDP is an acceptance that quantitative easing might not be enough.
Anything else?
The economist Milton Friedman once said it would be theoretically possible for policymakers to end a depression by dumping wads of cash on the populace below from helicopters. This was cited by Bernanke in a paper in 2002, winning him the nickname Helicopter Ben. Other "unconventional" suggestions include providing consumers with time-limited spending vouchers that would force them to spend, or even making people pay banks for holding their money.
What does it mean for the UK?
The Bank of England and the Treasury are looking at whether quantitative easing would be possible in the UK. The upside would be that mortgage rates, overdrafts and business finance costs would fall if long-term interest rates declined. The downside would be if the markets became alarmed at the risks to inflation, turning the recent run on the pound into a full-blown sterling crisis. The pound does not have the dollar's reserve currency status so the UK is more vulnerable than the US.
Is there an alternative?
The other option is to do what the Austrian school of economists suggest: wait for the crisis to blow itself out. What is needed, they argue, is not shoring up a failed system but a period of creative destruction that will lay the foundations for stronger long-term growth. Politicians, who have elections to fight, find the do-nothing option somewhat unattractive.
Related
5 Dec 2008
American economy is in freefall
5 Dec 2008
Harold James: A new Bretton Woods hinges on negotiations between today's economic superpowers
15 Nov 2008
The G20: Who is there and how desperate are they?
16 Oct 2008
Joseph Stiglitz: Paulson tries again
http://www.guardian.co.uk/business/2008/dec/18/federal-reserve-measures-ben-bernnake
Desperate times: how the Fed plans to save the world
Larry Elliott, economics editor
The Guardian, Thursday 18 December 2008
The unusual measures unveiled this week by the Federal reserve chairman, Ben Bernanke, promise to usher in an era of free money unprecedented in the history of financial markets. They include tools designed to lower long-term interest rates and boost growth in the world's biggest economy. Here we look at what the measures are, what they mean for you, and what will happen if they don't work.
Why has the Fed been forced to take such drastic steps?
After 18 months in which they have cut interest rates sharply, nationalised leading banks and provided tax rebates for consumers, US policymakers are now desperate to halt America's slide into a deep and painful recession. For historical reasons, fear of a slump runs as deep in the US as does fear of inflation in Germany, but all the conventional policy tools have so far failed. Non-farm jobs fell by more than 500,000 in November, the biggest drop since the mid-1970s, and the housing market is in freefall. Ben Bernanke is a former academic who specialised in the lessons of the Great Depression, one of which is that policymakers have to act fast and decisively to prevent a deflationary spiral setting in.
So what is the Fed proposing?
There are various forms of interest rates. Policy, or short-term, rates are set by central banks and affect the cost of money to the financial system. In the UK, the policy, or bank rate, is 2%. In the US, after Tuesday's cut, the Fed has set a target range of 0% to 0.25% - an all-time low. In normal circumstances, ultra-low policy rates make it easier for banks to lend money to their business and personal customers but these are not normal circumstances. The supply of credit has dried up as banks repair the damage to their balance sheets caused by losses on their ill-judged investments during the boom. Real borrowing rates for households and firms have fallen but not nearly so rapidly as have policy rates. The Fed's actions this week are aimed at cutting real borrowing costs.
How does it do this?
The Federal Reserve has already bought up mortgage-backed securities and the debts of Fannie Mae and Freddie Mac, the two giant state-owned mortgage finance companies. This week it said this programme would be stepped up and perhaps extended to purchases of longer-term treasury securities. Buying treasury bonds, the remedy proposed by Keynes in the 1930s and taken up by Franklin Roosevelt, is a radical step and as yet only being "evaluated" by the US central bank. But its aim is to drive down the long-term interest rates, normally set by buying and selling in the financial markets, through large-scale purchases of bonds. The interest rate - or yield - on bonds goes down as the price goes up, and buying bonds makes them more attractive by reducing the supply. Bringing down the interest rate on long-term bonds also brings down all other long-term interest rates, on fixed-rate mortgages, for example. It also gives the banks more money to lend because they exchange their bonds for money from the central bank.
So what's the drawback?
This process, known as quantitative easing, involves a huge expansion of the central bank's balance sheet so it can buy the bonds. It is not "printing money" since it no extra banknotes are churned out, but it gives the commercial banks more capital to lend on to their customers. To be effective, the central bank has to reassure financial markets that it will hold down long-term interest rates for as long as it takes to get credit markets working again. This means expanding the money supply, with the risk of re-igniting inflation once growth picks up. Bond markets are traditionally terrified by inflation and if investors start to believe that the central bank has lost control, a bond market bubble could potentially turn into a bond market bust.
What happens if it doesn't work?
In those circumstances, the next step will be wholesale use of fiscal policy. Keynes said in his General Theory that there might be cases when spirits in the private sector were so low that there would be no desire to borrow at any level of short-term or long-term interest rates. The state would then try to boost activity itself, either by public works or tax cuts. President-elect Barack Obama's plan for a fiscal boost worth 4% of GDP is an acceptance that quantitative easing might not be enough.
Anything else?
The economist Milton Friedman once said it would be theoretically possible for policymakers to end a depression by dumping wads of cash on the populace below from helicopters. This was cited by Bernanke in a paper in 2002, winning him the nickname Helicopter Ben. Other "unconventional" suggestions include providing consumers with time-limited spending vouchers that would force them to spend, or even making people pay banks for holding their money.
What does it mean for the UK?
The Bank of England and the Treasury are looking at whether quantitative easing would be possible in the UK. The upside would be that mortgage rates, overdrafts and business finance costs would fall if long-term interest rates declined. The downside would be if the markets became alarmed at the risks to inflation, turning the recent run on the pound into a full-blown sterling crisis. The pound does not have the dollar's reserve currency status so the UK is more vulnerable than the US.
Is there an alternative?
The other option is to do what the Austrian school of economists suggest: wait for the crisis to blow itself out. What is needed, they argue, is not shoring up a failed system but a period of creative destruction that will lay the foundations for stronger long-term growth. Politicians, who have elections to fight, find the do-nothing option somewhat unattractive.
Related
5 Dec 2008
American economy is in freefall
5 Dec 2008
Harold James: A new Bretton Woods hinges on negotiations between today's economic superpowers
15 Nov 2008
The G20: Who is there and how desperate are they?
16 Oct 2008
Joseph Stiglitz: Paulson tries again
http://www.guardian.co.uk/business/2008/dec/18/federal-reserve-measures-ben-bernnake
Helicopter money - a short guide
Helicopter money - a short guide
Ashley Seager
The Guardian, Thursday 18 December 2008
The idea of dropping money from a helicopter sounds great, particularly if you are lucky enough to be standing under one. But surely it would only happen in a banana republic or some weird work of fiction? Well, maybe.
The term "helicopter money" is on everyone's lips thanks to Ben Bernanke, the head of the US central bank, the Federal Reserve. Dubbed "Helicopter Ben" by his critics, he has been associated with the idea since he gave a speech in 1992 quoting legendary economist Milton Friedman as proposing it in extremis should deflation - or continually falling prices - ever grip a modern economy.
There are now fears that exactly that might be about to happen. On Tuesday night the Fed slashed interest rates to nearly zero in a bid to breathe some life into the collapsing US economy. The Bank of England looks about to do the same thing here. But both central banks are worried that cutting rates to zero may not on its own stop the rot so they are considering radical next steps to pump money into the economy to get people and businesses spending again.
The plan is known as "quantitative easing" which in layman's language means increasing the quantity of money in the economy rather than lowering its price by cutting interest rates. At first instance this will involve buying up government bonds, known as gilts, from individuals and pension funds, for an attractive price. As bonds are a form of saving, if you swap them for cash people are more likely to spend it.
If that doesn't work the government could simply give cash handouts. Poor pensioners or working people would be the priority, as they can be relied on to spend it. You can even issue time-limited spending vouchers for shops. You don't, in reality, need helicopters to do that, but it's a nice image.
http://www.guardian.co.uk/business/2008/dec/18/useconomy-economics
Ashley Seager
The Guardian, Thursday 18 December 2008
The idea of dropping money from a helicopter sounds great, particularly if you are lucky enough to be standing under one. But surely it would only happen in a banana republic or some weird work of fiction? Well, maybe.
The term "helicopter money" is on everyone's lips thanks to Ben Bernanke, the head of the US central bank, the Federal Reserve. Dubbed "Helicopter Ben" by his critics, he has been associated with the idea since he gave a speech in 1992 quoting legendary economist Milton Friedman as proposing it in extremis should deflation - or continually falling prices - ever grip a modern economy.
There are now fears that exactly that might be about to happen. On Tuesday night the Fed slashed interest rates to nearly zero in a bid to breathe some life into the collapsing US economy. The Bank of England looks about to do the same thing here. But both central banks are worried that cutting rates to zero may not on its own stop the rot so they are considering radical next steps to pump money into the economy to get people and businesses spending again.
The plan is known as "quantitative easing" which in layman's language means increasing the quantity of money in the economy rather than lowering its price by cutting interest rates. At first instance this will involve buying up government bonds, known as gilts, from individuals and pension funds, for an attractive price. As bonds are a form of saving, if you swap them for cash people are more likely to spend it.
If that doesn't work the government could simply give cash handouts. Poor pensioners or working people would be the priority, as they can be relied on to spend it. You can even issue time-limited spending vouchers for shops. You don't, in reality, need helicopters to do that, but it's a nice image.
http://www.guardian.co.uk/business/2008/dec/18/useconomy-economics
Saturday 20 December 2008
Federal Reserve battles debt and deflation
Federal Reserve is damned either way as it battles debt and deflation
We know what causes a recession to metastasize into a slump. Irving Fisher, the paramount US economist of the inter-war years, wrote the text in 1933: "Debt-Deflation Theory of Great Depressions".
By Ambrose Evans-PritchardLast Updated: 6:34PM GMT 18 Dec 2008
Comments 66 Comment on this article
"Such a disaster is somewhat like the capsizing of a ship which, under ordinary conditions is always near stable equilibrium but which, after being tipped beyond a certain angle, has no longer this tendency to return to equilibrium, but a tendency to depart further from it," he said.
Today we call this "Gladwell's tipping point". Once it goes, you can't get back up. This is why the Federal Reserve has resorted to emergency measures that seem mad at first sight.
It has not only cut rates to near zero for the first time in US history, it is also conjuring $2 trillion of stimulus out of thin air. This is Quantitative Easing, or just plain 'QE' in our brave new world.
The key is the toxic mix of high debt and deflation. An economy can handle one at a time, but not both.
The reason why it "departs further" from equilibrium is more or less understood. The burden of debt increases as prices fall, creating self-feeding spiral. This is what Fisher called the "swelling dollar" effect. Real debt costs rose by 40pc from 1929 to early 1933 by his count. Debtors suffocated to death.
Brian Reading from Lombard Street Research has revived this neglected thesis and come up with some disturbing figures. US household debt is now $13.9 trillion, down just 1pc from its peak last year. Meanwhile household wealth has fallen 14pc as property crashes, a loss of $6.67 trillion. The debt-to-wealth ratio is rocketing.
Clearly the US is already in the grip of debt-deflation. "The obvious conclusion is that the Fed should print money to purchase private sector assets so as to drive up their price," he said.
Fed chief Ben Bernanke does not need prompting. He made his name as a Princeton professor studying the "credit channel" causes of depressions. Now fate has put him in charge of the channel.
Under his guidance, the Fed has this week pledged to "employ all available tools" to stave off deflation - and damn the torpedoes. It will purchase "large quantities of agency debt and mortgage-backed securities." It will evaluate "the potential benefits of purchasing longer-term Treasury securities," i.e, printing money to pay the Pentagon.
Put bluntly, the Fed is deliberately stoking inflation. At some point it will succeed. Then the risk flips quickly to spiralling inflation as the elastic snaps back. There will be a second point of danger.
By late 2009, if not before, the bond vigilantes may start to fret about the liquidity lake. They will worry that the Fed may have to start feeding its holdings of debt back onto the market. The Fed's balance sheet has already risen from $800bn in September to $2.2 trillion this month. It will be $3 trillion by early next year.
"The bond markets could go into free fall," said Marc Ostwald from Monument Securities.
"The Fed went into this all guns blazing just as the Neo-cons went into Iraq thinking it was a great idea to get rid of Saddam, without planning an exit strategy. As soon as we get the first uptick in inflation, the markets are going to turn and say this is what we feared would happen all along. Then what?" he said.
New Star's Simon Ward said all three measures of the US broad money supply are flashing recovery. M2 has risen at annual rate of 17pc over three months.
"It has all changed since the Fed began buying commercial paper in October. If the money supply is booming at 20pc in six months, inflation will become a concern. Given that public debt ratios are already on an explosive path, we risk a debt trap," he said.
For now, the bond markets are quiet. Futures contracts are pricing five years of deflation in the US. Yields on 10-year US Treasuries have halved since early November to 2.09pc, the lowest since the Fed's data began. Three-month dollar LIBOR has plummeted to 1.53pc.
It is the same pattern across the world. 10-year yields have fallen to 1.27pc in Japan, 3pc in Germany, 3.2pc in Britain, and 3.49pc in France.
The bond markets seem to be betting that emergency action by central banks will take a very long time to work, if it works at all. By cutting to zero, the Fed has come close to shutting down the US 'repo' market that plays a crucial role in providing liquidity. It has caused havoc to the $3.5 trillion money markets - as the Bank of Japan, burned by experienced, had warned. It has become even harder for banks to raise money. Some argue that extreme monetary policy is already doing more harm than good.
Mr Bernanke is known for his "helicopter speech" in November 2002, when he nonchalantly talked of the Fed's "printing press" and said it was the easiest thing in the world to "reverse deflation."
Less known is his joint-paper in 2004 - "Monetary Policy Alternatives at the zero-bound". By then doubts were creeping in. He admitted to "considerable uncertainty" as to whether extreme tools will actually work. Liquidity could fail to gain traction.
Put another way, the Fed is flying by the seat of its pants. It should never have let debt grow to such grotesque levels in the first place.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3834108/Federal-Reserve-is-damned-either-way-as-it-battles-debt-and-deflation.html
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