It Won’t Work: Understanding the Bank of England’s Quantitative Easing

It was announced this week that the Bank of England will pump a further £75bn in to the UK economy in the alleged hope that it will create growth and pull us out of recession.

But what really is Quantitative Easing? Where does the money come from, and what does it mean for the average citizen?

Government Bonds

In the UK a Government Bond, usually known as a Gilt or collectively as “government stock” or “treasury stock”, amounts to a piece of paper that the Treasury sells to investors on the London Stock exchange, for immediate capital in sterling. It is a literal swap. The investor gets a piece of paper or digital receipt, and the Government’s accounts get credited with the agreed amount in Pounds.

The Government then has to pay this capital back to the investor over a set period of time with added interest. In a nutshell it’s the Government taking out a loan, just like if you borrowed money from a bank. It’s considered a low-risk investment to purchase Government Bonds because what we might call the collateral is backed by taxation of the people. Whereas you may lose your house or car for failing to pay off a loan, the Government’s back-up is to make the people work harder and pay more to the Tax Man. The recent proposal of a Fat Tax is an example of the Government looking for extra tax money to pay off its debts. In practice the Government will also create more bonds in order to pay off previous bonds, in a vicious cycle much like cycling through credit cards.

The current national debt including Bonds and pension liabilities is £4.8 Trillion.

According to September 2009 data, the largest holder of UK Government Bonds were Insurance Companies and Pension Funds, followed by overseas investors & offshore banks, and then the Bank of England & domestic banks. Unlike America who have a clear knowledge of which foreign countries hold their bonds (China being the biggest), the UK does not keep detailed records on where it’s foreign bonds are held.

Quantitative Easing

As part of its Quantitative Easing 2 program, the Bank of England is increasing the amount of Government Bonds it holds. Instead of using money earned to make these investments the Bank has the right to create it out of thin air!

At one time it may have physically printed physical notes and coins, today it will simply type £75bn in to its computer system. Just like magic!

When the Bank has created this new money it uses it to purchase Government Bonds already on the open market, other bonds issued by the corporate sector or supposed safe assets. So for example if Insurance Company A holds a Government Bond that isn’t near maturity (which is when the Government has finished paying back the principal + interest), the Bank will buy that bond, giving Insurance Company A an immediate injection of capital. The Government then owes the rest of their repayments to the Bank of England, the new holder of the bond.

The theory is that injecting liquid capital in to the private financial system will free up the credit crunch and allow the Banks and Lenders to start lending again, which then should help fund growth. However the system is not obliged to lend when it gets this injection of capital, it can hoard it, it can use it for bonuses, it can do what it wants. Thus there’s no guarantee that it will work. For the man on the street the first round of QE clearly didn’t work, neither did the first two rounds of QE in the United States.

Currency Devaluation & Inflation

Currency devaluation is a decrease in the purchasing power of the Pound, and occurs whenever new money is created out of thin air. When the Bank of England creates £75bn in new money, every other pound in circulation loses value. The coins in your wallet, the savings in your bank, the wage you get paid are all worth less.

This reduction in value also means imports to the UK are more expensive. This is then passed on to the consumer in higher prices or less adequate goods.

Not only is your money worth less, but the things you buy are worth more and are probably smaller.

QE may cause some growth in the higher echelons of society, but we’re already in such a state it’s highly unlikely to ever reach the poorest. They don’t want loans or credit to open businesses or buy useless tat, they just want to survive debt free on the low wages or benefits they receive. The most likely scenario is that the banks and financial giants will sit on the money, strengthen their own balance sheets and leave the rest of us to fight amongst ourselves.

It’s akin to throwing life jackets and dinghies at the upper classes on the Titanic and expecting them to pass some down to the peasants. The ship is sinking, who do you think is more prepared to survive?

“This is the most serious financial crisis we’ve seen, at least since the Thirties, if not ever.”
– Bank of England Head Mervyn King, Yesterday!

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