The Delayed Effect of Printing Money via Quantitative Easing

Gold reaches £913 per ounce

If political leaders and central bankers think that they can curb the currency debasing effect of QE merely by turning off the tap, they are mistaken.  Markets reflect not just today’s monetary policies but also rational players’ expectations as to future activity.

At a lunch recently with Ewen Stewart, the parallels between the UK’s QE and the Weimar Republic’s printing of paper Reichsmarks became starkly apparent.  Since QE began, Ewen explained, 69% of all gilt issuance has been bought by the Bank of England.  This makes sense when one digests the transactions entered into by the Government to create money and then issue gilts.  Consider the following transactional steps:

1. The UK Treasury’s Debt Management Office announces its intention of buying  specified financial assets, either gilts or bank loans;
2. Life funds and other institutions willingly compete in this ‘buy back’ auction to sell gilts and other ‘high quality’ assets to the DMO, and prices are moving in favour of the seller given the DMO’s initiative;
3. The Bank of England presses a button on a computer and transfers the newly printed cash to the DMO in order to settle the buy back trades.  The DMO credits the accounts of sellers with the newly created money;
4. The DMO subsequently announces a conventional gilt auction whereby gilts are issued by the DMO for purchase by banks.

What are the commercial drivers of these four steps?   Why would the DMO issue at Step 4 given that it has purchased at Step 1?  The only conclusion is the creation of money, which necessarily entails the debasement of the currency.

Would the DMO agree with this summary?  Perhaps not.  It explains the QE operation in different language.   According to its pamphlet “Quantitative Easing Explained”, the exercise stimulates the wider economy by ‘injecting’ money.

The MPC’s decision to inject money directly into the economy does not involve printing more banknotes. Instead, the Bank buys assets from private sector institutions – that could be insurance companies, pension funds, banks or non-financial firms – and credits the seller’s bank account. So the seller has more money in their bank account, while their bank holds a corresponding claim against the Bank of England (known as reserves). The end result is more money out in the wider economy

But this denial that banknotes are being printed is mere spin.  The term ‘injection’ is misleading – it implies that the substance being injected is already in existence.  This is not the case with QE.  A pamphlet purporting to explain QE should clearly state that the money is “created” before being injected.   It is true that banknotes are not actually physically printed as they were in Germany in the 1920s.  But that is because today, unlike in the 1920s, bank accounts are represented by computer entries.  Therefore it follows that the creation QE and the transfer of QE proceeds to a bank by increasing the bank’s account balance with the Bank of England is, in plain English, printing money.   It is an exact modern equivalent of rolling the printing presses and sending a pile of banknotes round to the physical headquarters of RBS or Barclays under the watchful eye of a bevy of burly bank stewards.

Indeed, the sophistry of the DMO’s denial that QE is money printing, based on the technical point that physical ink and pieces of paper are not required at the point of QE money creation, is exposed by the diagram summarising the above quoted paragraph from page 8 of the pamphlet:

The Bank creates money and uses it to buy assets such as government bonds and high quality debt from private companies

Upon recently re-reading Adam Fergusson’s detailed daily chronicle of the collapse of the German fiat currency in 1923, I was struck by what economists call the J-curve effect.  It was a matter of years, not weeks, before the full and dire consequences of the policy of printing money became apparent.  All of the characters whose lives Fergusson recounts, with the exception of the politicians, could foresee the dreadful consequences of money printing.

But the crisis evolved in phases.  As it started to bite, clever Germans worked out that debt would be inflated away and that hard assets would quickly rise in value.   At page 109 we learn how in 1922 the clever Hans-Georg von der Osten, borrowed in February to buy a substantial estate, then paid off the entire loan in the autumn with a modest crop grown that year on the land.   During that summer he also bought 100 tons of maize from a dealer for 8 million marks, only to sell the same crop back to the dealer a week later for twice the price.  With the profits “I furnished the mansion house of my new estate with antique furniture, bought three guns, six suits and three of the most expensive pairs of shoes in Berlin, then spent eight days there on the town”, he boasted.

There are of course many differences between the UK’s economic circumstances now, and those of Germany in the early 1920s.  But there are also many parallels.  One significant parallel is that Germany’s rulers knew that the country was unable to pay its war debts, and possibly embarked on their programme of currency debasement, to the ire of the Reparations Commission and creditor nations, as a deliberate policy to inflate the problem away.

So in March 2009, in order to address the banking crisis, the UK believed that a £200 bn programme of quantitative easing was an essential monetary policy tool to stimulate the economy and “control inflation”:

The instrument of monetary policy shifted towards the quantity of money provided rather than its price (Bank Rate). But the objective of policy is unchanged – to meet the inflation target of 2 per cent on the CPI measure of consumer prices. Influencing the quantity of money directly is essentially a different means of reaching the same end.

I can only assume that the German government believed that, when the nirvana of modest national debt had been reached, they could end the debasement and somehow revive the economy.   However, by 1924 many Germans could not afford food because confidence in the currency was so low that nobody wanted marks.  Fiat currencies depend entirely on confidence, and when the confidence bubble is punctured, no matter how slowly the air escapes, it proves exceptionally difficult to repair.  Both the US and the UK are now experiencing this.   When the UK launched QE in March 2009, gold stood at about £600 per ounce, today the same ounce costs over £900.

I would be grateful for any Bank of England officials to enlighten me as to where my above squaring of QE with Weimar money printing may be mistaken.  If our central bankers are unable, perhaps they would be so kind as to acknowledge that their website quotation above is grievously mistaken.  QE, far from being a technique of inflation control, represents the introduction of the germ of hyperinflation which, unless stopped or preferably reversed very soon, will continue to grow like a virus within our economy and in turn may wreck our society.

At what level of the pound to gold would the BoE start to lose confidence in the merits of QE?  Or is the price of gold in pounds irrelevant?  Was Isaac Newton therefore confused in his insistence on a clear relationship between the pound sterling and a specified weight of gold?  If that is their view, perhaps the BoE ought to take that famous bar of gold out of their own museum.  That would be more consistent with the BoE’s apparent present beliefs: we should forget that the pound was once a hard asset backed by gold, and learn to appreciate that the paper pound exists as a pure confidence asset.

Fergusson’s final paragraph should appear next to those absurd sentences on the Bank of England’s website.

In hyperinflation a kilo of potatoes was worth, to some, more than the family silver; a side of pork more than the grand piano.  A prostitute in the family is better than an infant corpse; theft was preferable to starvation…..

Thanks to Ewen Stewart and Andy Duncan who have contributed to this piece.