13 Jul 2012

Is Quantitative Easing the solution?

There's a very interesting piece by Simon Jenkins in today's Guardian called "Mervin King has turned our leaders into zombie puppets". He says
"It must be the biggest confidence trick of all time. It is a cheat, a scam, a fiddle, a bankers' ramp, a revenge of big money against an ungrateful world. It is called quantitative easing, and nobody has a clue what it means. According to the Bank of England, the past four years have seen £325bn pumped into the British economy to kickstart growth, with another £50bn now on the way. This enormous sum does not exist and never has. It is not "printed" money or funny money. It is no money. The one silver bullet on which the coalition relies to pull Britain out of recession is a fiction."
It's clear that QE as it is currently used is having no beneficial effect. But I wonder whether actually, Quantitative Easing could really provide a solution.

The mechanism is a bit opaque, but my understanding is that the Bank of England effectively buys back gilts from the commercial banks, replacing those assets on the banks books by freely usable "cash". This is supposed to get the banks lending, which of course it doesn't.

But maybe there is a way to use Quantitative Easing that gets us out of the current mess.

In some previous presentations (for example "Solving the Debt Crisis"), I have argued that Central Banks could lend money to governments via "publicly owned credit institutions" - a possibility that is left open by paragraph 2 of article 123 of the Lisbon treaty.

However, it's likely that such moves will be blocked by the vested interests who control politicians such as Cameron and Osborne.

QE could however provide a way round this. Currently the Bank of England has already generated £375 billion in QE, and they have just announced a further £50. But suppose that they went just a bit further and generated enough money to cover the entire £1200 billion currently owed by the UK government. They could buy up all the gilts, on which the government currently has to pay interest (£48 billion in 2011) and replace the whole lot with freshly minted Bank of England "money". The critical feature is that the banks cannot ask for interest payments on this - thus getting the government off the hook.

The really neat feature of this is that now it be abundently clear that the we don't need commercial banks to generate the money supply. It can be done directly by the Central bank, with no interest attached. Once this has been done, it could be relatively simple to say to the banks that we don't need them to create money at all. Fractional Reserve Banking by commercial banks could be completely outlawed and the government could start generating the money supply directly via the Bank of England.

Could it work? Well, I can't see why not. So, while I have previously argued against Quantitative Easing, it would now seem that it may provide the ultimate way to cancel off government debt entirely. And since the Bank of England paid the money, the government doesn't even owe the bank anything. Brilliant!

Basically, by inventing the Quantitative Easy mechanism, originally intended to help provide piles of cheap money for commercial banks, it may be that the Banking sector has just committed collective suicide. This could end up being very entertaining!

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