Printing Money Debate

The Bank of England, it is reported, has every reason to be pleased with the initial market reaction to its printing money policy. The newly-printed money process began last Thursday.

The bank seems to have three options on how to spend its new money. What appears to have happened from last Thursday on is for the bank to buy its own existing debt.

By stepping in with unprecedented amounts of new money, the Government’s aim was to push up the price of its own debt.

The hope was that as prices rose, and thereby the rate of interest fell, those selling gilts would not use the money to buy other gilts but, hopefully, put the money into company bonds or elsewhere in the economy where there is a better return.

When the printing money debate began, the Treasury was clearly briefing the media that the printed money might be used to go into the corporate bond market. By purchasing long term debt being floated by major companies, it was hoped that companies would use their increased capital supply to invest, and thereby help lay the foundations for a more hopeful recovery.

It does not seem yet, but it is early days, that this policy has been pursued. But there is of course a third alternative which is not mentioned.

At the moment, the Government is operating in a market trading in existing Government debt. At the same time as refinancing loans that expire, and thereby keeping the level of Government debt constant, the Government knows it is in the business of offloading additional debt, the size of which we have not seen since the financing of a World War.

My concern is how the markets are going to react when large tranches of new debt run alongside the operation and sales of existing debt.

This will be the test about how confident the market is in the Government’s long-term financial stewardship. Will additional buyers be found for £140 billion debt for this year and every year into the far-distant horizon?

I doubt it. Why should economies like Brazil, that have currency reserves, lend to a country that has helped get the world into the fine old mess we now face?

The only way of attracting buyers will be to push up interest rates, i.e. it will be the only attraction in trying and persuade people to part with their currency reserves and so sure up British Government finances.

Such a scenario would be serious as rising long-term interest rates would undermine and timetable for industrial recovery. But it might not be the worst scenario.

It may not be apparent to the lay-person’s eye just what quantity of new debt the Government is offloading at any one time. Every week the life of gilt issues comes to an end and the Government, unless it wants to cut the size of public debt, issues new bonds, to take the place of those expiring.

It won’t be easily apparent to our eyes that the new bonds are renewing existing debt or are about increasing the level of debt. But the market will know as the size of the amount of bonds at any one time being offloaded will begin to increase dramatically. If there are not enough buyers for this enlarging debt market the Government may be forced to turn to that third use of its newly-printed money, i.e. it will be forced to buy its own debt.

What will be the effect then on sterling? What will those people that hold sterling do in such circumstances?

My guess is, sadly, they will sell and once the Government encounters difficulty in finding buyers for debt other than itself, sterling will collapse.

So, we therefore will get a first-rate sterling crisis even though we have a flexible exchange rate. It is the combination of rising long-term interest rates and a dramatic collapse in sterling that will test whether the Government can survive.

Likewise, a similar collapse of sterling will occur if the Government loses its triple-A credit rating, as has already happened to Spain and Italy. As neither of these countries have reserve currency status, and both of them are now in the Euro where Germany is now propping them up.

Should that scenario occur, the Government will have to overnight convince the market that it is serious about beginning to get the public finances back into shape.

That will require immediate tax increases and, as a start, cash-limiting public expenditure. The test will be whether the present administration regains the confidence of the markets under the set of circumstances I have described.

But look at the strains within the Eurozone, bond markets in Italy in Spain show significantly higher interest rates than in Germany. The printing money story has only just begun in terms of its likely consequences.

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