Thursday, 8 April 2010

Tyler vs QE. Tyler wins.

Not many people seem to understand Quantative Easing (QE).

Tyler will now do his best to explain it all for you, in language that you can mostly understand. Keep up, you hear?

QE is essentially printing money. We all know that, right? But what you probably don't know, is that it really is Debt (in the shape of Gilts). More accurately, it is forward starting debt (for those of you with more financial engineering experience, it's the equivalent of a forward starting interest rate swap).

Let Tyler take you by the hand and guide you through it.

1. The DMO issues Gilts to the market via an auction. For arguments sake let's say they are 10y maturity.
2. The BoE electronically "prints" money, and buys those Gilts from the market. The market now has more cash. Thats the Quantative easing bit out of the way.
3. 10 years roll by, and the bonds come up for maturity. The BoE now has one of two choices;

4a. It removes money from the system, undoing the electronic printing it did in step 2. This money is transferred to the DMO, which then can pay it right back to the BoE for the maturing bonds.

4b. It can ask the DMO to issue more bonds, then use the cash from the sale of those bonds to pay for the maturing bonds. It has effectively "rolled" the cash position, but has done so at the cost of issuing more bonds. This is where the forward starting debt bit comes from.

So, QE in effect is adding money into the system now, but at the cost of removing it later. It is debt, albeit kind of odd looking debt. Many lefties don't seem to have any kind of sccoby doo what it really means. To be fair, some governments don't either, but that isn't an excuse.

The UK QE was particularly cheeky - it was just used to by government debt, and pay for the massive deficit, so the government could keep spending high as they went into an election year. In the US QE was partly used to by lower grade credit from banks, which allowed the banks to clean up balance sheets and get lending again. That said, it looks like the US is now buying their own debt, as there is so much of it that foriegn governments can't keep up.



  1. QE is just an asset swap. There is no extra money.

  2. You are correct - though the asset swap is effectively a time based one. You are effectively rasising cash now but delaying interest payments on it to some future date