Tuesday, 18 May 2010

Quantatively easing the curry house

I was in the curry house last night while the cleaner, Mrs Slipshod, did her best to rid the windows of FatBigot Towers of tar and cooking grease.

The conversation got onto quantitative easing. One of the proprietors said it sounds like a scam because the words used to describe it don't mean anything to the man on the street. He asked whether I know what it involves. I'm not sure that I do, but came up with an explanation and would be grateful for comments if I've not grasped it correctly.

To illustrate my understanding of the matter he sat opposite me and placed a £20 note on the table. He pretended to be a bank and I pretended to be the government. He lent me £20 for one year and I gave him an IOU promising to repay £20 in one year's time.

So far so good, the government has given an IOU and received a £20 note while the bank has parted with a £20 note in return for an IOU. Everything is in balance.

The government then decides to buy-back the IOU. It costs £20 to do so. Instead of using the £20 note it borrowed, it prints another £20 note and uses that. The bank is perfectly happy, it has received £20. The government is laughing because it still has the £20 it borrowed and no longer owes the bank £20. It has gained £20 by printing another £20 note.

By the simple procedure of buying an IOU using newly printed money the government had given itself an extra £20. It's tooth-fairy money, it doesn't really exist. Multiply that exercise by 8,200,000,000 and you have the "quantitative easing" project to a tee. I think.


9 comments:

Antisthenes said...

As I understand it QE is equivalent to what counterfeiters do flooding the market with funny money. Germany during WWII were intent on introducing forged five pound notes into Britain with the object of undermining the economy. Where Hitler failed Brown may yet succeed.

Anonymous said...

I would go along with your simple explanation, but take it a stage further, you keep that IOU you retrieved with your "especially printed £20 note" and, further down the line, when things are improving, you take the IOU back to your friend and say "want to have this back - give us £20 for it". Your friend agrees, you give him the IOU, you get the specially printed £20 note from him and immediately burn it - thus "balancing the books" on that specially printed £20 note, which was only ever intended to push some additional cash into the system pro-tem ! Of course, you do still owe your friend £20, and he has your IOU to prove it ..

Barnacle Bill said...

I think I would equate QE with riding your bicycle with a slow puncture.
Think of the bike as the UK, whilst the tyre with the puncture is the economy.
When the tyre has deflated enough to affect your ability to continue your journey. Like the UK after the credit crisis. You have to stop and pump some more air into the tyre to continue. As Broon did with QE.
Now you can continue to do this until you damage the tyre beyond repair. A position we would have reached had NuLabor been re-elected.
Or you can stop and repair the puncture properly. A point we seem to have reached with the result of this general election.
That Mr. FB is my simple barnicalled take on QE.

john miller said...

Spot on. The £40 held by your friend is, in fact, worth only £20.

This is confirmed by a simple thought experiment. If the government gave everyone in the world £100 million, then the pound would not be worth very much. In fact, a bit less than it is now...

Mark Wadsworth said...

Nope. The whole point of QE was to enable the government to borrow £150 billion from the banks, while pretending to lend it to the banks.

I agree as far as this bit:

To illustrate my understanding of the matter he sat opposite me and placed a £20 note on the table. He pretended to be a bank and I pretended to be the government. He lent me £20 for one year and I gave him an IOU promising to repay £20 in one year's time.

But the story ends there (apart from the govt spending the money, of course).

That is QE. There is no more to it than that.

The next step is in one year's time when you, the govt, give the man his £20 note back (or indeed a new one you have printed, having spent the original one) and he gives you the IOU.

In any event, a £20 note IS an IOU. There is no fundamental difference between them.

Mrs Rigby said...

Oh.

I thought they used their QE money to buy government gilts because nobody else wanted them.

CynicusEconomicus said...

A good explanation (though more could be said).

I notice you comment on my blog, and you will find plenty of material on QE there. The more people pointing out the corrupt nature of the entire QE policy the better. I sought to stop the policy, and apparently ended up with MPs lobbying the Bank of England when the policy was first proposed. Sadly, it was too little (a pinprick) to make any difference.

David Cantrell said...

I thought it was the other way round - the Bank of England printed a shiny new twenty pound note, lent it to a commercial bank in exchange for an IOU and will, maybe, at some point, demand to have its twenty pound note back. We are told that that twenty will then be destroyed.

But either way, it was just printing money, a policy that worked so well for Zimbabwe and for the Weimar Republic.

james c said...

Fat Bigot,

QE is a mechanism by which a central bank lends money to the banking system.

Lending money, whether by the central bank or any other part of the financial system, results in the creation of new money. (loans create deposits and deposits are money)

There is little difference between QE and any other type of lending.