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Cowley: QE is not working - gilts are effectively worthless

by Stewart Cowley on Feb 08, 2012 at 00:01

Politically a corporate bond QE program would be a winner as it would help stimulate the rise of the private sector which would, in turn, begin to absorb the jobs lost in the public sector, as has been promised by the Conservative/Liberal Coalition government.

The flip side to this prospect is that any hint that this is about to occur would be bad for gilts – yields would rise from the current artificially depressed levels.

But with corporate bond yields still at elevated levels a corporate bond/loan QE program would carry with it a possible by-product; that the Bank could actually make a profit from the next phase of QE.

Having transferred a huge amount duration risk into our central bank the next phase could well be the biggest transfer of credit risk out of the hands of the private sector and into the state that this country has ever seen. So if any of you thought there was light at the end of the QE policy tunnel think again. It’s not a light, it’s the next train coming…

Stewart Cowleyis manager of the Old Mutual Global Strategic Bond fund . According to Lipper, in the three years to 6 February the fund has returned 43.2% versus a 13.75% rise in the benchmark.

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3 comments so far. Why not have your say?

John A Clarke

Feb 08, 2012 at 15:17

I am disappointed that so much confusion continues to reign over what QE is supposed to do. Its primary purpose is not to increase bank lending--although this would happen if the banks had not been forced by regulators to hold substantially higher amounts of capital relative to their assets. Instead, its main objective is to compensate for weak bank lending. Therefore to suggest that the ongoing weakness in bank lending proves QE isn't working is unfair. Nor is it designed specifically to drive down long term interest rates. Instead, the purpose of QE is to directly increase the quantity of money and hence nominal national income. QE works by the Bank of England, financed by the issuance of new reserves to the commercial banks, purchasing gilts (or corporate bonds) from the non-bank private sector. As cash is deposited into the bank accounts of the sellers, the quantity of money is increased everything else being equal. But as this is likely to increase cash holdings above desired levels, the non-banks are likely to respond by buying other assets such as equities, driving up their price. The primary transmission mechanism of QE to the real economy--as Mervyn King has pointed out on numerous occasions-- is through positive wealth effects. I accept that monetary growth has stalled again in the three months to December despite the implementation of QE2, but this is because declining bank lending has offset the monetary injection from the Bank's asset purchases. Imagine how much lower the quantity of money, and hence the level of GDP, would be now had there been no QE.

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The City Grump

Feb 12, 2012 at 11:19

Suggest you read Liam Halligan in today's (12.2.12) Sunday Telegraph if you want to find out just how horrIfic QE is going to be for all of us thanks to the duplicity of politicians and the BoE.

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John A Clarke

Feb 13, 2012 at 10:47

Suggest you (and Mr Halligan) understand the difference between the expanding the monetary base and the quantity of broad money. The ratio of the base to broad money has oscillated wildly in the past with no implications for economic activity or inflation. The key relationship between "money" and the real economy--as Keynes recognised--is a broadly defined one and not the sum of notes and coin plus banks reserves held at the Bank of England. If the quantity of money thus defined is contracting, so too, over the medium term, will nominal GDP.

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