The CEO of the UK's debt management office - Robert Stheeman - is very concerned about the Bank of England's quantitative easing.
In some respects, the story surprised me. On reflection, I couldn't think of any other public official voicing who had suggested that there was something amiss about the £325 billion worth of funny money created by the country's central bank. I thought that QE was shrouded in a conspiracy of silence and that only highly marginalised bloggers like myself could liberally question the policy.
Mr. Stheeman willingness to speak out suggests that concerns about UK macroeconomic management is now starting to have a resonance within policy circles. The UK is now in its fifth year of stagnation and there is no end in sight to either the BoE's money creation scam, nor the government's reckless spendfest.
Mr. Stheeman's is worried that quantitative easing distorrts the country's debt markets. The Bank of England now owns almost a third of the UK's government debt stock. Superficially, that might seem like one arm of the public sector borrowing to another. It might also lull others into thinking that if the debt is held by the Bank of England, then in some vague way, it doesn't really matter, since it is not held by the private sector. Not true. The increasing domination by the Bank of England for government debt market is extremely perilous.
To see why, think for a moment what would happen if the government was running up those huge deficits and the BoE wasn't around to help. The Debt management office would have to issue huge amounts of debt to the private sector, who would have to be persuaded to hold it. The only way that they could be persuaded would be if interest rates increased. This will increase the government's debt servicing costs and if the borrowing continued the government reach a point in which debt sustainability would come into question. Or to put it more bluntly, bond holdres would begin to doubt that the government could repay its debts.
This brings us to the real purpose behind quantitative easing. Instead of relying on the private sector to finance the government's huge deficits, the central bank issues newly created money to cover the shortfall. It does this by buying bonds from banks, who then go and buy the newly issued bonds from the debt management office. Moreover, this newly-created money also keeps interest rates down.
This may seem like a wonderful risk-free solution to the country's fiscal deficits; the government runs up big deficits and interest rates remain low. It is true that over the short run quantitative easing will allow reckless fiscal policies and keep interest rates down. The counterpart to the BoE's bond buying activities is cash. If the central bank prints money but eventually there will be inflation. In the case of the UK this has, to some extent, already happened. We have the highest inflation rate of any major advanced economy.
Inflation is a thing that bondholders fear above all other risks. It destroys the real value of their investments. The UK debt management office know that if bondholders start to believe that inflation is going to rise, then they will start to dump UK debt.
The problem for the debt management agency is that this could happen any time. All it would take would be for a comparatively small number of bondholders to become frightened and start to sell their bonds. Interest rates would quickly rise, sending a signal to other bondholders that the game is up in the UK. Before you can say, "UK government is solvent and there's no reason to panic", the bond market implodes and bondholders are running towards the fire exit.
On a net basis, it appears that the private sector is unwilling to hold higher levels of government debt. Another round of QE might prove to be very destabilising in terms of bond-holder expectations. An announcement from the BoE that the economy needs yet another surge of money creation might be the detonator that blows up the UK government bond market.