*****Britain Monetizes Its National Debt*****

Financial Times reports about stampede to sell government bonds.

(emphasis mine) [my comment]

Stampede to sell government bonds
By David Oakley and Chris Giles , Financial Times, 11 Mar 2009

[When investors are "stampeding" away from your debt as if it was the plague, it is NEVER a good thing. Watch how this article tries to put a positive on this terrible development]

Investors flocked to sell government bonds to the Bank of England as it launched an unprecedented program to expand the money supply and breathe new [suck the] life into [out of] the economy. [No nation has EVER reach prosperity through the printing press. Hyperinflation will make life worse, not better.]

The Bank was overwhelmed with offers to sell the bonds by some of the country's biggest investment groups in an early sign of success over its historic quantitative easing move.

[quantitative easing = money printing]

John Wraith, head of sterling rates product development at RBC Capital Markets, said: "So far, so good. The UK bond market has really moved as a result of the Bank's quantitative easing plan. We have seen yields fall by 50 basis points [half a percentage point] since the announcement last Thursday."

The Bank was pleased with the result of the so-called reverse auction
, in which investors sell their bonds rather than buy them from the authorities. It augurs well for the rest of the program, in which the Bank aims to buy up to Ł75bn in gilts over the next three months.

It was inundated with Ł10.5bn of offers to sell gilts — five times more than its Ł2bn target,
quashing initial worries from some City analysts that investors might fail to show up. [The UK is essentially giving away free money. Who exactly are these people who were worried no one would show up?]

The Bank also paid close to the market price for the six bonds, which had maturities ranging from five to nine years, it had offered to buy. There had been worries that it might be forced to pay above market rates as investors demanded a big premium to sell their bonds.

[There is no "good" price for a nation that is monetizing its debt.]

The quantitative easing initiative may put pressure on the European Central Bank, assuming the program continues to attract investors, to follow suit, as UK bond yields, which have an inverse relationship with prices, have fallen so sharply.

UK bond yields are now trading at the same level as German Bunds, historically the lowest in Europe because of the strength of Germany's economy and the depth of its bond market. [Yes, isn't that great? Of course, Germany ISN'T MONETIZING ITS DEBT.]

Benchmark 10-year UK bonds closed at 3.08 per cent on Wednesday, compared with 3.07 per cent for 10-year Bunds. Gilts typically trade about half a percentage point, or 50 basis points, higher than Bunds.

The US Federal Reserve will be watching the Bank's moves closely.
The US has embarked on quantitative easing but by buying corporate assets rather than its own government bonds. However, the Bank's announcement has had a much quicker and more dramatic impact on yields than the Federal Reserve's move.

The gap between gilt yields and US treasuries has also narrowed. US 10-year bond yields settled around 3.03 per cent at the close of London trading.

The fall in bond yields should act as a big stimulus as it is likely to bring down corporate borrowing costs, which track the so-called risk-free rate of government securities. Swap rates, from which many fixed-rate securities are calculated, have been brought lower by the fall in gilt yields. Swap rates are the cost of switching to a fixed from floating rate and are used by many lenders to set fixed-rate mortgages.

Sterling fell to a six-week low against the euro, although this was primarily due to continuing worries about the banking system [Don't think it had anything to do with the UK running the printing press do you? Of course you don't.]. It cost 93 pence for €1 at one point on Wednesday.

My reaction: The pound and the dollar are dead. I urge anyone who owns dollars or pounds to buy physical gold, euros, Swiss francs, or anything else for that matter. The dollar and the pound are about to become the two worst performing asset classes on the planet.

If you h aven't already, I read about The Nightmare German Inflation. In offers grim preview of what awaits the UK and US.

[This is an extract from a 1970 report on Weimar Germany's hyperinflation. I advise you to read the full version.]

Inflation seemed to bring prosperity.
In 1921, when the rest of the world was in a severe post-war recession, production indices in Germany rose sharply. Late in 1921 the mark stabilized temporarily, and business promptly weakened. By early 1922 the mark was sliding again, and business immediately revived. People were buying goods as fast as they obtained money; companies rushed to expand plants and turn money into fixed investment. Germany was actually envied for its "prosperity" by many foreigners. [The US/UK has been enjoying the same "prosperity"]

The mechanism of inflation was simple. The government issued paper promises to pay, and the Reichsbank issued money on the security of these promises. [UK sells bonds, and the Bank of England buys them with printed cash. Simple no? Today this process is called quantitative easing.] When a government spends more than its income, it must borrow. If it merely borrows money from its citizens by selling them bonds, there need be no inflation. Instead of that money being spent or invested by the citizen, it is borrowed and spent by the government, but the total amount of money is not increased.

When the government needs more money than its people are able or willing to lend it, it monetizes the debt. [This is the quantitative easing] That is what happens in this country when the government runs a big deficit. The Federal Reserve (our central bank) "buys" as many bonds as necessary to stabilize the market. It prints money on the security of these bonds. Despite the facade of the government supposedly "borrowing," the net result is the creation of printing press money. (Actually these days the money is created in the form of new bank deposits--checkbook money--but the net result is exactly the same as if bills were printed.)

This is what happened in Germany. The government issued notes which were promptly discounted by the Reichsbank, i.e., the bank issued money on the "security" of these worthless notes. To compound the evil, the bank failed to raise its interest rate sufficiently. Businessmen found it very profitable to borrow money from the bank and buy up goods, shares and companies. Their debt was wiped out within weeks by the rapid inflation, and the businessman remained holding the valuable assets he had bought. The net result was a huge "private inflation" caused by the rapid expansion of credit. Even foreign exchange was bought with borrowed money, so that the Reichsbank actually financed speculation against its own currency. Yet the bank refused to raise interest rates, arguing that this would only add to the cost of business and thus would increase inflation!

The tax system virtually broke down. Businessmen found that by merely delaying tax payments, the depreciation in the mark would virtually eliminate their true value. But the government, lacking adequate income, felt forced to resort more and more to creating money. By October 1923, 1% of government income came from taxes and 99% from the creation of new money.

But the main force which gave inflation its momentum was the steady decrease in the true value of money in circulation. This has been observed in all past rapid inflations and it is vital to understand it if inflation is to be coped with. During the war, as we saw, the price inflation lagged behind the rate at which money was issued. But now, as people lost confidence, prices began jumping much faster than the government could generate new money. Thus the total circulating currency fell drastically when measured in terms of its true value. One economist stated that, "In proportion to the need, less money circulates in Germany now than before the war. This statement may cause surprise but it is correct. The circulation is now 15-20 times that of pre-war days, whilst prices have risen 40-50 times." In fact, the total currency when calculated in gold value fell from 7428 million marks in January 1920 to a mere 168 million by July 1923.

Despite the proliferating billions of trillions of marks, the average citizen found it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks. Businessmen were strapped for money to buy materials an d meet payrolls. [like what is happening today due to credit crisis!] The government faced the same problem. It appeared that there was not too much money around, but rather much too little. The clamor for more money grew on all sides. [like today's bailouts!] It seemed that any halt to the printing presses would bring business to a standstill and throw millions of workers out on the street. [like fears of big three bankruptcy!] The government itself would be unable to carry on. Riding a tiger, it dared not dismount. On October 25, 1923, the Reichsbank noted that it had that day printed 120,000 trillion marks. Unfortunately, the day's demand had been for one million trillion. However, it announced that it was expanding production and the daily issue would soon be 500,000 trillion! [KEY POINT: before one of the greatest period of hyperinflation in history, the money supply appeared to be contracting (deflation).]

Once people lose confidence in a currency, they try to get rid of it. As Lord Keynes pointed out, this makes circulation speed up enormously, and hence prices rise faster than the government can print new money. Marshall, studying this process, concluded that, "The total value of an ' inconvertible paper currency cannot be increased by increasing its quantity; any increase in quantity which seems likely to be repeated will lower the value of each unit more than in proportion to the increase."

Customarily, however, governments blame everyone and everything except themselves for inflation. When inflation lags behind issue of money, as it did in the war, they say that this shows that the issue of money is not dangerously high. Later, when confidence vanishes, and prices soar ahead of currency issues, that again is taken to prove that the government is not to blame--it is only reluctantly issuing money that is desperately needed in view of rising prices.

We will conclude this discussion with a quotation from Dr. Milton Friedman's book, Dollars and Deficits. Friedman notes that after the Russian revolution, the Bolsheviks introduced a new currency. They printed huge amounts of it and soon it became almost worthless. At the same time some of the older Czarist currency still circulated and maintained its value in terms of goods. It appreciated enormously in terms of the new money. Why? This money was not redeemable. Nobody expected the Czarist government to return. Why did this currency hold up? "Because," says Friedman, "there was nobody to print any more of it."

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10 Responses to *****Britain Monetizes Its National Debt*****

  1. Raf says:

    But hold on.

    Monetary inflation (which we have had for the last 10-15 years) is now in reverse.

    If it's the total money supply that is the issue then that should be the focus. If the money supply starts to contract (as loans are written off and new ones not created), then that means the creation of new money is not necessarily inflationary.

    We are in a period of serious asset deflation (long overdue) but let's not get to carried away with hyper inflation forecasts just yet.

    Not that I agree QE is the way to go but just a point.

    I would much prefer direct government spending with new interest free money into core services and infrastructure but that's another story.

    The financial sector is kaputski...let it fold and focus on the productive sector.

  2. dogismyth says:

    eric...great article.

    Any ideas on why the euro and yen are having such erratic moves today? I would have thought the euro would have dropped, and stayed there, in light of your article. Or are we talking currency intervention here?

  3. Anonymous says:

    Futures indicate Euro will collapse in 3 months.

  4. Martijn says:


    According to this article in the Telegraph the market has taken positoins against the euro.


    @anonymous: it helps others in their research if you post your sources

  5. Anonymous says:

    In the end all currencies now are fiat. Any of them can fall off into the abyss. Only gold and silver are sound money and will preserve wealth.

  6. Jose Luis says:

    Sure you can have a laugh with this "quantitative easing" boat route:

  7. Hugo says:

    Raf, are you saying that banks wont never start lending again. When they do, what will happen? Besides, deflation is what its needed now. Irresponsable banks and company should go bankrupt, and succesful business should take their place.

    And why do you want the politicians stealing the savings of the responsable people through inflation (wich also affects negatively the purchasing power of the wages) and spending it the way they want. Politicians allways help their friends and benefactors (mainly banks) as we have seen recently.

  8. Anonymous says:

    don't take any notice of the telegraph -they seem to have a vested interest in talking down the euro cos of their peculiar anti european stance- my regret i didn't put my life savigs into euros two years ago when I first noted this happening-I'd be 35% better off today! Take alook at Ireland-AIB would have bankrupted them if they weren't in the euro just as some states of the US would have completely collapsed if they weren't in the dollar.The pound as an offshore gambit against the euro has failed.

  9. GUMNAAM says:

    I am a Forex trader. I trade online (successfully to date) based solely on technical analysis and pay no attention to the fundamental macroeconomic changes in my trading decisions. But I try to keep myself aware of major developments around the world and I am keen to keep learning more about how the world's financial system really works. It is all fascinating stuff for me, learning about money supply, credit creation, asset inflation and deflation etc. I attended MBA program at NYU Graduate School of Business. Some of the professors were excellent.

    According to my charts, Euro looks bullish. I can't give you any reason why. The charts just seem to know. The Euro showed a low of 1.2452 on March 4. Thereafter, it has been making a higher low every day. The trend appears to be continuing for the short term.

  10. Anonymous says:

    Euro go up? Could be because they have no mortgages crisis?
    Or somebody maneuvering in the back ground to make it so.
    I have no trust in WALL Street or banks...they have been the ruin of this nation since 1913 like the fed reserve, and created for the sole purpose to collect interest and keep the people poor and slave on the system.
    Save your cash, buy with cash and hold land rather than stock.

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