Britannia Radio

This gels with my earlier posting  "BRITAIN'S ECONOMY - BLEAK 
PROSPECTS" and even earlier "QE starts amidst market scepticism".

But to those who see sinister motives in all this QE stuff please 
note the answer given here and nowhere else.  The terpsichorean 
manoeuvres by the treasury and the BoE are all due to the need to do 
what our government wants to do and "two-fingers" to the EU and its 
Maastricht Treaty!

xxxxxxxxxxxx cs
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TELEGRAPH 11.3.09
Inflation will kill the gilt rally in the end
The announcement by the monetary authorities in the UK that a policy 
of quantatitive easing (QE) would be implemented was greeted with 
euphoria by the gilt market.

By Ian Williams

The reason the market became so excited was that the method chosen to 
implement QE would involve the Bank of England buying billions of 
gilts in the open market to put on its own balance sheet. This 
expansion of the Bank's balance sheet is the modern day equivalent of 
printing money and has longer term inflationary implications that are 
anything but bullish for the longer gilts and longer corporate bonds.

But before everyone gets carried away it is important to understand 
that while the Bank of England may be a net buyer of gilts, the 
Government is still a net seller.  [Hope you're withus on this - it's 
coming out of my ears now! -0cs]  At the start of the year gilts were 
heavily sold as the full implications of the Government's truly 
dreadful fiscal position dawned on the investing public.

Indeed numbers were being bandied around suggesting gilt issuance in 
the region of £120bn or more and even the head of the Government's 
own Debt Management Office (DMO) warned of the possibility of failed 
gilt auctions in 2009 as the sums required seemed to be unmanageable.

So instead the Government is in effect deliberately under funding its 
fiscal deficit by printing a significant proportion of the money 
required. It is having to do this in a convoluted route as the 
Treasury cannot sell gilts directly to the Bank of England as this is 
not allowed ( for very good reason ) under the Maastricht treaty. 
[Typical!  I queried this all day today in the City and here is the 
explanation on my screen at home -cs]

The DMO, on behalf of the Treasury, will issue gilts by auction to 
the investing public and the Bank of England will hold a reverse 
auction of a different gilt to buy it back from the market. So the 
Bank of England buying gilts in the open market is a wheeze to get 
around the Maastricht treaty it is not net buying of gilts by the 
Government.

Let's examine the numbers. Say, for example, the fiscal deficit turns 
out to be £120bn and the Bank of England buys £75bn of gilts, the 
Government therefore only has to sell £50bn of gilts instead of £120bn.

So will it work and what are the longer term implications? The answer 
to the first question is that it will almost certainly will work in 
killing any deflation that exists by confronting it head on with 
newly manufactured inflation.

Zimbabwe suffers from a collapsing economy but the one thing that 
Zimbabwe does not suffer is deflation. The only circumstances in 
which it would fail would be if the Government fell short on the 
amount of QE required and, judging by the comments from the 
authorities, this will not happen.

Will it therefore end the recession? This is more problematic but 
again if they are prepared to print enough money it will eventually 
turn the economy around. So if it is the answer to all our problems 
why is this measure so controversial?

The answer is that while it may end deflation and recession there is 
a cost: there will ( not may ) be higher inflation down the road. 
Since Emperor Nero starting clipping coins 2000 years ago, all 
attempts in history by Governments to print money to pay for their 
overspending have eventually led to inflation.

Claims by the authorities that they are alive to this threat and will 
act to drain the newly printed money back out of the system once the 
economy recovers should be treated with a pinch of salt as the sums 
involved are simply too big. You could not drain £75bn from the 
economy without putting it back in recession.  [= "they're lying" -cs]

So what should Gilt Investors do? In the gilt fund, The City 
Financial Strategic Gilt Fund, that I run, I've switched a 
significant proportion out of conventional Gilts into Index Linked, 
or inflation-protected, gilts. I've also avoided ultra long 
conventional gilts as I expect the yield curve to steepen sharply 
once the full implications of QE come home to roost. Index Linked 
Gilts on the other hand could do quite well.  [In my City meetings 
today the statement was "Provides security but there is little value 
left" -cs]
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Ian Williams runs the City Financial Strategic Gilt Fund. It has, 
according to Lipper, ranked Number 1 in the UK since its launch in 
December 2006.