The Bank of England is going to buy £75 Billion of Gilts to increase the money supply and, hopefully, ease credit problems by getting the Banks to lend. Now having read Roger Bootle in the Telegraph this morning, I see a couple of problems, one of them an absolute humdinger.
Lets do the little one first. getting the banks to lend. This will not happen until the amount of “Toxic Debt” is identified, quantified and accounted. Until then we have the Lloyds Group situation where bank that was always seen as being run conservative way has been brought down by having a merger forced on it by an over eager Government, due mainly to the fact that the amount of Due Diligence done was inadequate. Just on the news today, there was a comment, that I believe could be actionable in the courts, that for the last six months of it’s existence, the corporate lending book of HBOS was not “just” risky, it was extremely risky. Could it be that by this time the Directors of HBOS were aware that things were going down the pan and therefore took bigger and bigger risks like a loser at the roulette wheel? Gambling is an addiction, they were addicted, but they were doing this gambling with money that was either ours, or borrowed. My memory isn’t as good as it used to be, but I can remember from years ago, hearing a Government Minister saying that you should only invest in shares if you could afford to lose the money. They lost, big time, in the process, they made sure we all lost, as their Balance Sheets now hold huge amounts of assets that are have absurdly high valuations. The upshot is that, until ALL these assets are identified, you can assume that the Banks will not lend, to each other, let alone to us.
Now that was the little problem, the big one is much bigger. This is primarily about the £75 Billion the Government, sorry, the independent Bank of England, is injecting into the system by buying up Gilts. Again, my understanding is that Gilts are just a piece of paper that pays a fixed Interest rate for it’s life, followed by the return of the Capital initially invested. So far so good, the BoE will go and buy some of the Gilts it issued and as a result inject money into the money supply. From comments I have read, and things I have heard on news bulletins, it seems the BoE is going to buy mainly at the long dated paper, due for redemption between 15 and 30 years. Most of the holders of these Gilts are Insurance Companies, Aviva and the like. With the thought that Aviva’s share price last week dropped by 25%due to fears of their Capital Reserves not being big enough, what on earth makes people think that any Gilts bought by the BoE will be channelled back into asset purchases? The first thing that Aviva and other Insurance Companies will do is increase their Capital reserves to exceed, by a margin those required by law, once they’ve done that they will consider buying assets, but if asset prices are still falling at the time, they risk, again, eroding their Capital Base. I believe this will make insurance companies do exactly what the banks have done until they see a recovery in asset values, and that means a vicious circle, I expect the BoE to, eventually, inject over £200 Billion to get things moving, by which time there will be too much money in the system and the debasement of the currency will mean that we will no longer be able to say that Zimbabwe is a bad example.