So a caveat up front - this is most definitely a noobie question, it may be stupid and Iâm not even sure this is the best place to post it.
But if youâve made it this far, then Iâm going to carry on.
So in the current climate weâve seen most of the most wealthy countries pulling together stimulus packages to keep everything going. The US has committed $2tn, Germany has committed to 750bn the UK has offered 66bn.
My question is, where is this money coming from? Normally it would come in the shape of a loan from another country. But Iâm assuming thatâs not feasible at the moment, given that everyoneâs going to need every penny they can get their hands on for their own stimulus offerings.
So are countries finding it within their own borders? If so, howâs that possible given the size of these deals? Are they just printing more cash? In which case, are we likely to see a massive hike in inflation?
Thanks for your time with this. Iâm just curious as to understand how this is being dealt with to get a grip on the global impact that these deals are likely to have once things start to return to normal (whenever that might be!)
The money comes immediately from the bank accounts which governments hold with each respective central bank. So, for example, in the UK the BoE has an account (called the âWays and Meansâ account) which the government uses to fund expenditure. Normally it holds ÂŁ400 million but this has essentially been raised to infinity. The central bank deposits money into that account as it has the power to create fresh funds.
The money will then be repaid by the government issuing new government bonds. This debt will be bought UK by pension funds, retail investors and other institutional investors.
Well the idea is central banks will now be a buyer of last resort in the bond markets, thats why the BoE intervened after last months crazy - to stop spikes in interest rates and maintain stability.
As for inflation I think everyoneâs worries are on deflation right now. Zero/negative rates, collapse in oil and the economy is nowhere near productive capacity. Aggregate supply is still way ahead of demand, which has been obliterated, except maybe for staples like food. The only way hyperinflation happens is if we get a chronic shortage of a commodity or a loss of confidence in and credit of the currency issuer, so frankly any form of inflation from the induced demand of stimulus measures is more than welcome!
These are fairly complex concepts to understand, but to address your question head on:
Where is the money coming from?
In order to fund the stimulus packages that governments are proposing. They sell bonds (i.e. they increase government debt) in a not dissimilar way that major corporations do.
The problem as you then point out is who is buying the debt ( Or, if you like, who is lending out the money) ? The answer to that will be usual investors: financial institutions, large corporations, pension funds that would want to keep bonds as an investment. To a small extent retail investors will as to, if you own for example the UK Gilts ETF on Freetrade you are buying UK government debt.
However the next problem is demand: during a global crisis even big financial institutions will not have the money washing around to make large purchases of government bonds, so is left who can buy then so that the UK government has the ability to make this big stimulus spends?
The answer is the Bank of England (or equivalent central banks, the Federal Reserve in the USA or the European Central Bank in the eurozone). The BoE is able to buy UK government bonds via the process of quantitative easing, and it can in effect do this as much as it wants because the BoE has the ability to print more money to do so. There are some potential downsides to doing this as others have pointed out such as inflation, but this is how the money is available for large stimulus spending.
(Edited above paragraph to clarify the fact that the BoE prints new money increasing the money supply)
Check out these marvellous vids for further research:
As far as I can tell, they simply printed new money.
(They issue more bonds, which then central bank buys anyway through QE, and central bank contributes back any interest it receives, so net effect itâs just new money created. Itâs ok, as long as everyone else is doing it, and they are. It only messes up emerging markets who are not trusted to do the same. Thus imho for every printed billion foreign aid should be given too.)
Fake money, printed out of thin air, that we will consequently be taxed onâŚthatâs your governments for you, unfortunately the majority donât have a clue this is happening.
Valuetainment done a recent video on this and asked a former fed chairwoman about this and she couldnât even answer him, Iâm paraphrasing but she more of less said âyour not meant to know that, but yes it isâ
The key function is that the BoE buys bonds from other investors rather than purchasing freshly issued government debt. This pushes money into the hands of investors who then deposit this money into the banking system. This builds up banks capital and spurs lending etc.
Do you have a reference for this? The BoE have extended the âWays and Meansâ account the government holds with them to infinity but I had not heard that the BoE was buying government bonds directly.
How much quantitative easing have we done in the UK?
Following the programme of QE announced in March 2020, our purchases of government bonds will total ÂŁ645 billion.
Rounds of QE have been announced in response to the economic conditions at the time.
(/source)
The Ways and Means account is more of an emergency overdraft line of credit. Although the limit has been raised to effectively infinity this will not be the mainstream of financing of the government stimulus package. So far the UK Govt have pledged ~ÂŁ400B (including the ÂŁ330B government backed business loans), in 2008 the Ways and Means account topped out at ÂŁ20Billion. The main way that the package will be financed will be government bond purchases directly by the Bank of England.
Where does it say the BoE is directly buying bonds from the government though?
The âWays and Meansâ account will not finance anything as any money drawn down will have to be repaid by the issuance of fresh debt at a time when the market is functioning properly. However, the debt which will be sold to raise these funds will he sold into the market and the BoE will conduct market operations as it has done previously to buy government bonds from existing holders.
Sorry, yes you are right. The BoE purchases Government bonds on the secondary market from institutional private investors, increasing demand for bonds and freeing up more money to be invested elsewhere by the private institutional investors.
Bond investors say they are relaxed about the Bank of Englandâs move to directly finance state spending â as long as it does not become a permanent feature of government financing.
The UK government on Thursday announced it was expanding the size of its own bank account at the central bank, known as the âWays and Means Facilityâ, allowing it to bypass bond markets as it increases spending to counter effects of the coronavirus crisis.
So yes you are right, government doesnât even issue bonds, and BoE is not even buying those directly. So even worse than I thought. They have infinite fee free overdraft with BoE.
This move is interpreted as direct financing by BoE to government bypassing the sharrade of issuing bonds, somebody buying them, and then BoE repurchasing them.
Somehow I doubt bonds will ever be issued to cover this infinite overdraft.
What is interesting is how tempting it could be for the figured around the draw down to be hidden and thus that part of the debt wiped out. It just goes to show how much of a black hole government finances can be.
If there was no central bank the UK would be under extreme stress right now. Just another reason to be glad Blairâs dream of us joining the Euro never went through.
Each country isnât able to just put their hands on the cash. Instead they need to raise it by selling bonds. This is presumably part of the reason why itâs taken so long in some areas to get the cash to the people that need it.
The main buyer of these bonds, in this case is the BoE (or central banks)
But to raise the money to buy these bonds, they need to print more cash (Quantative Easing), which potentially runs the risk inflation.
Even when buying these bonds though, they donât buy them directly from the government. Instead, they buy existing bonds from large organistions/private investors in an attempt to put money into the hands of existing investors who will deposit profits into the banking system thus hopefully generating more lending
The government then essentially takes the money put into the system by the BoE and hands it out to those people who theyâve promised it to.
