If the government simply cancelled the £300 bn+ of QE gilts held by the BoE, who would be unhappy?

4 min read 11 Apr 12

Summary: The UK sits unhappily at the very boundary of what debt burden is acceptable for a AAA rated economy.  If growth continues to disappoint, or if more austerity becomes socially impossible, the UK will be downgraded – and neither of these possibilities look very remote.

At the moment the UK public sector net debt to GDP ratio is about 63%, equivalent to about £1 trillion (these numbers exclude the debt of the part nationalised banks).  Debt servicing costs are over £50 billion per year  – a large chunk of our annual deficit.  Additionally our debt position is likely to deteriorate before it improves.

But do we really need to be paying interest to the Bank of England on the £300 billion+ of gilts that it holds as part of the Quantitative Easing programme?  In fact the Bank holds these gilts on behalf of the Treasury anyway, so the Treasury is effectively paying interest to itself on assets that it bought with “free” printed money.  Could we decide that this is a waste of time, that we are unlikely to sell these gilts back to the market in any case, and that we may as well just cancel the gilts we bought for the nation?  Gold bugs and inflationists will at this point be spluttering into cups of tea – what about all of the printed fivers that have been set free into the economy like in a modern day Weimar Republic?  Well, how about this for a potential statement from the authorities on gilt cancellation announcement day:

“Today the Treasury announces the cancellation of £350 billion of gilt-edged stock held by the authorities.  These gilts were bought as part of the Quantitative Easing programme started in the aftermath of the financial crisis.  The purpose of Quantitative Easing was to boost nominal growth after what we thought was a temporary fall in UK output.  Several years later it appears that this fall in output was permanent – the fall in UK GDP remains more severe than that experienced during the Great Depression.  We will therefore make this liquidity injection permanent in order to boost UK growth and reduce unemployment.  The Bank of England of course remains fully committed to its inflation target of 2% – a cornerstone of UK economic policy. Should inflation rise, or be forecast to rise above the target range, the Bank may raise interest rates, or sell Treasury Bills to the market in order to drain excess liquidity from the system and return inflation to its target.  Today’s action also reduces the UK’s debt to GDP ratio from 63% to 41%, and slashes our interest bill from £50 billion £32 billion per year.  This prudent action safeguards the UK’s AAA credit ratings and leaves holders of gilt-edged securities in a stronger position than before.

Note from the Debt Management Office: the gilt cancellation will take place using the same process and precedent set with the cancellation of £9 billion of UK gilt-edged securities acquired from the Post Office pension scheme in April 2012.”

So who would be unhappy with this?  No default has taken place (no CDS trigger, no D from the ratings agencies who are only interested in failure to pay private investors), the UK’s public finances become sustainable, the economy gets a boost from the knowledge that the QE cash injected will stay there for the foreseeable future, and a mechanism exists to remove cash from the economy should inflation return.  Apart from the fact it all feels a bit banana republicy everybody’s a winner.  In fact the genius of this idea is that it doesn’t need to be done at all – if the Bank of England were to start paying gilt coupons and maturing gilt proceeds over to the Treasury automatically you would have an equivalent economic impact, without any of the awkward Zimbabwe comparisons.

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