Salmond’s QE grab

I read on Faisal Islam’s twitter feed that Alex Salmond had suggested on Sky to Adam Boulton that the SNP should get its rightful share of the gilts bought under the QE program by the Bank of England.  This prompted an exchange between finance gurus Frances Coppola, Dan Davies and Eric Lonnergan.

A QE grab would be nice for a newly independent Scotland.  Take a share of the gilts, and when they mature, the Treasury pays them out of RoUK taxes!  Lovely-jubbly, as one TV character used to say.   I’m sure the RoUK government would not accept that.  As things stand, when the gilts mature, the Treasury pays out money to the Bank (in fact it does so all the time on account of the gilts’ coupons).  But, remembering that the Bank is part of the public sector, this is really just one part of the public sector paying itself.  Salmond’s proposal, taken on its own, would lead to the UK government paying out not to itself, but to another government.

How could this be dealt with fairly?  One way would simply be to unwind QE before Scotland sets up its own currency.  Another would be to financially engineer a clean split of the BoE’s balance sheet.  When it sets up its own currency, Scotland takes away 1/10th of the debt stock, but the Scottish Central Bank takes 1/10th of the gilts on the BoE’s balance sheet.  The gilt contracts would have to be rewritten so that when maturing, the SCB gets a payment from the Scottish Treasury.  (Nothing would be rewritten presumably, but new liabilities would be set up to make this happen).

It’s easy to get blinded by thinking about reserves and cash and confusing things like that, when trying to fathom the fairest division of the ‘spoils’.  The only really significant thing about QE is debt management.  Exactly the same effect could have been achieved when embarking on QE by the DMO issuing lots of very short-term Treasuries and swapping them for longer term gilts in the market, tilting the private sector portfolio away from longer term gilts.  (In fact, this could still be done, by the consolidated public sector ‘swapping’ the reserves that were created for short-term debt.)  Then, Alex Salmond would simply be saying:  ‘can we inherit 1/10 of the share of the new, slightly shorter term portfolio of government debt liabilities please?’  Oh, well, I guess he would not be shouting about that!  It’s the artifice of the Bank holding the gilts, and them being a result of electronic reserve creation that fuels the sense that there could be a fair profit to make.

[The Bank itself might not agree with this, at least if their early communication about the importance of expanding the money supply, or their educational material about pumping or injecting money into the economy are to be taken at face value.  But this part of QE is hot air in my view.]

Salmond’s financial sophistry is akin to the SNP’s consistent message that, in exchange for taking their share of the debt, they should get a ‘share of Sterling’, as though it were an asset, and not a club with a set of rules the SNP want to free themselves from.

That said, to be fair, the UK Government has engaged in its own naughtiness over QE, appropriating the coupon payments from QE to make its own public finances look healthier than they really are.  The presumption is that those flows will be reversed, so that the Bank of England can ultimately reverse QE itself and restore its balance sheet to (something like) its former state.  But the fact that the funds were taken in the first place for no reason than massaging the accounts did not bode well for that.  The latest protracted undershoot of the inflation target, while very unwelcome and worrying in itself, has the fortunate side-effect that it works against suspicions that dangerous mixing of monetary and fiscal matters could be the harbinger of debt monetisation and inflation stealth.