Numbers Game: Quantitative Easing.

Reading comments on various blogs and papers it's clear that many ordinary people don't really understand a lot of what's going on. The numbers are hard to get your head around for a start. The UK's GDP (roughly speaking what we earn in a year) is £1.5 trillion. That's

£1,500,000,000,000

When the Bank of England talks about printing £50 billion it sounds like an huge amount. In absolute terms it is.

£50,000,000,000

But as a percentage it's only about 3.3%.

People ask things like "how come we've got £50bn to give to the banks but we can't afford £20bn for the NHS". The answer is quite tricky and involves the difference between money and wealth which I have to confess I don't fully understand.

The £50bn is money created out of thin air. The UK has a certain amount of wealth and we use tokens to represent it which we call money. For a couple of centuries now our system is set up so that we can make an arbitrary decision on how many tokens represent our wealth (when I say 'we' I mean the government). In printing more money the Bank of England has basically made each token worth about 3% less. In the old days we called this a devaluation. So we haven't created more wealth, we've just divided our wealth up into smaller piles.

If we were still using gold, then imagine we had 1,000,000 gold coins in circulation. The devaluation is like rounding up all the coins, melting them down, and then minting 1,033,333 coins. Each of the new coins is worth 3% less, but the total amount of gold is the same. Before coins were standardised people would often file a bit off each coin and eventually they'd have enough gold to make an extra coin. Thus devaluing the currency.

Buying a service like the NHS, which costs about £100 billion in round figures (about 6% of our GDP), requires us to spend some of our wealth to pay salaries and maintain buildings and such like. We do this by the government giving money to people. But in this case the nett amount of wealth the government has goes down by that amount of money. The government has to spend some of it's income, which comes mainly from taxation.

A small amount of printing money is not a big problem. If we buy and sell things in pounds then nothing much changes. But now that each token is worth 3% less we must give 3% more of them when we buy something from outside the UK, say oil from Saudi Arabia for example. Because we are so reliant on oil the price of it is very important. If we have to pay more for it, then the price at the pump goes up. This causes inflation as the cost of oil affects the price of just about everything. If prices go up then people are worse off and want more pay, which means business makes less profit and wants to put prices up. And since almost every economy involves external inputs, inflation is always a worry.

This kind of inflation caused by printing money can create a feedback loop that causes hyper-inflation such as we see in Zimbabwe where the currency becomes so debased that it can hardly buy anything. It's not that Zimbabwe has no wealth, but that each unit of currency represents such a small slice of the pie that it is worthless. This kind of inflation is disastrous.

To try to prevent inflation caused by devaluing the currency, the Bank of England is able to manipulate interest rates on lending. But I think that's another story (and one I need to know more about before attempting to explain it).