Blain’s Morning Porridge (2) – May Day – 2020 – Solving Sov Debt?
“These are not the Gilts you are looking for…”
After my rant about Boeing earlier this morning, let’s be more positive. Let me propose some financial magic in Sovereign Debt. Everyone is panicked soaring Sovereign Debt will destroy western economies. Unless we do something – they may be right.
For years I’ve been trying to think clearly about Money and Sovereign Debt – it leaves me with a headache and confused. I have economist friends who write very clever books about money, but privately admit they don’t particularly understand it either. Money is complex.
However.. I have an idea…
Let me start with the simple stuff…
The UK’s National Debt is rising because of the Coronavirus spending splurge. Doomsters say burgeoning debt is certain to result in default and a downgrade. But to worry about such trivialities demonstrates fundamental misunderstandings about how markets and Sovereign Debt work. The UK is not going to default or go bust. Government owns the keys to the Sterling printing press, (it’s now digital), and can print as much money as required.
There might be problems and consequences.
Exchange rates are complex and factor in productivity, interest rates, demand and supply, and a host of confidence related issues including debt and the quantum of money. Unconstrained printing could hit confidence and collapse sterling, triggering inflation and rate rises. There are fears we might become the next Zimbabwe or Argentina. Hang on – that’s utter nonsense. These sillies borrowed in someone else’s currency – the dollar. Inflation meant their domestic currencies devalued and they could not afford to buy dollars to repay their debts.
The reality is the UK retains considerable fiscal and monetary credibility – and borrows in a currency it controls.
If the UK is downgraded to junk – everyone else will be there already! If not, then it will just highlight how stupid the rating agencies might be. There are countries much closer to this blessed isle that really could go bust. Some foolish countries, just to the East of Dover since you ask, gave up control of their domestic printing presses, and signed up for a shared currency – which they have no control over, and is proving very difficult for some of the weaker members. That’s a story for another day…
UK Government Bonds, Gilts, are issued by the Debt Management Office (DMO) on behalf of the Treasury. Through April till the end of June, the DMO will be auctioning a record £180 bln of Gilts. To finance all the government bailout and salary schemes, we could be talking issuance in excess of £300 bln in this fiscal year – another record. The Bank of England has also extended the UK’s overdraft – to cope with any sudden cash shortfall.
The UK’s debt/GDP ratio is going to soar. The UK’s Office of Budget Responsibility (OBR) expects borrowing this year will rise to £273 bln, and push the the Debt to GDP ratio to 94.6%. Conventional wisdom – Rogoff et al – suggests any country with a Debt to GDP ratio in excess of 70% will start to crowd out private investment and damage economic growth. Yeah.. right..
Does it really matter how much debt is raised?
As long as people keep buying gilts and interest rates remain close to zero (around 0.5% on average for Gilts weighted across maturities) – why should it?
There is a fairly robust system that ensures there will not be a problem. While the DMO issues Gilts, the Bank of England has committed to buy them from the market as a function of Quantitative Easing.
Of course, there is no collusion between Treasury and Bank.. Of course not. The BoE does not buy gilts directly from the DMO via the new auctions. There is a polite little fiction whereby the DMO sells them to the market (in the morning), the market takes a turn, before selling them to the Bank of England in the afternoon. Everyone smiles and is happy. It’s a market. It means interest rates aren’t pressured because the BoE effectively backstops the price and yield of gilts.
The BoE and The Treasury are seen not to collude. If anyone suggests it, they will get a spurious explanation of yield curve mechanics and how the BoE might sell the gilts someday in order to push up rates or to dampen runaway inflationary growth.. Sure.. and pigs might fly. The investors who sold the Gilts can now use the money to boost the economy by lending to it. (In reality, they go and buy more Gilts to sell to the BoE – but that is another story for yet another day.)
The UK Government’s Debt will likely exceed £2 trillion by the end of this year – a seriously grown up amount of money. And that is another worry for the doomsters. Surely it has to be repaid? “How awful!” they cry, “we are burdening generations as yet unborn with insurmountable debts they will struggle to ever repay.”
A number of particularly anxious people, including a former chancellor from a few years back, think we should immediately cut spending and commit to perpetual austerity to get the debt back under control. Yeah. Austerity worked really well during the last recession… NOT! Cutting spending while the economy needs a fiscal boost is just daft. Of all the really silly ideas held as gospel by idiots and politicians, Austerity is right up there with the Euro.
We’ve actually proved that pretty much unlimited money creation doesn’t hurt. Over the past 10 years of QE, the Bank has become the biggest owner of gilts – effectively putting all that money into the economy. The money printing already happened and we didn’t get galloping inflation or a sterling crisis. Pre-Coronavirus the BOE held about 23% of the Gilts Market. Under the Coronavirus emergency plans, it will raise its total to around 30% of UK debt – £600 billion.
This is where the magic might happen…
The UK looks heavily indebted as the Debt/GDP ratio climbs through 100. Let’s reduce it with the proverbial stroke of a pen…
At its simplest Govt Borrowing is a matching item on the books of UK Group Holdings Plc. There is a £500 bln credit/asset on its subsidiary, the Bank of England. There is a similar £500 bln debit/liability on an another UK Group Holdings company, the Treasury.
It’s basically an intergroup transfer. There is a whole genre of intercompany taxation porn literature about how to do it… Doing such an transfer might require some accounting chicanery… but that’s a skill not exactly in short supply here in the UK.
The Bank must be sitting on a massive profit on its Gilts book. What about passing some legislation about 100% tax rate on Central Banks Gilt Profits? C’mon.. that’s what enabling legislation is all about…
Why don’t we simply match the asset and liability off? The Debt/GDP would ease below 70%. £600 bln of debt will never have been. We could pretend it never happened. A new Ministry of Truth can scour the media, libraries and the internet to “correct” anything erroneous about the numbers.
So far, this “Magic” is all very obvious and fairly mechanical..
This is where it gets complex and philosophical.
This is where the consequences become apparent. If we can simply use QE and some financial abracadabra to make 30% of the National Debt disappear, why can’t we make it all disappear?
Why bother with tax or national insurance? Raise all the finance government needs through the magic of QE write offs. Why stop there? Why not allow companies and individuals do the same thing? At what point does confidence in money disappear in a puff of logic?
At what point did your brain start to hurt?
If you have any thoughts on Sovereign Debt, the risks and how to solve it.. please let me know..
Bill Blain
Shard Capital
Have a great weekend..