I have noted that when my explanation of why the UK owes much less debt (see also here) than the Tories claim was posted on the Liberal Conspiracy web site some of the right wingers who inhabit that space suggested I could not consolidate accounts. As a result they claim my conclusion was wrong: they said the debt owed by the government could not be cancelled by the fact that the debt was owned by the Bank of England because I ignored the liabilities of the Bank of England to repay the cash it had used to buy the government issued gilts. Well, they are, of course wrong and let me explain why the accounting behind my claim is exactly right.
Let's start with the government issuing a gilt for £100 million. It creates a loan (the gilt) for £100 million that is a credit in its accounts and it then has £100 million in cash (a debit balance).
In accounting terms this looks like this:
| Government Accounts | |
| Cash | |
| Dr £'m | Cr £'m |
| 100 | |
| Government Accounts | |
| Gilt Loans | |
| Dr £'m | Cr £'m |
| 100 | |
Then it spends that cash on buying an asset (or a lot of assets!). The accounting then looks like this:
| Government Accounts | |
| Cash | |
| Dr £'m | Cr £'m |
| 100 | 100 |
| Government Accounts | |
| Fixed Assets | |
| Dr £'m | Cr £'m |
| 100 | |
Now there's no cash. The £100s balance out to nothing. The accounts balance though. There's an asset of £100 million balanced by a liability of £100 billion for the gilt. There's just no cash left.
Now let's suppose the Bank of England does a quantitative easing programme, as of course it has. Let's look at the double entry of that.
First it creates the cash:
| Bank of England | |
| Cash | |
| Dr £'m | Cr £'m |
| 100 | |
| Bank of England | |
| Promise to repay account | |
| Dr £'m | Cr £'m |
| 100 | |
Remember that this is a bank making cash out of thin air. It has effectively 'printed' cash. So it has created £100 million in cash, which is a debit entry in its books. What's the matching liability since you can't have anything but double entry in the accounts? Well, it is, of course, a liability and for ease I've called it the 'promise to repay account'. Why? Because that's what it says on a bank note: the Bank of England promises to pay it. It's that promise that represents the liability. The fact that if someone went to the Bank of England and asked for repayment of their £10 note they'd be given another one does not change the promise to pay. £10 is owing - but it's payable with the money that's just been printed. That's what legal tender means: it's cash made out of thin air. The liability will not be paid: it's pure gain, but that's what happens when you make cash out of thin air. This then is a very different liability from the government's gilt. That will be repaid, in cash. And it carries interest. The Bank of England will never repay on its promise and the liability carries no interest.
Now let's suppose that the cash that has been created is used to buy the gilts the government has issued. It's pretty simple double entry. It looks like this:
| Bank of England | |
| Cash | |
| Dr £'m | Cr £'m |
| 100 | 100 |
| Bank of England | |
| Promise to repay account | |
| Dr £'m | Cr £'m |
| 100 | |
| Bank of England | |
| Gilt asset account | |
| Dr £'m | Cr £'m |
| 100 | |
The cash has gone: it has been paid to the previous owners of the gilts. The two 100's balance out to zero. That cash has now entered the economy and left the Bank of England. That is how the cash enters the economy in a quantitative easing programme.
The net result is that now the Bank of England owns £100 million of gilts (the debit balance) matched by a liability of £100 million in the 'promise to pay the bearer' account which will in reality never be paid.
Now what I have then suggested is that we should consolidate the resulting accounts of the government and Bank of England since the government owns the Bank of England. Let's look at what the accounts look like before we consolidate. The government accounts now look like this:
| Government Accounts | |
| Fixed Assets | |
| Dr £'m | Cr £'m |
| 100 | |
| Government Accounts | |
| Gilt Loans | |
| Dr £'m | Cr £'m |
| 100 | |
The government has £100 million of assets and owes £100 million in gilts.
The Bank of England accounts look like this:
| Bank of England | |
| Promise to repay account | |
| Dr £'m | Cr £'m |
| 100 | |
| Bank of England | |
| Gilt asset account | |
| Dr £'m | Cr £'m |
| 100 | |
The Bank owns £100 million of gilts and has made a promise to pay £100 million.
Now let's be clear about what happens when you consolidate: you cancel out trading between the consolidated parties but as I have ignored interest for ease there is no trading to get rid of here. And second you cancel assets and liabilities owing between the consolidated entities, which are the government and Bank of England in this case. What is cancelled out? Well it's the gilts: they are debt after all. The government owes £100 million to the Bank of England in this example but since the Bank of England is owned by the government then it is like owing debt to itself - or if you like, it's like a husband owing a wife when they agree they really share all their property in common. So it can simply be cancelled out.
The net result is that the accounts really look like this. The two gilt accounts balance each other out to zero and we're left with:
| Government Accounts | |
| Fixed Assets | |
| Dr £'m | Cr £'m |
| 100 | |
| Bank of England | |
| Promise to repay account | |
| Dr £'m | Cr £'m |
| 100 | |
So the government has now got assets paid for with a promise to pay - it's printed the money to pay for the asset. It's used the subterfuge of owning the Bank of England and printing money to achieve the result but let's not deceive ourselves, this is the result. But, as I have explained, it can do that precisely because there is both no risk of inflation now because of the state of the economy and because the economy needs that cash - there is a shortage of cash at present that is threatening to close down economic activity and create deflation if this new cash were not created by the Bank of England now.
So, what's the conclusion? First, the double entry works: the critics are simply wrong. They forgot there's an asset. Incidentally, it doesn't also actually matter if it was spent on the running costs of the NHS instead for double entry purposes; there would still be a debit. I use an asset to indicate it's better that liabilities are matched by assets and that the current account be balanced if possible. That's the logic of the Green New Deal. But I stress, either way my double entry works and my critics are guilt of doing single entry accounting - which is always a mistake.
Second, the economic logic is right: the national debt has to be stated net of quantitative easing gilt repurchases or the figure is simply mis-stated.
Third, this radically changes the whole economic narrative, completely. But that's another blog. The point here is that technically I have to be right.
Having said which, I know the assets repurchased may not have been paid for at the price they were issued at: I accept that's leakage in the matter but it does not change the fundamentals of the argument one iota, it just means that the banks pick up some subsidy on the way (which fact will, I suspect surprise no one). But we still have not got debt of £1 trillion. Very soon we'll have national debt of less than £700 million and what is more we're only borrowing about £35 million or so a year on average.
And we need to recognise that if we're to have an honest economic debate.
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There is a similar situation for Japan where, “Oh, and about that debt; it’s not good – but net debt is about 100 percent of GDP, not 200, because the BOJ holds so much of it” (Krugman blog, September 9, 2010, ‘Lost In Translation’).
You will probably delete this, but I’ll say it anyway. I never suggested that there would be single-entry accounting in the government accounts. What I said was that in the government accounts the liability represented by gilt issuance would, after consolidation, be replaced by a cash liability representing the money issued by the Bank of England to buy the gilts. This is in fact what your accounting shows, so actually you have proved my point. The debt declines, but the government liabilities do not. All that has happened is the debt has been monetized.
I can see the argument for showing national debt net of QE purchases, but the increase in money arising as a consequence of those purchases can’t be ignored and should be unwound at some point. So if you treat the gilts purchased by the BoE as redeemed (which is in effect what you are doing by consolidating them out of existence), at some point the government will have to issue new ones to enable that money to be recovered from the economy. Or, of course, we could simply leave the increased money supply as it is, and suffer inflation when the economy returns to growth because of the reduced purchasing power of the monetary unit.
Respectfully, that is complete nonsense
a) The liability is not payable, as I show
b) There is no reason why the cash will be recalled – ever growing economies require growing cash balances. You don’t ask banks to unwind their cash creation – why should the government? There is no prospect at all that this £350bn of cash will be cancelled with new gilts – ever.
c) There is no prospect of the QE causing inflation either – for all the reasons I note and which, of course you ignore. We just let commercial banks take over the creation of money again at that point – about which you, I note, express no such inflationary concern at all, without giving reason why
I conclude that like most bankers, ex or otherwise, you really don’t understand money, let alone macro economics
Good, at least we agree that my understanding of consolidated balance sheet accounting was not wrong as you suggested. No, the liability isn’t payable, but then arguably debt is never repayable either – it is simply rolled over when due (assuming that anyone will buy it, of course). It still has to be shown on the balance sheet.
Whether QE is inflationary is a matter of debate. When I looked into this recently I concluded that QE in a closed economy can’t possibly be inflationary because it is simply replacing one sort of money with another. But in an open economy whose currency is freely traded on the international markets inflation is a real possibility, because the additional money supply debases the international value of the currency and therefore increases the price of essential imports such as fuel and foodstuffs. Sterling has fallen by about 25% in the last 3 years and that has undoubtedly contributed to the inflation that we are currently experiencing. We are actually undergoing quite serious money supply deflation at the moment – M4 is falling despite QE – and yet we still have CPI inflation, partly because of the depreciation of sterling. I know this appears contradictory but it is because we are not a closed economy.
For these reasons I conclude that in an open economy it is not safe to assume that the money supply increase arising from debt monetization wouldn’t have to be recalled at some point. Yes, if the economy grows sufficiently strongly the additional money supply will be mopped up by the extra production. But if it doesn’t then inflation is likely. The alternative to reversing QE would be serious hikes in interest rates to counter inflationary pressures and support sterling.
You may have noticed the inflation had little at all to do with QE, or indeed ina very real sense our currency deflation, which merely exacerbated international trends but let us sell more
And you did get the consolidation wrong
And you have not answered the question on private banks
And you have ignored the current likelihood of deflation if there is no QE
Selective blindness is, of course the curse of the right wing economist. You’re suffering badly which s why debate is not worthwhile
Pretty strange role reversal here. In fact it is the left-wing economists who worry that QE is ineffective, that is roughly the New Keynesian philosophy. Right-wing economists are split between the “liquidationists” who just want to make everybody suffer because we’ve been really naughty getting into so much debt, and the monetarists who think we have an aggregate demand problem but need monetary policy not fiscal policy to fix it.
Osborne arguably falls into the latter camp, he’s called for more QE lots of times.
The book-keeping might (indeed does) make the debt disappear but is that not just “smoke and mirrors” to disguise what is really happening or is there no distinction at all between an economy with an unindebted government and one where its government owes its central bank billions?
I’m not arguing the deficit disappears, just the debt
But it means we do not need to debt obsess as we are
And that clears the decks for action on the deficit that is very different from the debt fuelled fear that is driving cuts now
You conflate cash (physical paper) currency with Bank of England reserves. Bank of England reserves are interest-bearing liabilities; they are remunerated at Bank Rate (currently 0.5%). It is reserves which are “printed” not physical cash, in QE. Regardless, both physical currency and reserves are liabilities of the Bank of England, as shown on their balance sheet.
Say I’m a pension fund owns £1K of gilts. That is an asset for me, and a liability for the public sector. After a QE operation:
a) Pension fund still has assets of £1K (no change), but now owns reserves not gilts
b) Bank of England gains assets of £1K, liabilities of £1K (new reserves)
c) Government still has liabilities of £1K gilts (no change)
The public sector accounts net out across BoE and government, and there is no net change in assets or liabilities; they gained £1K of assets and added £1K of liabilities, though the nature of the liabilities changed.
In fact, it is necessarily true that since the private sector balance sheet has no net change in a QE operation, the public sector balance sheet cannot either, since the public sector accounts must be a mirror image of the private sector accounts.
I don’t think you read a word I wrote
If the gilt is cancelled – and can be – the only liability left has no repayment date and no cost
And you say that changes nothing?
Sorry – you’re just wrong
The liabilities do have a cost, they are remunerated at Bank Rate. If the Bank had no assets to back those liabilities, i.e. it had a balance sheet which doesn’t balance, I don’t think its auditors would be very pleased.
A simpler way to look at it is to realise the Bank will somebody have to reduce the size of its balance sheet. It can only do that if it has assets to sell in exchange for the outstanding reserves. Those gilts, hence, cannot be cancelled; or if they were, the government would have to inject equity into the Bank, and hence, the tax payer is ultimately liable.
All that is left is cash
There is no interest paid on that
Please note what I wrote – not your version of it, which was wrong
The equity injection could be made by HMG
It would pay with the gilts that were then cancelled….
Cash and central bank reserves are different things. QE involves creation of reserves, not physical cash. The Bank does pay interest on reserves.
Gilts are a liability of HMG, if they are “cancelled” HMG receives no cash.
If the BOE loses assets because of “cancelled” gilts, HMG would have to do an equity injection equal the value of the “cancelled” gilts, to repair the balance sheet. That is a real cost to HMG (taxpayers), hence, there is no free lunch in cancelling QE gilts.
You really just don’t get it, do you?
So the government has to pay in cash – which the BoE would create for it out if thin air
You always come back to my result because that’s the economic substance of the issue however you want to dress it up
Justanother voter is right, what you talk about of as cash is actually reserve accounts at the BoE and are owned by the banks. To cancel the govt debt, would mean cancelling these reserves which obviously isn’t going to happen. You could roll the debt indefinitely, but it only works if the gilt rate is less than base rate. If base rate goes back up, you could get to a point where it begins costing money.
For heavens sake – get your thick head round the fact the cash is created – printed if you like. Made out of thin air. It did not come from someone else. That is how all money is created but you seem – like most bankers – to have not a clue about that FACT
For heaven’s ask go and learn something as basic as that which seems at present utterly beyond your comprehension and then quietly slip away and admit I am right
No apology will be needed
Unfortunately PaulF is correct, Mr Murphy, perhaps his head isn’t that thick after all. It is you who needs to do a little reading up, I suggest a read of the Bank of England publications on QE.
Before QE, the govt accounts consolidated with the BoE were:
Assets 100
Liabilities 100 (in the form of gilts, a promise to pay an annual interest rate + £100 principle in cash)
After QE (and your cancellation), the govt accounts consolidated with the BoE are:
Assets 100
Liabilities 100 (in the form of bank reserves, a promise to pay annual interest rate)
To believe that the bank reserves are any less a liability of the government than the gilts were is deluding yourself, given they both earn interest and are assets of the private sector.
If it really were as simply as you believe it is, why doesn’t every country just do it?
Quite extraordinary misrepresentation of the truth
Before QE there was a liability due for repayment with interest
After there is just cash in issue
No interest
No repayment date
No difference you say
Who are you kidding,
Who is anyone at the BoE kidding?
This is printing cash
And that is what you can’t get your head round. That is made out of thin air but you,d really like to deny it
Fascinating idea that bank reserves are an asset of the private sector too
I thought reserves belonged to the owner of the enterprise – the state in this case.
If you want to see a state that does account for cash – see note 16 here http://www.gov.je/SiteCollectionDocuments/Government%20and%20administration/R%20FinancialReportAccounts%202010%20JMB.pdf
Jersey actually gets this right
With all due respect (which is something you seem to struggle with) there is no need to call me thick headed when you have a problem understanding how a central bank operates with the bankling sector. As SF points out, the liability still exists in the form of bank reserves which are owned by the banks and receive interest.
QE is not printing physical cash, is exchanging high interest bearing gilts for low interest bearing bank reserves. These reserves are a liability of the central bank (and hence the state) and pay interest at base rate.
In the BoE the reserves are a liability, in the banking sector they are an asset. Although there is not repayment date, they bear interest and they will be redeemed in the future by selling the gilts back into the market to remove the massive excess reserves in the banking sector.
What you need to get your head around is that QE does not change the net financial assets in the economy. Gilts are sold by the private sector who gets reserves in return. To think that you can just cancel the gilts, would mean destroying net financial assets in the private sector.
No hang on – my accounting is right
What you’ve done is assume the cash has gone back in as deposits – that’s a different transaction entirely
It is what actually happens maybe – but it does not change the fact that literally cash is printed electronically – like all cash now – and used then to create deposits
And yes interest is paid – but at a tiny percent
And that does not stop the gilts being cancelled as I say
And not does it change the reality that the deposits are quais cash
So a) you’ve gone a step too far and b) I remain right
And c) you still ignore the fact that QE creates new cash or it does not work
So we’re back to my contention as to your understanding, I guess. And at every stage you show yourself wrong. Gilts are cancelled regularly – and can be here – and your denial of that reality is your indication of ignorance
Cash is created everyday electronically by the Bank of England, that is how they manage the level of reserves in the banking sector, an asset is exchanged for reserves and vice versa. QE is just this on a massive scale. This does not magically remove it from government debt levels, there has been no change in the level of govt liabilities to the private sector. The whole intention of QE is to sell those gilts back into the private sector at some point to remove the excess reserves, so those gilts will not be cancelled.
Although interest paid is low at the moment, when the economy recovers, base rate will go up and suddenly the cost of QE will become much higher.
Maybe it would be easier to understand from the other side, i.e. the private sector. When the insurance company (as QE is geenrally not undertaken with banks) sells its gilts, the Bank of England deposits the money into the insurance companies account at a bank, so on the banks balance sheet a liability (the deposit) and an asset (central bank reserves) is created. The govt no longer owes the insurance company the money, but owes the bank the money. It cannot cancel this debt unilaterally, and there is no fixed maturity for it. But the individual bank can effectively get the money from the government by using the reserves it has been given to pay its tax bill.
But again you deliberately miss the point: that intention will never happen. There is no way £350 billion will be sold back so like time expired gilts just cancel them.
I do not dispute cash is created: I am not arguing the cash should be cancelled.
I am arguing the gilt should be
What point atre you trying to make?
Do you really think gilts and cash are the same thing?
Actually, I think you have a point, but you are not making it well because of a confusion about what “cash” means. Which of these do you believe is false?
1. The Bank of England’s balance sheet must balance at all times; assets = liabilities + equity.
2. The Bank of England may have to shrink its balance sheet from current levels at some point in the future.
3. Bank of England liabilities currently held by the private sector as assets (physical cash and reserves) cannot be unilaterally cancelled by the Bank.
There is an economic case that (1) is false, but you do not seem to be making it here.
Your problem is that you are in complete denial that QE is just cash printed out of nothing
Until you can accept that you will not understand
Go back and yet again read what I have written
The substance is 100% right
[…] is not £500bn, it’s £500bn less QE which may well be £350bn by the end of this week, as I have argued. So we have not got the debt crisis the government argues we have. We do have a deficit: we […]