I have already written this morning about the need for an intelligent debate on the need for an increase in government spending . Let me make a first contribution. I actually wrote what follows on this blog in May (barring minor edits) but it bears repeating: we really do need more national debt, and that, right now, is the correct way to pay for an increase in spending.
It's a popular myth that government debt is a bad thing.
And it's a dangerous myth that we have reached the limit of government debt that we can afford and that any new government spending must be paid for with taxation.
First, some facts. It's a fact that the UK government does not need to issue debt. In the modern era of money the Bank of England can create any amount of money that the government requires without having to borrow or tax a penny of the sum in question. That is because all money is now, as a matter of fact, created out of thin air when banks lend money, including when (as might be legal again after Brexit) the Bank of England lends directly to the Treasury. This is because all money is debt: if in doubt read what it says on a UK bank note, and realise that these are just debt, a fact that is confirmed by this cash being included in the national debt in the UK's government accounts. Quantitative easing also proved this: £435 billion of UK national debt has been monetised since 2009. There is then no technically reason why all government debt could not be cancelled (as this QE debt has, in effect, been) in this way. As a result it has to be appreciated that when the UK has its own currency and its own central bank government debt is a choice and not something that has to be issued.
But this this then leads me to state the other obvious fact: government debt is just another form of government created money. It's convertible into cash, as QE proves. And all it provides is a savings mechanism. But it is a very important savings mechanism. In fact it's the most secure for of saving available in the UK. That is because whatever happens the UK government will always be able to repay its debts because it can always, on demand, electronically create the cash to do so. It has that right. No one else has it in the same way. And creating that money is effectively costless: it happens simply by entering data into a computer.
Having made these obviously correct points (which appear to have passed most politicians by) let me now say why we need steady growth in government debt. There are several good reasons.
First, if we are to have some inflation (and we generally agree two to three per cent is good) then we need more money. And government debt is money. It is, in effect, the promise to pay that underpins the economy. So inflation says we need more of that debt each year. If we don't get it then the economy is starved of cash and that causes economic stress, at the very least. It might also lead to more private debt, and that is much more dangerous as it carries much higher interest costs than government debt and so constrains real growth. So inflation demands more government debt. It's the best deal for a growing economy that there is. That's why governments have to create it.
Pensioners also demand more of that debt. The annuities that underpin all private pension payouts involve a delicate juggling act that balances life expectancy against the funds available and the return that they can generate. One variable where the risk can be reduced is the rate of return and the certainty that it will be paid. The return on government debt may be very low (it's effectively negative at present after inflation is allowed for) but it is guaranteed to be paid, and that is exactly what pensioners want. No one wants their pension to expire before they do. So, government debt is what pension annuities are very largely invested in. And as we face an increase in private pensioners as the baby boom generation retires the need for government debt to underpin their pensions is growing.
Third, banks need this debt. When most people put money in the bank they assume it is safe. That is because the government guarantees the deposits most individuals make in banks so that if the bank fails the depositor will get their money back. That is the only reason most of us trust a bank. But this does not apply to businesses depositing millions of pounds in their bank accounts overnight, as happens every night in the UK. Those businesses have no such guarantee. If the bank fails on them, as Lehman did in 2008, then they might well go down with it. So they don't deposit the cash. They enter into contracts with banks. The banks sell them government bonds in the evening, which the depositor then own, and which cannot fail because the UK government (unlike banks) can't fail, and which the bank agrees to buy back in the morning at a slightly higher price, with the increase representing the interest due. If there were no government bonds to fulfil this role then the banking market would grind to a halt.
Fourth (and I like this one), at times like the present when the real rate of interest (as adjusted for inflation) is negative those who own government debt subsidise government spending. The more debt there is the more the taxpayer is subsidised.
Fifth, interest paid on government debt is a good thing. As already noted, it underpins private pensions for a start. And a lot of the most stable savings funds. I'm not saying this is a perfectly equitable redistribution of wealth, because it is not. But I am also saying it is not income lost to the economy. And because it's taxable some is even recovered. But saying it's terrible is akin to an argument against usury and is again akin to an argument that a government should not have a role in seeking to provide a secure, stable and safe banking, pensions and savings sector in the country. I would argue that is precisely one of the roles government should have.
So we need debt, and because of inflation, growth and growing numbers of pensioners we need more of it. How much more? Notional national debt is now about £1.8 trillion and after QE it is around £1.4 trillion. Assume inflation of between 2% and 3% and how much extra debt do we need a year? Anything between £30 billion and something in excess of £50 billion would seem to be the answer. It's not a precise science: there will be swings and roundabouts.
But the point is that this new dent is vital: it has to happen or the economy is harmed. And this sum excludes debt issued for specific purposes, like an infrastructure fund. Issue less than this and the economy will be in trouble. That's a simple fact and explains why the Tory obsession with a balanced budget is so dangerous.
Which brings me to the final fallacy that needs to be addressed, which is that one day the debt will have to be repaid. No it won't. That's because this debt is money. That makes it unlike all other debt which is denominated in money. They're simply not the same thing. Debt denominated in money has to be repaid. Debt that is money is only repaid if we want to destroy money. And why would we want to do that? Is anyone seriously suggesting that we can live in a moneyless society in future? I seriously doubt it. And in that case national debt does not have to be repaid, ever, which is exactly what history tells us.
Government debt is a good thing. The danger is the myth that it isn't.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
You’ve won me over to having more government debt.
But please don’t have more government spending – they’ll only waste it on programmes that make us worse off like subsidies, eco funding or renewable heat incentives. Better just to let it sit there in the vault.
By the way, that arithmetic progression thing doesn’t work as you haven’t subtracted the tax not collected from the new government employee if they were left alone.
The progression works as I said
And without spending we can’t have more debt
Whilst the whole point of government is to deliver subsidies and correct externalities
I think you need to do a lot of reading
No, I checked, and your friend over at Progressive Pulse has not allowed for the effect of tax lost from moving someone in whole or in part from the private to the public sector.
And it’s a geometrical, not arithmetical progression. You would think Professors would know this.
You are assuming full employment?
Why?
And is geometry not within the range of arithmetic?
Leung Chun-ying is being a bit pedantic but in strict terms correct as is is a power series hence a geometric progression.
I agree
But pedants are never appealing
[…] is under control. The real rate allowing for QE is at historically low levels. And we actually need more debt, and not less of it. And to therefore say that we cannot have schools, healthcare, benefits and university education […]
Occasionally some of our neighbours used to disappear before the rent man called and they were owing several weeks rent. My father said this was a reason why our rent was so high.
“Fourth (and I like this one), at times like the present when the real rate of interest (as adjusted for inflation) is negative those who own government debt subsidise government spending.”
We can go further: even at times when the interest rate on the national debt is greater than inflation, the debt still has no real cost, providing that the interest rate is less than nominal economic growth (i.e. less than inflation + real economic growth). Because that ensures that rolling up the interest (adding it to the debt) won’t make the size of the outstanding debt grow, relative to the size of the economy (i.e. the debt-to-GDP ratio won’t rise).
And this assumption – nominal rate of return on national debt being less than nominal economic growth (or, equivalently: real rate of return on national debt being less than real economic growth) is very realistic. At least when a country has its own currency.
This is perhaps an exception to Piketty’s idea (disclaimer: I haven’t actually read his book) that the return on capital exceeds economic growth (r > g). Well, not when the capital is in the form of national debt (from a currency issuer).
More national debt, as an alternative to capital in other forms, is a way of reducing (or at least: avoiding increasing) wealth inequality.
Richard – I’m sure you’ve already explained this elsewhere but maybe it is worth repeating here:
How does QE work to create new money and cancel government debt?
How or why does QE circumvent the EU rules on government spending?
Adam
I have indeed written this but as I only find it by googling might I ask you to do the same? I have an aged father to visit the afternoon
Richard
“How or why does QE circumvent the EU rules on government spending?”
Due to the Maastricht treaty (article 104 / 21.1) the Bank Of England cannot directly buy government debt.
The Maastricht Treaty doesn’t bar the central bank from holding government bonds. The relevant passage from the treaty is article –
21.1 – Operations with public entities
ln accordance with Article 104 of this Treaty, overdrafts or any other type of credit facility with the ECB or with the national central banks in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments
Since the bonds were bought through the secondary market (and not directly) – then the Maastricht Treaty hasn’t been breached.
“How does QE work to create new money and cancel government debt?”
Lets take one case.
Between Oct 2011 and July 2012, the BoE “printed” £175 billion of QE to help the Gov finance the deficit. This is how they did it.
The QE transmission mechanism was as followed:
Step 1 – BoE creates 1 billion of central bank reserves (out of thin air)
Step 2 – BoE buys £1 billion of Gov bonds from pension/insurance companies
Step 3 – Pension/insurance companies buys £1 billion of new issue of Gov Bonds
Step 4 – Gov spends that £1 billion into the economy (NHS, Wewlfare etc…)
Step 5 – Repeat until someone notices!!
Start of the day. BoE 0, Pension £1 billion, Gov 0
End of the day. BoE -£1 billion (new money out of thin air), Pension £1 billion, Gov +£1 billion
The numbers to back it up – all you need to do is look at how much of the National Debt the Bank of England (Asset Purchase Facility) held before and after the printing spree. Before – £198 billion (Q2 2011) – after £386 billion (Q3 2012) – bond quoted at Market value hence doesn’t exactly equal an increase of £175 billion which was the amount of central bank reserves created – or in old parlance – “printed”.
http://www.dmo.gov.uk/documentview.aspx?docname=publications/quarterly/jul-sep11.pdf&page=Quarterly_Review
Distribution of gilt holdings at 30 June 2011 – Bank of England (Asset Purchase Facility) £198 billion (Q2 2011)
http://www.dmo.gov.uk/documentview.aspx?docname=publications/quarterly/oct-dec12.pdf&page=Quarterly_Review
Distribution of gilt holdings at 28 September 2012 – Bank of England (Asset Purchase Facility) £386 billion (Q3 2012)
I’ve seen suggestions that QE is a “ruse” to get around EU rules, do the stated aims and method in the redbook still stand if that’s the case?
http://www.bankofengland.co.uk/markets/Documents/money/publications/redbook.pdf
I read that very little QE money actually made it into the real economy, presumably this is why the TFS was created? a whole £69 billion after the referendum
an aside, I think I read a comment from you that as a matter of policy the government hasn’t paid interest on the national debt since 2012, but my tax statement says different. I assume therefore that the government doesn’t pay interest on money owed to the BoE but does on other debt which is what is shown, is that correct?
Many thanks
a) It is a ruse
b) Debatable how much made it to the real economy
c) It only pays on the net national debt – i.e. it does not pay itself
“£435 billion of UK national debt has been monetised since 2009. There is then no technically reason why all government debt could not be cancelled (as this QE debt has, in effect, been) in this way.” Indeed, Japan’s already doing this http://www.truthdig.com/report/item/japan_write_off_nearly_half_national_debt_inflation_20170628 so we should be asking why we aren’t doing the same.
While I share your frustration that politicians seem mostly ignorant about how all this works, really it is the education of the general public which is if anything more important. If we all understood what you are explaining here, politicians would find their austerity narrative was not acceptable, instead of which it is widely accepted (now endorsed by Norman Lamont and Vince Cable) that there is no escape from this punishing regime.
I am probably going to show myself up here but in effect you are saying we have a cashflow problem, not enough being put into the economy? Every businessman realises cashflow is far more important than profit. So you need cash flow to get to profit and effectively government is surpressing, in fact actively reducing cashflow, hence the economy is in trouble. More cashflow would help the country and even, dare we say, at somepoint allow the country to become profitable again (although that may be many years away but mirroring Swedens current situation)?
Yes
Pretty much