In the light of media interest in UK government debt I thought it was worth offering an explanation of it:
The transcript is something like this:
The subject of government debt is in the news at present. It is , then, worth clearing up some misunderstandings about it.
At one time the government thought it had to fund its spending either by taxing people or by borrowing money from people.
That, though, was back in history.
Now we know that's not true. Now it has four choices as to how to finance its activities.
First, it can run an overdraft at the Bank of England on what is called its Ways and Means account. There is no real cost to this.
Second, it can issue bonds, and then buy them back again.
To understand this it's important to realise that a government bond is very like a building society or bank bond. You save money for a fixed period. And you get a fixed rate of interest in exchange. And then you get your money back. That's it.
The twist is that if you want to get out early you can sell a government bond: there is a second hand market.
And one of the buyers of second hand bonds is the Bank of England, which has bought £635 billion of government bonds since 2009. It's created new money, by making loans to a company that it owns, to do that. Importantly though, all that this really means is that this process - which has the fancy name of quantitative easing - is simply a complicated way for the Bank of England to create some pretty big, cost free, overdrafts for the government if and when the need ever arises, which it has in moments of crisis.
But that also means that the third option that the government has when it comes to funding is to simply sell bonds and leave them out there in the market place.
There are banks, pension funds, life assurance funds, companies and people overseas who are desperate to own them, because for them they are like bank deposit accounts. Only they're better. Because unlike banks, the UK government cannot go bust. So it's a much safer place for them to put their money than a bank.
And the last way of funding a government can use is that it can tax, which is an issue requiring more explanation, but at another time.
So what is the role of bonds in all this, which is the subject of concern right now as it is suggested that the national debt - which is simply the total value of bonds in issue - might increase as a result of coronavirus?
Firstly, because of what I've just explained it's important to note that bond issues by the government are voluntary. The government does not have to issue them. It chooses to.
Second, it does that because people want bonds: in effect the government is running a savings account service by issuing them to people who want maximum security for their money, whatever the interest rate, and the government is happy to do that to support the economy.
Third, if those people change their mind and want their money back, that is no problem. Partly that's because they can sell their bonds to others in the bond market and there has never been a time when that market has failed to find a buyer for a bond. And partly that's because the market is very big because on average U.K. bonds have a life of more than ten years now. So selling bonds is a completely normal thing to do.
And fourth, as all bond holders knows, if there was a bond market failure the government can now always buy its own bonds back: that means this system cannot fail. The government's ability to make money on demand whenever it wants guarantees that.
So does it matter that the number of bonds in issue is rising? The answer is that it does not matter at all because all this means is that there are lots of people who want to save their money with the government and that the government is happy for them to do so.
And the cost of the government providing this service is very low. 10 year bonds are paying a nominal interest rate of around 0.2% at present. When inflation is taken into account people are actually paying the government to hold their money in that case. And this is unlikely to change, firstly because the trend has been downward, and secondly because the government really does now have the tools it needs to set its own interest rates.
Government debt is not then a matter of concern right now, unless the fact that big savers have confidence in the government to be the best person to look after their money is an indication of a lack of confidence in it. And I promise you, that has never been the case to date.
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Another great article. I see the BBC is running yet another article that includes the ominous question “So where is all the money going to come from?” And why does the question always begin “So…”? As I learn more from you and other writers, I feel increasingly dismayed at the level of ignorance inherent in such questions, and am more and more staggered that people, myself included, have been misinformed for so long. I don’t think I’m being a conspiracy theorist in concluding that this is deliberate, as I’m aware of the role this question plays in neoliberalism, equating government spending with household spending, and its use in the justification of austerity, which ultimately transfers more wealth to the already wealthy. Surely a journalists role would be to investigate how fiat currencies operate, where money comes from and how it works, if they don’t know the answer? Isn’t that what actual journalists do – investigate – and then inform? If a journalist is asking the question, far from sounding clever, it simply signals their sheer failure to do their job at all. Any journalist worth anything would find out how money actually works, and use that knowledge to investigate the truth claims of politicians, not simply ask such a dumb question to then be fed an unquestioned line. I don’t know how you keep going given the tidal wave you’re up against, but I’m glad that you do.
https://www.bbc.co.uk/news/business-52663523
Coronavirus: How much will it cost the UK?
So where is all the money going to come from?
That article is trite…
That makes me angry
And keeps me going
David, I agree entirely with your post. I have learned a great deal from Richard’s blog, but it has raised the same questions for me, about how this has been hidden for so long. It certainly puts the last 10 years of austerity in the criminal bracket. And all those “economics editors” who never challenged these myths, can’t be stupid, so must be in on it.
It makes me angry to think about all the people who have died, without reason, because of these policies.
Sean wrote “And all those “economics editors” who never challenged these myths, can’t be stupid, so must be in on it.”
Perhaps it’s because these “economics editors” actually believe the myths are real. As Richard has pointed out, pretty well the only brand of economics which has been taught in universities in the capitalist world in the last 30 -40 years has been neoliberal economics. The result is four decades of Economics graduates who know no better. It has taken years of patient preaching by people like Richard, Stephane Kelton and others to get the message across about how money is actually created and how the monetary cycle works. And it’s only recently that this message has gained wider public prominence and understanding.
So-called reporters are apparently often little more than rewriters of press releases these days. How did we come to this? I recommend you read ‘Flat Earth News’ by Nick Davies by way of explanation.
Excellent.
I think the penultimate paragraph is not quite correct…… the 10 year gilt has a yield of 0.2% – but this is the nominal yield, not the real yield. Real yields for gilts are about -2%.
I know….but people don’t get that
You have…..
“10 year bonds are paying a real interest rate of around 0.2% at present.”
all I am suggesting is……
“10 year bonds are paying an interest rate of around 0.2% at present.”
Everything else can stand as is…… but without the change what is written is not true.
Sorry – I had not realised I had put real in there – that is a mistake
I meant nominal….
Now I see your point
Right-wingers always evade explaining how sovereign governments create the currency (medium of exchange) because citizens are so used to having money in their pockets or bank accounts. It’s simply preying on complacency and as such immoral. As Michael Hudson argues the immorality stems largely from the FIRE sector (Finance, insurance, real estate) that works hard through politicians to perpetuate the evasion because it doesn’t want government to be funding those citizen needs this sector finds very profitable.
Great piece… very readable/listenable to…. Probably the best podcast/article in the recent set you have produced.
Excellent last paragraph.
Perhaps, there is another way of describing Government “debt” (bonds) other than a debt or a savings account.
If bonds and taxes are the two ways government removes money from the economy to create spaces for further government spending, then bonds could be seen as one big Government sanctioned, TAX AVOIDANCE SCHEME!?
If people with excess wealth didn’t buy bonds then the government would be forced to tax their money out of the economy instead (destroying it) to create space for government spending. (Government spending being vital for a vibrant society)
By buying bonds, people with excess wealth are avoiding being taxed on the money “tied up” in the bonds.
Better to be persuaded to buy bonds.
At least you will have something to show for it when the bond mature even if the yeild is -2%!!!!!!!!
Government Debt, savings account or tax avoidance scheme??
Take your pick?
[…] Cross-posted from Tax Research UK […]
How the economy works can be elusive but your articles Richard always help make it understandable and for that I can’t thank you enough. I do have some questions though. Sorry in advance if the answers are staring me in the face. To get this straight, the BoE prints money which it loans to a ‘company’ which it owns which uses the money to buy second hand government bonds? Does this ‘company’ also use the printed money to buy government bonds? If yes, is there interest paid by the gov. to the BoE’s ‘company’ on these bonds? Have there been instances when the BoE’s ‘company’ put pressure on the Treasury to buy its bonds back? If there is no pressure, does the gov. have any justifiable grounds to engage in economic programs like ‘austerity’ to slow and eventually reverse a rise in the government deficit such as after the GFC and now dealing with covid-19? Sorry again for the questions I’m just a layman trying to make sense of this.
The company is lent money by the BoE to but bonds
The company buys second hand bonds
The whole arrangement is agreed with and underwritten by the Treasury. There is no independence going on here – the company does what it is told to do. There has been no pressure to resell bonds, not will there be. The interest on the purchased bonds has been cancelled since about 2013 as it us the government paying itself and that is pointless .
Austerity was always unnecessary
Like James, I too was a bit puzzled by the original sentence which stated “It’s created new money, by making loans to a company that it owns, to do that”. Originally I was assuming that the “it” in this sentence referred to the government and the ‘owned company’ was the BoE. But then I was confused about the direction in which the loan was flowing and was wondering does the government make a loan to the BoE or is it the other way round (as I had previously assumed)?
But after reading Richard’s response above I realised that perhaps the referred to ‘company that it owns’ is actually the APF (Asset Purchase Facility)?
Clearly I have not yet got my head round the 3 way relationship between the Government, the BoE and the APF. Neither am I sure of the direction of the causal links between them.
I hope my comment makes sense and if so, could some kind soul straighten me out please?
Sorry
Yes – it is the APF hat I ma referring to
Richard
Thank you for setting this out. I’d like to believe it is as easy as that, but something tells me there must be a catch. Is it really true that ‘the Government cannot go bust’. I think I understand this in the sense that as the debt is issued in a sovereign currency there is not going to a default, as can be the case with a foreign currency debt. But currencies are traded. If the global markets take serious fright at what the Government is doing and lose confidence in the pound, won’t that lead to a significant drop in its value, and potentially to a risk of hyperinflation? Or is that another myth we’ve been sold?
The government cannot go bust if it only issues debt in its own currency
In that case it can always pay: it always has the means to do so
This should not be confused with currency trading: MMT says currencies should float. Currencies can change in value and do: Brexit did a lot of harm, for example. Such big factors (and external duopoly sticks, like the price of oil) are the big issues there
But this is not a government issue: it is a market issue – and assuming the government uses MMT to deliver a vibrant economy the risk of major currency variation is very low indeed
The two are distinct, but not unrelated. I would argue that MMT is a currency support mechanism, but not bevcause of money intervention but because it encourages high unemployment and so wellbeing
Eh, I think perhaps you mean “employment”?
Where?
The BBC is at is again by giving free rein to George Osbourne on today’s The Week in Westminster
https://www.bbc.co.uk/sounds/play/m000j7gc ~14 mins in
Nauseating stuff – especially the self aggrandisement over the unnecessary, appalling and damaging austerity that Osbourne brought in
I may (and I stress the may) address the claim he makes that we are poorer
It’s an absurd claim to make: some financial capital has been destroyed but to claim we are poorer is absurd
What we have realised is that we need to do things differently
That’s not the same thing, at all
Very useful. Thanks Richard (and others).
So to summarise, if our intention now was to engage constructively with the lay public, would it be fair to characterise the four available options for dealing with the Covid-19 Government debt, as follows:
1. Borrow from The Private Sector (Money Markets) by issuing Bonds; a conventional and relatively familiar method.
2. Raise Taxes; Another conventional and familiar method (although potentially misunderstood).
3. Issue bonds, and then buy them back again; i.e. Quantitative Easing (a post 2008, relatively recent and less familiar but tested innovation that defied gloomy expectations of inflation offered by many orthodox ‘thinkers’).
4. Run a BoE overdraft; enacted via a Ways and Means Account (a very recent innovation with which few will be familiar).
If so, the challenge now faced is to disseminate the realities of these four options in a way that laypeople can identify with (recognising that in doing so, we will probably come up against significant cognitive dissonance and powerful vested interests). For example, when expressed as above, Options 3 and 4 might not sound quite as alarming given that the emotive term ‘money-printing’ has been avoided
Would it be useful to start by briefly but clearly listing the relative advantages and disadvantages of each option, possibly in tabular format? Then ask people which one, on-balance, appeared most favourable, given a particular set of economic circumstances?
We would then have to be prepared for the inevitable questions and concerns about future inflation, exchange rates, legacy debt for future generations etc., but presumably we now possess the wherewithal to address these convincingly as they arise.
I will seek to do this
That would be very good of you Richard. It could stimulate some informative debate on here and also place those such as myself, who are less well informed, in a better position to go forth amongst ‘the great unwashed’ and spread the word.