There will be much talk of unaffordable debt burdens from Sunak today, none of which is true.
The reality is that are about £1,500 billion of conventional gilts or bonds in issue, but since the government owns more than half of these there are only about £675 bn owned by the public. The annual cost, net of the debt owned by the government using quantitative easing is about £15 billion a year. Around £20 billion of interest paid on the rest of these bonds goes straight bank to the government.
£500bn of index linked stock is in issue. The cost a year ago was around £5bn pa, and will now be around £40bn because of the increase in inflation.
The only other so-called debt to worry about is balances held by clearing banks on deposits with the Bank of England on their central bank reserve accounts. These are around £900 billion so the cost was less than £1 bn until recently and now maybe £8 bn
So, index linked stock is the problem.
But then note that there is no obligation at all on the Bank of England to pay interest on central bank reserves and almost all the index linked cost is an accrual i.e. an estimate of a cost that may, or may not be paid one day, and as a result is subject to change. There is no current cash cost to most of this.
In other words, this issue is being massively overplayed, not least by using gross debt figures that ignore quantitive easing. It is likely that the Chancellor may overstate the necessary interest cost by up to £30 billion today to provide reason why he cannot spend, and that makes me very angry when millions will suffer as a result.
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I think the two simple question are:
1) how much of this so-called interest cost must actually be paid in cash right now?
2) who is is paid to?
The first eliminates the accruing redemption cost – what, £10 billion or more? – of index linked gilts. (That will need to be settled in due course, probably from the proceeds from an issue of more gilts – the left hand paying the right hand again, cash being just as much government debt as gilts are: but if the government are accruing for this cost, why aren’t they accruing for all their other known liabilities, such as pensions?)
The second eliminates the c£20 billion interest paid back to the government. (This goes in the same box as the mythical £350m per week for the NHS.)
I may do a blog on this tomorrow
Bush whacked now, and heading for home at last
You know how I think this data should be treated, we have discussed it on you blog. Although arcane it does matter; it matters because our Chancellor will use this data in a misleading way to justify bad policy.
Not simply bad policy, malevolent, harmful policy. I suspect we’ll be witnessing an exercise in sadism today.
We did
Correct – fiscal sadism from a man who drinks his coffee from mug whose price tag would feed a low income family for a month.
A real gold plated Tosser is Mr Sunak.
Apologies – but I cannot believe the guff I’ve heard on the radio today. I’m going to try not to watch the news tonight as I can’t really afford a new TV at the moment.
The interest on index-linked treasury stock seems to be an optional payment for the government – how so? Doesn’t it have to be paid twice a year?
Mist iof the interest on index linked stock is paid on redemption – and we have no idea what that will be
The optional bout is on central bank reserve accounts – where no interest need be paid
… at the risk of pedantry.
Interest is paid semi-annually on the outstanding principal. For Index-linked gilts that outstanding principal is uplifted by RPI…. and repaid at maturity. I don’t know of any bond trader who would consider that inflated redemption amount as rolled up interest…..
But what I am really looking forward to is the next budget or the one after that – how will he explain the rapid drop in “interest payments” (as they surely will as inflation moderates)…. and will he use that money to reverse austerity?
I tweeted a chart showing that drop is going to happen…
Isn’t a predictable proportion of treasury stock being redeemed all the time?
Yes. But it is replaced.
But isnt a predictable amount always being “cashed out” as well , so to speak?
Yes
And it is replaced
I haven’t heard one media outlet ask yet to whom does the Government owe the money to?
We all know the answer here.
Suppose the Government redeemed all its third-party debt tomorrow; what would happen? Foreign creditors may or may not return (but that is not where the bulk of debt rests). Domestic creditors would, in large measure return to the Government and ask it to take the money back; provided it continues issuing the currency and demanding taxes, Government provides the only definition of “safe assets” in the community. In the hierarchy of money Government-backing is all that counts in a crisis. The popular confusion arises here I suspect because most people think their money is an asset; when in reality it is simply a Government promise to pay (but no one notices the difference, except in a major crisis, because the hierarchy of money is largely hidden from view in ordinary daily life).
I should have said it is thought “money is a personal asset”, when it is simply a Government promise to pay; and stripped to its essence the promise is only fronted by a bank as a screen for the guarantee, only sovereign prerogative power can give; hence Government alone provides the ultimate currency “safe asset”.
In global terms the US dollar is the ultimate world ‘safe asset’ currency. The proof there is that much of China’s trade surplus is held in USDs.
Interesting idea, buying in the debt…..
Can someone unpack this for me as an example: https://www.reuters.com/markets/europe/uk-sells-new-2073-index-linked-gilt-with-record-low-volume-2021-11-23/
In November 2021, the government issued a 50 year index linked gilt, with a coupon of 0.125%. It was massively oversubscribed. I think the nominal value of the gilt was £1.1 billion (which sets the amount repayable in March 2073, although that will be increased by inflation) but it was sold for £3.9 billion. Over 50 years, that is a “real yield” at issue of -2.3883% pa. (If I have this right £1.1 billion = £3.9 billion x (1- 0.023883) ^ 50).
To put it another way, the amount of interest payable on day one is £1.375 million per year (£1.1 billion times 0.175%). If inflation is 6%, what “interest cost” is booked? The difference between 6% and 2.3883%? What do the numbers look like after one year with 6% inflation? And what if this is a temporary blip, and we have 2% inflation for most of those 50 years?
sold 1.1 billion pounds ($1.47 billion) of a new index-linked gilt maturing in 2073 on Tuesday, which will pay investors a record-low inflation-adjusted yield for a bond sold via a syndication.
Clive?
I am sorry – but totally bogged down today
They sold £1.1bn “face amount” of this bond with a coupon of 0.125%.
Let’s consider what happens if I own a £100,000 portion of this issuance. It will repay at maturity £100,000 adjusted by inflation. So, if inflation is zero over the next 50 years it will repay £100,000. If it is 2% (BoE Target) it would repay £100,000 x 1.02^50 or about £270,000. If inflation is (on average) 5% it will repay £1,150,000.
What about interest payments (or coupons)?
It will pay interest of £125 each year (in fact £62.50 every 6 months) and this amount, too, will be increased with inflation. If there is no inflation it will pay £125 a year. If inflation is 2% it will pay £125 x 1.02 this year, £125 x 1.02^2 next etc.
The reason things are structured this way is that it does what a lot of savers want. If I invest £100,000 today then when the bond matures I will be able to buy the same stuff as £100,000 would get me today PLUS I get £125 a year (increasing with inflation). So, if £125 buys me a good lunch with my friends today the interest I earn will buy me a good lunch EVERY year whatever inflation is.
Now it gets complicated. IF I bought this bond at “par” or “face value” then the real yield would be the same as the coupon – 0.125%…… BUT if I pay more than face value then my return will be less. The bond’s cash flows are not dependent on what I pay so any “extra” I pay will be “lost” over the life of the bond.
In this case, the bidders in the auction paid 356 (ie. £356,000 for £100,000 “face amount”…. or £356,000 to get £125 a year (inflated each year) and £100,000 (inflated for 50 years) at the end.
It turns out that if you pay 356 for this bond (as buyers did) and inflation turns out to be (on average) 2.39% then they will earn zero (nominal) on their investment.
At the time, conventional, fixed rate gilts for 50 years yielded 1% this suggests that the market was expecting average inflation of 3.39% (over 50 years).
I would note in passing that “average” is a dangerous term – it DOES matter quite a lot whether the inflation is “front loaded, stable or volatile….. but that is a knotty (but fascinating) issue.
The key take away is that the “hurdle rate” for any investment that the government wants to make is NEGATIVE in real terms…. and a LARGE negative number over a LONG time scale. PERFECT conditions to finance Climate Change projects etc..
Thanks Clive
Thanks Clive. Fantastic. I think that is about the best explanation of this I have ever seen.
Can I press you on one more thing: do you know what finance expense the government would claim it was “paying” on your £100,000 of gilts, if inflation is 6% this year?
Is it the £125 (or £125*1.06 = £132.50) that is actually paid out in cash?
Or the actual interest plus £6,000 – i.e. the difference between the £100,000 issue price and the indexed principal of £106,000 after one year?
Or perhaps £132.50 plus £3,610 (that is, the £6,000 added to the principal, less the negative 2.39% yield implicit in the premium on issue?)
Is there an assumption that the average inflation for the remainder of the term of the note will be the opposite of the implicit yield on issue?
With regards to the question ” If inflation is 6% what interest is booked?”
ONS records 6.125% as interest. (0.125% on the face amount plus 6% for the inflation uplift). Ie. £61.25mm per billion in issue.
If inflation falls to 2% next year they will record 2.125% x 1.06 (0.125% interest plus 2% inflation both on the inflated principal). Ie £22.525mm per billion originally issued.
That is why we saw “debt interest cost” soar this year and why this number will be very volatile as inflation bounces around. In my view, this mischaracterises the “inflation uplift” which is an increase in “principal owing” with “interest” which should be an ongoing measure of debt servicing costs.
This matters because the “National Debt” is being used to drive policy and if that is the case it should, at least, be characterised correctly
First, “you can’t owe money to yourself” – and Richard as written eloquently about the BoE/APF gilt portfolio.
Second, we must not confuse the size of the debt with the cost or servicing the debt. If I am in debt and want to see what has happened over the last year there are two questions I ask. How much more do I owe than last year and how much interest did I pay? If I add those two together it captures my situation nicely…… if I paid a very low interest amount then this will be reflected in a higher amount owing. If I apply that reasoning to the ONS methodology I “double count”.
With our Index linked gilt ask yourself…
Q1 If after 1 year I wanted to repay the debt, how much would I have to pay? Answer: £1.06bn – £60mm more than last year. I don’t know what other number you could come up with.
Q2 How much interest did I pay? Answer £1.25bn
Add these two together and you get the all-in change in your situation…. but if you use the ONS definition of interest you get £12.25bn… which is incorrect.
Sure, if you dig into the detail it is all there but it is the duty of statisticians to present data in the most useful and intuitive way…. or else people will abuse the data.
I admit I will need to think about that in the morning…..
Thanks, Clive. I’ll ponder that too. But it seem to me that, if you are going to accrue for the increase in the redemption amount due to inflation each year, then you also need to take account of the unwinding of the premium paid on issue (2.39% in year one, the square in year two, etc.)
Yes
In correspondence with the ONS they admit that they have not got their reporting of this right as yet.
Thank you, Mr Parry invaluable. “This matters because the “National Debt” is being used to drive policy and if that is the case it should, at least, be characterised correctly”. If I understand this, it implies the inflation portion of the capital is being expensed off the debt; inflating (and deflating) the interest cost; and therefore the deficit (I am not sure of the overall impact on the debt profile, or how widespread this technique – or, as a method restricted solely to inflation adjustments).
I am also not sure of how this treatment reconciles with general accounting principles? I can recall when ‘inflation accounting’ led to vast tomes being produced by the accounting authorities. Am I right in thinking that under the US GAAP rules, inflation-adjusted financial statements are not permitted? But of course I presume the Fed is a law unto itself.
Sorry, Richard, run that by me again. The UK has been issuing index linked gilts since 1981, but the ONS still doesn’t know how to report the interest cost in a way that is not misleading, or indeed just plain wrong?
Apparently so
I think that idea of a paper is important now
@ Clive Parry
CLIVE PARRY says:
March 23 2022 at 6:15 pm
… at the risk of pedantry……
Carry on pedanting – I am here to learn. Thank you for your patience.
Be careful what you wish for!!
The interesting bit in Sunak’s speech was the moment he said: “we know that individuals spend their money better than governments do”.
This coming from a chancellor who is responsible for c35% of the economy and who has just produced a raft of measures that proves the opposite is a breath-taking example of saying one thing and doing the opposite.
But it augurs badly for the NHS who he warned would be stuck with its current level of hypothecated taxes while giving away those taxes in the form of NIC relief.
At least he put on a better show than the unhinged Prime Minister behind him.
Does he really think individuals are better placed to source health and social care, education, roads, bridges, railways, defence, social security, police, fire services, courts, prisons, waste disposal, water, sewerage treatment, an electricity grid, parks, protection from pollution and from workplace exploitation, and many other public goods, than those same people clubbing together as social animals and using the power and resources of the state to do it together?
It is dogma, and it is untrue.
What it does do it empower the few with sufficient resources to do what they want, and makes beggars of the rest of us.
Precisely
There is a thread coming on this tomorrow