yes to all this.

tiny quibble, although you do go on to talk about gross borrowing as opposed to net, in the paragraph after “this matters” you write “still needs to borrow less in any given year.” – I’d have thought the natural reading of “borrow” is change in net debt position, so perhaps you might insert a ‘gross’ in that sentence too.

What you say above is true, but as the nominal amount of debt increases (which it is and has been doing for the last ten years) the profile of maturing debt also steadily increases.

Effectively by issuing more now we just kick the can down the road for ten years or so. It also shows how well the last Tory administration managed the public purse…

@2: “It also shows how well the last Tory administration managed the public purse…”

Of course, it wasn’t until the last quarter of 1995 – after dropping out of the European Exchange Rate Mechanism in September 1992 – that Britain’s standardised unemployment rate dropped below the standardised unemployment rates of France, Germany and Italy.

“I certainly don’t say that there is no chance the markets would lose faith in a British government that’s adopted a different approach, I just think the balance of risks points towards a less extreme and more growth friendly fiscal package.”

So we’re finally starting to talk about the puke point then (http://www.cashandburn.com/2011/04/puke-point.)

Can’t agree with your judgement on risk. When we’re talking about flight to quality – which is what the UK has benefitted from – then maturity is not particularly relevant.

I still can’t believe that after 4 YEARS of financial crisis people are still trying to seriously argue that there’s not much risk of taking chances with excessive debt and investor confidence.

the link that works: http://www.cashandburn.com/2011/04/puke-point.html

The debt maturity profile is the single most important factor and you are correct that if it is mentioned at all in the media it gets a brief mention at the end of a piece. For example, in 2009/10, Germany had to issue 450 billion euros in debt and the UK half that number despite the UK having a much larger deficit. However, the long-dated maturity of UK debt actually made in our banking crisis worse in late 2008. In a liquidity crisis the only thing safe and liquid is short-dated government debt. The UK banks did not have any short-dated government paper because the Debt Management Office had not been issuing much in recent years. All the banks’ assets were illiquid securities that no one trusted because they did not know what they were worth. The BoE initially would only accept government paper in repos knowing full well that the banks did not have any. See Mervyn King and the Northern Rock debacle.

It was the pension funds and insurance companies who persuaded the DMO in recent years to lengthen the maturity of government bonds. The pension funds and insurance companies got burnt and lost a fortune by selling equities at the bottom of the market after the dot com crash and were desperate for safe securities to cover pension liabilities. The long maturity was good in the sense of making the government safer but they went too far and made the banks unsafe. Banks need assets and government paper is the safest of all and as a consequence in a liquidity crisis government paper is the most liquid of all assets. With no short-dated debt they were forced to load up their balance sheets with asset backed securities that proved useless in a liquidity crisis.

Market sentiment can turn without much warning. However, so far when things have blown up in the eurozone the gilts market has benefited from an inflow of capital. Therefore, there is zero evidence of market sentiment turning against the UK. There is a curious paradox at play with the current gilts market. The lower yields are the cheaper it is for the government to fund itself. When will we know that the government policies are working and the economy is improving? When yields start to rise. The gilts market is the inverse of growth in the economy. Falling yields actually mean the market estimation is that there are less growth prospects and investors are parking capital in safe low-yielding assets. When yields rise significantly in the UK, it will almost certainly mean the economy is normalising.

Luis @1 – fair quibble.

Tyler @2 – may well be the nicest comment you’re ever made on anything I’ve every written.

Tom @4 – I think your disagreemtn is about where that point comes.

may well be the nicest comment you’re ever made on anything I’ve every written.

In fairness to Tyler you are not, on this occasion, trying to persuade us that the moon is made of blue cheese

Thanks for the interesting piece Richard, my specialist area is restructuring corporate and ABS finance so interesting to see which counter-intuitive indicators there are.

This was particularly interesting:

“Falling yields actually mean the market estimation is that there are less growth prospects and investors are parking capital in safe low-yielding assets. When yields rise significantly in the UK, it will almost certainly mean the economy is normalising.”

You just KNOW this will be misreported in the press.

I will take issue with one element:

“Therefore, there is zero evidence of market sentiment turning against the UK.”

http://www.guardian.co.uk/business/2010/sep/20/viewpoint-credit-rating-agencies

http://www.cashandburn.com/2011/04/wheres-fool.html

I work in debt restructuring. The amount of times I see borrowers state, just before the fall, “there’s no sign of liquidity issues” …

CRASH!

@3 Bob

Bit of a straw man there….unemployement was a lot higher when Labour left power too….happens in recessions.

@4 AT

Check out zerohedge – one of the posts ysterday links to a JP Morgan piece, talking about the US debt. DOesn’t make nice reading, and the parallels to the UK are definately there. Long/short is that government spending is a bit out of control, and implicit default could be a reality at some stage.

PIMCO also shorting US debt….which is bold given they were the biggest US holder of such.

@6 Richard W

Sorry, you are wrong. Gordon Brown changed the laws surrounding pension fund liability management which forced them to hold a lot more longer dated Gilts. The effect was dramatic – because there wasn’t enough long dated GIlts out there yields fell dramatically….which then allowed Brown to start issuing large amounts of it knowing full well he had a captive audience in the pension funds.

Quite devious, but it did screw the pension fund, and by dint of that, pensioners, in a big way by reducing their returns.

@7 Duncan

I don’t dislike you at all, I just think you are often wrong because you politicise your arguments, selectively using data.

“We face a trade-off between cutting and hence harming the economy and not cutting and hence risking a loss of bond market confidence.”

Which is why Osborne really is cutting by the minimum amount necessary to reduce the deficit and not, as MiliBalls complain, for the sake of it. If Osborne/Cameron/Clegg were as evil as the left like to say they are they would be doing a bit more than closing the deficit over five years.

@10

I just think you are often wrong because you politicise your arguments, selectively using data

Let he who is without sin, and all that…

@ 12 Blue

To be fair, I normally only comment about banking/finance/economics when someone says something a bit daft, or the usual rhetoric trotted out by those with little actual knowledge of the situation.

Just wait till we have a post on the Robin Hood Tax…..

2. Tyler

” It also shows how well the last Tory administration managed the public purse ”

The average maturity of the portfolio was 9.53 in 1997. Would this be the same last Tory administration who had 17 deficits in 18 years? The only surplus was 0.2% during the Lawson Boom.

The occupational pension schemes lost £250 billion from their market value in the dot com crash. They piled into equities after 1999 near the top of the maket and sold at the bottom of the market. No doubt Gordon Brown made them do it.

” In his Budget two weeks ago, Gordon Brown, the chancellor, announced that the Debt Management Office would sell a limited amount of extra gilts maturing in more than 10 years, following demands from pension funds, which use them to match their long-term liabilities. ”

“There was an outcry on Budget day that Gordon Brown did not issue more long gilts. But Treasury sources said the continued tight supply should be interpreted as Brown “adopting a neutral stance” and not wanting to encourage a gilt bubble.

This followed a meeting in January between the DMO and pension funds, which pleaded for more long gilts. One person present claimed that DMO officials “effectively said this was not their problem”.

“The investment strategy of pension funds is a matter for them, not us,” the Treasury said last night. ”

“…which saw life insurers sell billions of pounds of shares at the bottom of the market”

http://www.telegraph.co.uk/finance/2935826/Brown-seeks-to-wean-pension-funds-off-gilts.html

Without a doubt the introduction of things like FRS17 forced institutions into government bonds. Probably a good thing. Just imagine what kind of crap they would have bought and managed to lose money on if they were not forced to hold safe assets. I never rated Brown personally. However your obsession Tyler with blaming him for every thing is quite funny.

@2 Tyler

The last Conservative administration had a far larger current budget deficit than the Blair/Brown governments – £327 billion versus a world depression-skewed £155 billion (Labour had a current budget surplus 1997-2009).

See table A2 of http://www.hm-treasury.gov.uk/d/public_finances_databank.xls

They only balanced the books by culling investment massively and selling off much of the state’s assets (either to their mates in the City at a large discount or to buy the votes of the council house dwelling working classes).

The deficit only paid for the cost of their dreadful economic policies (unemployment, worklessness, crime, social failure) and left a massive mess for Labour to clear up.

Certainly not my definition of managing the public finances well.

In last comment, Labour’s current budget surplus was 1997-2008, not to 2009 as my typo suggested

“Just imagine what kind of crap they would have bought and managed to lose money on if they were not forced to hold safe assets.”

The equity obsession of big investors in the UK mystifies me. They lose money hand over fist decade after decade.

Where does PFI feature in these debt figures?

The uk gvt is sovereign in the pound. It doesn’t actually need to issue ANY debt to finance it’s deficit at all, unless it chooses to for ideological reasons.

@ 14 RIchard W

Not talking about what pension funds did with equities. Totally different question. That said most pension funds are buy and hold types, so I doubt they bought the top and sold the bottom unless they had redemptions – most of them would have done very little at all.

I was indeed talking about the effect of FRS17 though. Please just chart the yields of 15y Gilts, and the plummet into 1998 as the change took effect. The pleading for long Gilts came AFTER 1998, when there weren’t enough in circulation for the funds to fulfll their new duration hedging requirements without payment through the nose for it – thus denting their returns.

@ 15 Sev

Trying modifying your results by the GDP deflator to get the real answer.

As for unemployement – Labour left it much higher than when they came to power, along with much higher government debt.

@ 18 Cherub

PFI is not included in government debt. There is about 170bn outstanding at the moment. Brown basically used PFI as an off balance sheet vehicle to hide some of the amount he was spending.

@ 19 Lewis

You’ve clearly stopped smoking crack and have moved on to the really hard stuff.

The Trillion Dollar note I have (Zimbabwean) is a pretty good reminder why governments can’t just keep printing money. The UK government can’t defaukt as such, but the debt and the currency can stil become worthless, which is default by any other name.

@Tyler

Why do that to figures that are in 2009-10 prices?

I personally think we should Put { Sinn Féin go na mé féin }ourselves before myself in my language

@20 Tyler

“You’ve clearly stopped smoking crack and have moved on to the really hard stuff.

The Trillion Dollar note I have (Zimbabwean) is a pretty good reminder why governments can’t just keep printing money. The UK government can’t defaukt as such, but the debt and the currency can stil become worthless, which is default by any other name.”

Never knowingly understated.

Be a bit more respectful. The OP did not say that we should print money regardless. Just that issuing bonds was not required to finance the government. Answer a simple question. What is the essential difference between a bond and “money”? They are both promisory notes. The only difference is that the former offers interest and is redeemable in the future. They just exist in different asset classes.

Of course there must be restraint in money creation. And there may be a different utility for issuing bonds. But they are different arguments.

issuing bonds was not required to finance the government

well, it is required if you want to repeatedly spend significantly more than you are taking in tax revenue, without debasing the currency. Which we do. So all these people, who have read a bit of MMT theory, popping up saying oh don’t worry about bonds we don’t really need them, are really talking rubbish.

In case anybody thinks inflation is a right-wingers concern, here’s Keynes on the topic:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some.

The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat.

As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose…

@24 George

“The OP did not say that we should print money regardless. Just that issuing bonds was not required to finance the government”

Then what was the OP saying? If we don’t issue bonds and don’t print money how do we finance the Government?

“What is the essential difference between a bond and “money”? They are both promisory notes”

The differnece is that issueing bonds does not increase the amount of money in circulation as printing money does – or am I missing something?

@ 20. Tyler

Here is the historic benchmark 10-yr gilt yield.

http://av.r.ftdata.co.uk/files/2010/10/gilt_historic.png

Of course gilt yields fell after 1997. Implied forward inflation expectations were lower through central bank independence. See chart 1.

http://www.dmo.gov.uk/docs/publications/annualreviews/gar9798.pdf

” The reform of monetary policy, distancing interest rate decisions from the political context, led to reinforced expectations that the new Government was committed to low inflation and market expectations of future inflation fell. ”

The market will trust an independent central bank before ever trusting fly-by-night politicians of any party. Moreover, the fiscal position was better than expected and that also contributed to a fall in yields.

” The July Budget contributed to the downward pressure in gilt yields as markets became aware that the Government’s fiscal position in both current and future years was stronger than expected. The 1997-98 Central Government net cash requirement (CGNCR) forecast was revised down from £20 billion to £12.4 billion in the July Budget. The CGNCR forecast was further reduced again to £11.7 billion in the November pre-Budget statement and then again to £6.1 billion in the March 1998 Budget itself. The shrinking CGNCR caused a fall in yields as the market anticipated a reduction in the future supply of gilts. The final outturn CGNCR for 1997-98 was £3.4 billion. ”

You are not seriously arguing that the government should have borrowed more than required or increased inflation just so the pension funds could have had higher nominal yields? It was up to the pension funds and insurance companies to employ investment strategies to cover their liabilities or don’t make promises to members that they can’t keep. In hindsight forcing the UK institutions to hold more government bonds saved them a fortune. I have no doubt if that had not happened they would have piled into US sub-prime toxic waste like so many of the European pension funds. In contrast, the UK institutions escaped relatively lightly.

@25 Fungus

There is a difference between “printing a bit of money” and “printing money regardless”.

My point regarding bonds is that there is on essential difference between them, that issuing bonds is essentially a zero sum game. The government gives you a bond in exchange for money – but they are essentially the same thing monetarily.

@24 Luis

You’re entirely correct about people such as me with a bit of MMT. But I’d like to see a full refutation of it’s “essential truths”. Certainly I don’t see why the managed printing of money should be inflationary – as long as it reflects the Gross Product of the country. If we’re busy creating value, then why shouldn’t that be reflected in more money in circulation (in the long term)?

Of course you could ask whether we should trust governments to manage that printing of money? Bonds could have a different function in that respect, as a way of the markets pricing currency risk (and as a way of removing excess liquidity). But that’s not the same as “financing the government”.

23. gastro george

” What is the essential difference between a bond and “money”? ”

Government bonds are close substitute for money. However, they are not perfect substitutes, as one can’t spend them in Tesco’s etc. Moreover, a pound is always worth another pound so although its purchasing power value changes with inflation its still worth another pound. However, a government bond can lose value in relation to the cash that purchased the bond. Therefore, a bond price has an imputed liquidity risk premium in the price to compensate. Of course, bonds can also increase in value and if that is what investors expect to happen they effectively demand less premium by paying higher prices.

25. Fungus

” Then what was the OP saying? If we don’t issue bonds and don’t print money how do we finance the Government? ”

Duncan is not speaking about printing money. He is pointing out the longer maturity of UK debt means we do not have to constantly roll-over debt like countries with shorter average maturities. Some of the euro-zone have maturities of only 18 months, which means they constantly have to go to the market for refinancing. Short-dated is cheaper for governments but leaves them exposed to the risk that the market refuses to refinance or blows out their yields.

@29 Richard

Yes I realise this!! I was responding to post no 23 who unfortunatly referred to post no 19 as ‘OP’.

@10: “Bit of a straw man there….unemployement was a lot higher when Labour left power too….happens in recessions. ”

I’ve made plain enough in many postings here my criticisms of New Labour’s management of Britain’s economy 1997-2010 – especially the lack of management of financial institutions and markets, why Labour in the 1980s was a dead loss and about the dreadful management of Britain’s economy during the 1970s by both Conservative and then Labour governments supported by the Libs.

I was saying to card-carrying Conservative politicians in the early 1980s that it was nonsense to claim – as the Thatcher government kept saying – “there is no alternative – because there are 10,000 alternatives”.

Even after Howe had moved from the HM Treasury to the FCO and Lawson had taken over as Chancellor and formally abandoned “monetarism” in the autumn of 1985, he then proceeded to screw up management of the economy – hence the unsustainable Lawson boom at the end of the 1980s bringing resurgent inflation with a house-price bubble. Major followed him as Chancellor and proceeded to take Britain into the European Rate Mechanism in October 1990, which led on to the hike in interest rates to curb the inflation from the unsustainable boom and then to Britain dropping out out of the ERM in September 1992. Sterling depreciated by c. 25% as a result and the economy picked up in consequence of the boost to exports.

The fact is that Britain’s economy has been badly managed for decades, albeit for different reasons – and it’s not as though economists working in government weren’t aware of this.

On the evidence, there is absolutely nothing for the Conservatives to brag about.

Hi Gastro G

well you are quite right – nothing to do with MMT, if for example the central bank wants to keep the money supply growing in line with GDP then say real output grows at 2% per year, the money supply has to grow at 2% per year which, over the long run, requires the printing of new money at a rate of 2% per year, known as seignorage, which is a perfectly normal state of affairs and corresponds to text book economics.

Problem is that if you decide you “don’t need bonds” and want to finance a big gap between government spending and government revenue, not just with a one off burst of money printing, but something that is happening year after year, then you need to print money a lot faster than is consistent with keeping pace with real output growth, and then inflation kicks off, you need to even more money next year, and that way inflationary spirals lie.

the fact that central banks do need to keep growing the money supply over time means that governments are able to finance a proportion of government spending via printing money, but right now we’re looking at a situation where our public financing needs exceed that sort of ‘steady state’ rate of seignorage.

Tyler: you’re simply wrong on PFI. Liabilities under IFRS for the leasing component of PFI (ie “getting someone else to build a hospital”) were about GBP30bn in 2008, and won’t be much higher now.

You can only get the scary huge figures if you also add in contracted payments for services which haven’t yet been delivered (ie “paying hospital cleaners and security guards in 2035″). Counting the money that we’ll need to pay for services in 20 years time as part of the national debt doesn’t seem entirely sensible.

@25 (the UK does) not have to constantly roll-over debt like countries with shorter average maturities

this is simply untrue – liability management means providing a range of debt maturities (which also helps other sterling borrowers to benchmark against)

moreover, the need to refinance isn’t the issue. as I have explained numerous times here, and on my blog on the link above, the issue is that if market prices for UK debt were to spike then we’d have crisis in a matter of hours.

I was talking to a sterling bond guy yesterday and he emphasised how much of the price is largely technical – ie long debt maturities on gilts are there because the government under Brown for a long time didn’t provide them, and that pushed the price down.

Luis,

Actually, the BoE pays interest on reserves, so by design it can only take advantage of seigniorage by issuing notes and coin.

vimothy

I don’t understand, sorry – I thought the government does benefit from seignorage, via the CB expanding it’s balance sheet over time (buying bonds). perhaps reply over email? I need you to explain to me how paying interest on reserves relates to the matter.

Luis,

I’ll be brief then: When the BoE adds new money in an OMO, it issues liabilities and acquires assets. The Bank earns interest on these assets, and the holders of the new money (M0) do not, which is seigniorage.

However, in 2006 the Bank decided to pay interest on reserves. Consequently, the Bank no longer earns seignorage revenue on the total stock of outside money (M0), only on the stock of notes and coin held by the public and vault cash held by the banks.

Google the BoE paper, “Publication of narrow money data: the implications of money market reform”, and check the short paragraph at the end where it takes you through a couple of govt budget identity variations with and without IOR.

ah, right – we are talking cross purposes and I have probably been misusing the term “seignorage”. I was talking about the fact that to increase the money supply over the long run, the bank has to (roughly speaking) monetize some of government debt, so the government gets to sell some bonds which it will never have to repay because they’ll sit on CB balance sheet being rolled over in perpetuity. Otherwise OMO would eventually exhaust the outstanding stock of bonds held by private sector. So the government has to issue net new debt, and the CB has to buy it and keep it (because selling it again would contract MS but objective is to grow it over long run).

Yeah, that’s not quite how I define seigniorage. Interesting though: I guess having a money supply implies that the govt violates the no Ponzi game condition, unless M -> 0 in the limit too…?

Unless it backs the money with private sector assets, of course.

ah, well there’s a very interesting discussion about no-ponzi conditions with Nick Rowe in the Interfludity comments, which you are a participating in too I recall, sorry to say I haven’t followed it in enough detail!

34. AnotherTom

“this is simply untrue – liability management means providing a range of debt (which also helps other sterling borrowers to benchmark against) ”

I don’t recall saying anything against good liability management having a balanced range of maturities. In fact, if you read the thread I pointed out that there was too much issuance at the long end and not enough short-dated gilts and bills, which made the banking crisis worse in the 2008 UK liquidity seizure. Here is Tim Congdon pointing out the problem.
http://www.iea.org.uk/sites/default/files/publications/files/upldbook450pdf.pdf

” moreover, the need to refinance isn’t the issue. as I have explained numerous times here, and on my blog on the link above, the issue is that if market prices for UK debt were to spike then we’d have crisis in a matter of hours. ”

Of course refinancing matters. Writing something in your blog does not contradict the whole field of knowledge on the subject. If you have to refinance large portions of the stock of debt by refinancing in short periods of time then you are more vulnerable to a spike in yields just through the sheer quantity being rolled over. If the average maturity is short you are more vulnerable than a country with a long average maturity. Think about what you are saying for a moment. Do you not think if the UK was bringing £400 billion in gilts to the market in any particular year they would be more vulnerable to a spike in yields than if they were bringing £200 billion. Nobody is saying that yields can’t spike for other reasons no matter what the average maturity. What they are saying is it is less likely if the average maturity is long. Feel free to tell the IMF and everyone else why average maturity is not an issue.

” I was talking to a sterling bond guy yesterday and he emphasised how much of the price is largely technical – ie long debt maturities on gilts are there because the government under Brown for a long time didn’t provide them, and that pushed the price down. ”

I think you are reinventing the laws of arithmetic. You can’t have a long average maturity through not providing long gilts. Not providing long-bonds would shorten the average maturity. As I’ve explained further up the thread the DMO under pressure from the pension funds and insurance companies were constantly pressed to issue more long-dated debt and left the short end under provided. This left the banks exposed.

Not providing enough long gilts would lower their average yield the inverse of the price. However, it would not lengthen the average maturity. The average yield on the whole stock of gilts is the inverse of the average price. Your bond guy is speaking about the average yield not the average maturity. The average maturity of the stock is self-explanatory. If every gilt in issue matured in twenty years the stock would have an average maturity of twenty years. Likewise if every gilt matured in one year the stock would have an average maturity of one year. The maturity is just an average of when the whole stock matures. The price gilts are trading at in the market gives one the average yield.

Although there has been a bit of a bubble at the long-end of the yield curve in recent years as the institutions scramble for assets to cover their pension liabilities. This only lowers the cost to the government of issuing debt, it does nothing to the average maturity which is entirely in the hands of the DMO.

May I please publish your very informative graph “G7 Gross Funding needs 2011 (% GDP)” in an election campaign leaflet in the current Local Government Elections?

Paul Courtel
Election Agent to Labour Party Candidates for Bexhill Central ward
Rother District Council