The National Debt is £375 Bn Less Than You Think It is

by Marcus Mulholland

Given the current troubles of Britain’s coalition government, it might seem a crying shame from the point of view of David Cameron and George Osborne that they feel unable to announce a fact that would surely be regarded by the public as an excellent piece of economic good news.

That is, that the net national debt, generally thought to have ballooned by an additional £140 billion since the general election, has, due to government policy, in reality been reduced; and even better, rather than being an amount equivalent to nearly 68% of the UK’s annual gross domestic product, the national debt has been kept down to a quite ordinary 45% of GDP, a proportion which occurred under the previous Conservative governments of Margaret Thatcher and John Major without causing undue concern.

This, however, has not been achieved by the coalition’s flagship strategy of cutting public services and benefits. Rather, the means by which the national debt has been held down and even slightly reduced is a policy which in Britain was initiated and put in to action enthusiastically under Labour prime minister Gordon Brown, and merely continued by the present Tory-Liberal coalition. The name given to this policy is quantitative easing.

To simplify only slightly, the British state has for the past few years been printing money to cover its deficit and pay the national debt, a policy which has the added benefit, from a capitalist perspective, of raising the price of financial assets and thus ensuring that the rich carry on getting richer, despite reduced corporate profits due to the economic slump. Although Britain began using this strategy in 2009, it has been employed by Japan since 2001 and became a key plank of US financial policy in 2008. Similar methods have hitherto been used by many countries, including the USA, during the 20th century and previously.

This is how it works: in order to raise funds to cover the deficit, ie the gap between what it brings in by taxation and what it spends (a gap which got much bigger after 2008 due to the impact of the capitalist economic crisis), the state sells interest-bearing bonds, which are bought mainly by the private sector including banks, pension funds, insurance companies, non-financial firms and individual investors. These bonds- known in the trade as ‘gilts’- constitute the bulk of the national debt. Since 2008 the UK government has had to increase the number of gilts it sells, giving the appearance of a steep and sustained rise in the national debt.

But, under the quantitative easing (QE) scheme, the Bank of England (BoE) has been authorised to create hundreds of billions of pounds electronically (the modern equivalent of printing money) and use this cash to buy back, from those who purchased them from the UK Treasury, huge quantities of gilts with this specially created money.

Thus far the BoE has acquired, following the the latest tranche of QE bond-buying, £375 billion of these UK government bonds.

As nobody can deny, the Bank of England is a wholly state-owned public utility. Thus the  UK government bonds which the BoE now owns are state property; ie the ‘debtor’ and the ‘creditor’ of the obligation that these gilts represent are one and the same organisation- the British state. Therefore this £375 billion does not actually represent any debt, as the idea of owing money to oneself is a nonsense.

That these BoE-held gilts (more than 35% of the total) do not represent any money owed by anyone to anybody else, is not taken into account in the official public sector net debt figures.  As Richard Murphy of the Tax Justice Network has been persistently pointing out, those figures thereby overstate the amount of the national debt by over one third- currently as £1,065 billion instead of the real amount of approximately £690 billion.

This considerably better-than-advertised soveriegn debt position, associated with the ability to run a deficit without increasing the net national debt, even in the absence of economic growth, pertains not only to Britain but also to the two other major advanced economies which utilise QE- Japan and the USA.  The countries of the Eurozone, on the other hand, have given up their own currency and thus their ability to ‘print money’. This is a factor which needs to be taken into account when considering why Eurozone countries have been particularly afflicted by the sovereign debt debacle in the recent period.

As Anatole Kaletsky, the former economics editor of The Times, remarked in his Reuters blog in July 2012:

… the racist stereotyping that passes for rational analysis of the European crisis deflects attention from a genuine difference between Europe and the rest of the world that perfectly explains the markets’ behavior. There is one simple difference between all the European victims of financial crisis and the lucky countries that are given a free pass by investors, despite even bigger deficits and worse banking crises. The countries with immunity control their own currencies and central banks. They thus have the power to print money, which they use to the full. By the principle of Occam’s razor, this one simple explanation should be viewed as the main reason for Europe’s present crisis.

Kaletsky added:

The ability to print money, officially known as quantitative easing (QE), has allowed the U.S., British and Japanese governments to run whatever deficits they wanted and to offer their banks unlimited support without suffering the sky-high interest rates that are now driving the Club Med countries toward bankruptcy. Instead of raising money from private investors, these governments finance their public spending and deficits by borrowing from their own central banks. This means that the U.S., British and Japanese governments are actually much more solvent than their huge deficits suggest, because much of their debt does not really exist. They are an accounting fiction – an IOU from one branch of government, the treasury, to another, the central bank. The Bank of England, for example, is lending £375 billion to the British government in 2009-12, out of a total planned deficit of around £450 billion. The Fed’s $3 trillion balance sheet effectively reduces the U.S. government’s total debt by 20 percent, from $16 trillion to $13 trillion.

When evaluated on this basis, QE has evidently been highly effective; whereas when its efficacy is judged on the basis of the main official justification for the policy- to stimulate the economy by injecting money into it, thus increasing demand- it is clearly not resulting in any significant improvements.

This may be at least partly because any stimulating effects of QE are negated by the impact of the cuts programme, which of course reduces demand in the economy. In any case, if the official purpose of QE is to be taken seriously, the hundreds of billions of pounds are being thrown at the wrong target. The current lack of investment by private sector companies is not caused by lack of money on their part- indeed, UK firms have accumulated an astonishing £700 billion in cash reserves, which they are unwilling to invest because, since the credit crunch, their potential investments would not yield a high enough rate of profit. Of course, there is a severe lack of money in the UK economy, but not in the corporate sector. The sectors being starved of funds are the public services and the majority of individuals and families.

Wages, price and assets

However, the QE strategy has contributed to an overall recovery of the price of private sector financial assets, despite the ongoing effect of the recession on company profits. This is because, through their bond purchases, the central banks put money into the financial markets, and in return withdraw from those markets a large proportion of an important group of financial assets- that is, UK, US and Japanese government bonds. So by the effects of supply and demand, the price of these bonds, in relation to how much interest the owner receives on them, rises; to put it conversely, these governments pay lower rates of interest on their debt than would otherwise be the case (which, in the financial jargon, is referred to as reduced ‘yields’). And in addition, also due to the impact on supply and demand, the prices of alternative financial assets traded on the markets are pushed up.

While this has helped end the fall in share prices following the credit crunch and return them towards pre-crisis levels, QE has had an even bigger upward effect on the price of corporate bonds- which, like government bonds, give fixed payouts to their holders, and thus represent safety or reliability within a financial portfolio. Thus the super-rich, a large proportion of whose wealth is comprised of portfolios of financial assets, have seen their riches increase during the ongoing crisis.

Among various other outcomes of QE is higher inflation- as one would expect to result from the government using the 21st century version of printing money to cover its deficit. Indeed, the Bank of England, on its web page entitled ‘Quantitative Easing Explained’, while skirting round the unmentionable matter of paying off the national debt, gives the objective of preventing inflation falling below 2% (as measured by CPI) as a key aim of QE:

The purpose of the [UK bond] purchases was and is to inject money directly into the economy in order to boost nominal demand. Despite this different means of implementing monetary policy, the objective remained unchanged – to meet the inflation target of 2 per cent on the CPI measure of consumer prices. Without that extra spending in the economy, the MPC [Monetary Policy Committee] thought that inflation would be more likely in the medium term to undershoot the target.

In the event, prices as measured by the CPI index rose more than 3% in 2010 and 5% in 2011, and, while currently at 2.1%, another sharp rise in the cost of living is predicted. The RPI measure of inflation, which more accurately reflects the outgoings of most households, has been running at much higher rates.

As an article in the Economist in July 2012 entitled ‘Quantitative easing: QE, or not QE?’ pointed out, “Temporary, higher-than-normal inflation can facilitate wage and price adjustments”. That is, increased inflation caused by quantitative easing is a means which can be used to help assist the process of cutting the real wages of workers; thus resulting (assuredly) in further redistribution of income towards the rich, and (hopefully) increased competitiveness in the capitalist world market. In the UK, wages have been frozen in the public sector and rising at a rate lower than inflation in the private sector; that, on top of the abolition of hundreds of thousands of (relatively well paid) public sector jobs and their replacement in the UK employment market by low-paid private sector positions, added to the impact of benefit cuts, has severely reduced average post-inflation incomes for the majority of people.

Meanwhile, an arcane debate has been taking place within financial policy circles on the future of the QE strategy, and this has included the question of what should be done with the several trillions in pounds, yen and dollars, which the  British, Japanese and US governments supposedly ‘owe’ to themselves. At the time of writing, commentators are predicting that the Monetary Policy Committee of the Bank of England will, for now, ‘hold fire on more money printing’, but nobody seriously imagines that its £375 billion in gilts will be sold back to the private sector in the foreseeable future.

Philip Coggan, author of the ‘Buttonwood’ column in the Economist, noted on 15th October 2012:

THE idea that central banks might cancel their government debt holdings, or restructure them into zero coupon debt [ie, debt on which no interest is paid], is gaining traction. A speech by Adair Turner, a candidate to be governor of the Bank of England, was reported as alluding to the idea last week (although it certainly wasn’t mentioned explicitly). Gavyn Davies, the former Goldman Sachs economist, discusses the possibility in his blog.

It certainly seems the logical endpoint of the policy. In several previous posts, I have suggested that it is difficult to imagine how central banks will offload the bond piles they have accumulated. (There is no practical difference between selling the bonds and not reinvesting the proceeds when they mature; the private sector will have to absorb the bank’s unwanted bonds plus whatever new supply the government is issuing that year. As there is no immediate prospect of governments eliminating their deficits, that would likely lead to indigestion in the markets and a big jump in yields. The central banks are unlikely to want yields to rise sharply any time soon. After all, the Fed has indicated it wants to keep short rates low until 2015.)

So central banks are likely to be the biggest single holders of government bonds for a while. And to the layman this looks rather absurd. The government is paying interest to a body that is an arm of itself, rather like a husband paying interest to his wife. It would surely be simpler to write the whole lot off.”

Although Coggan’s metaphor dilutes its impact (after all, some progress has been made since the days when a wife was just an arm of her husband) his point about interest payments is correct. In Britain, interest on these gilts is paid by one part of the public sector, the UK Treasury, to another part of the public sector, the Bank of England, which then returns most of the interest money back to the Treasury. Intriguingly, some of the money- £14 billion at last count- is kept in a special account at the BoE, presumably for use on a rainy day; one could speculate that this might be in the run-up to the next general election. Although the Economist columnist cannot quite bring himself to say it outright, to cancel these state-issued and state-owned bonds would be, aside from simplifying the accounts, merely to give official recognition to the existing state of affairs.

Ideology and perception

But why not make such a simplification, or just make a public acknowledgement that, due to QE, the net national debt is much lower than is is generally supposed? For the top central bankers, and those among the leading politicians who have a grasp of the relevant information, to do so would also be to admit that they have been, effectively, printing money (or have been complicit in doing so) to cover the gap between state expenditure and taxation income.

In mainstream economic doctrine, that is a mortal sin, anathematised as ‘deficit montetization’. Hence this key effect of quantitative easing must be concealed under layers of obfuscation.  Nevertheless, in 2010 and 2011 two officials in the US central banking system, Richard Fisher and Thomas Hoenig, publicly admitted that the USA’s national debt is being ‘monetized’ by means of QE.

In Britain, the Conservative-led coalition government has further motivations. The Conservatives need the perception of a very high national debt which, if it is being controlled, is being controlled by making cuts in state services and welfare. And, for the government’s members and supporters, it would be loathesome to concede that the strategy which has actually been keeping down the UK’s sovereign debt is one that was implemented under the premiership of the reviled Gordon Brown.

For the Tories, the national debt is not the reason for the cuts in the public sector and benefits. Rather, that debt-or, more accurately, the perception of it- is what provides them with the opportunity to make those cuts. Yet the Labour Party, although it lacks the intellectual and political bravery to challenge that perception, now appears as if it might be in with a possibility of winning the next general election.

If so, to what extent will a Labour government reverse the cuts in public services and benefits, or maintain the reduced level of welfare, or carry out further cuts? Public perceptions on the level of the national debt, and the means of controlling it, may have some influence on this question.

5 comments on “The National Debt is £375 Bn Less Than You Think It is

  1. jock mctrousers on said:

    That seemed very good. Certainly very well presented and extremely readable for an economist.

    I think he seems to be saying that the government has inflated away the value of the national debt (?) by printing money, and disguises this as bond ‘purchases’ because they don’t want to admit that’s what they’re doing, nor admit that it was Gordon Brown’s idea, and because ‘the debt’ is a handy excuse for the Tories to rip us off some more.

    I’m not clear from this article whether Marcus Mulholland thinks the ‘national debt’ was really anything to get worked up about in the first place; and he seems sometimes to use ‘national debt’ and ‘deficit’ as if they were interchangeable…

    And lastly the million dollar question:

    ” … to what extent will a Labour government reverse the cuts in public services and benefits, or maintain the reduced level of welfare, or carry out further cuts? Public perceptions on the level of the national debt, and the means of controlling it, may have some influence on this question. ”

    Ed Balls used to be quite vocally skeptical about whether our debt was anything to get worked up about – but he seems to have fallen silent now… Doesn’t augur well.

  2. jock mctrousers,

    No, it doesn’t bode well. What also may be be a concern, if I’m reading this right, is that all that dormant capital will allow private investors to aggressively outcompete publicly-owned providers once the new NHS funding structure and changes get put in place next year. The Condems can then talk of renewed “growth” in private sector investment and a corresponding reduction in public expenditure for those NHS providers who fall by the wayside.Or am I missing something (economics isn’t my strongest suit)?

  3. jock mctrousers on said:

    #2 if you mean what I think you mean, yes, I’m sure a fire-sale of the NHS is part of the plan.

  4. jock mctrousers: I think he seems to be saying that the government has inflated away the value of the national debt (?) by printing money, and disguises this as bond ‘purchases’

    Actually, when the government ‘prints money’ it really does use it to buy government bonds. It’s not exactly the same as the government purchasing bonds directly from itself (which used to happen and is the classic form of ‘deficit monetisation’) – instead, the government sells the bonds to, eg, a bank, and then buys the bonds back again with the specially ‘printed’ money.

    Another way of looking at this is that the government creates money and then lends that money to itself, which of course it does not have to actually pay back, as paying money to yourself is only an accounting excercise.

    So in the final analysis, the government ‘prints money’ and spends it. The inflation is a by-product of the extra money in the economy from doing this.

  5. jock mctrousers on said:

    Now here’s something interesting (note how much interest this topic has generated) – another view of the very same £350 billion in gilt bonds, from the TUC’s blog (there’s more than the exerpt I printed here, all of which adds to my feeling – do any of them really know what’s going on?):

    http://touchstoneblog.org.uk/2012/11/an-incredible-way-to-maintain-credibility-todays-qe-news/

    Today the Treasury and the Bank of England have agreed what sounds like an arcane accounting treatment change but which may have profound political consequences.

    The Bank of England has purchased £375bn of gilts (Government debt) as part of its extraordinary monetary policy to support the economy. The purpose of this was to lower interest rates, not to fund government spending.

    At present we have the somewhat odd situation whereby the Government is borrowing money to pay interest due to the Bank of England own the gilt’s it owns. This situation does not exist in the US or Japan where the fed and the BOJ simply transfer any interest received back to the Treasury/Finance Ministry.

    In an announcement today (accompanied by an exchange of letters between the Chancellor and the Governor) we have been informed that the UK is adopting this approach.

    As a result the Bank will now hand back around £35bn of accumulated cash to the Treasury by March next year and the Treasury will effectively pay no interest on the £375bn of government debt (around one third of the total) held by the BOE as long as QE is in operation.

    Now this impact will only be temporary, eventually the BOE will (or at least currently plans to) sell its gilts back to the private sector at which point the Government will have to resume paying interest on them.