Britain has taken another step down the road to hyperinflation
John Stepek Nov 12, 2012
Wouldn’t it be great if your mortgage lender made a snap decision one day to stop charging you interest on your home loan?
You’d think Christmas had come early.
Better yet, imagine if your bank manager then decided that it also made sense to give you back all the interest you’d paid on your mortgage so far.
That would make budgeting for the next few years a lot easier. You might even feel inspired to splash out on a few unexpected treats.
Of course, this sort of improbable windfall is a complete fantasy for any normal person. But not for the chancellor of the UK, George Osborne.
Because this is exactly what Sir Mervyn King, the nation’s bank manager, has just done for him…
The government’s tasty £35bn windfall
As a result of quantitative easing (QE), the UK government owes the Bank of England a lot of money.
Since March 2009, the Bank has printed enough money to buy up around a quarter of the government’s total outstanding debt. It now holds £375bn in British government IOUs, (also known as gilts).
So what’s it been doing with the interest payments on that debt? Nothing really. Up until now, the money has just been sitting in a bank account (called the ‘Asset Purchase Facility’, or APF). By March next year, the Bank will have racked up £35bn in interest payments.
Or rather, it would have, if the government hadn’t just snatched the lot.
The way George Osborne sees it, it’s stupid (or ‘economically inefficient’) for the Treasury to pay interest to the Bank of England. After all, it means the government has to borrow more money to do so.
The argument goes that the taxpayer stands behind the APF. So the government will have to make up for any losses the Bank of England incurs when it eventually sells its gilts (or it would get any profits, if there were any).
So rather than pay interest on the loans today, it makes more sense to use that money now to reduce the overall debt.
As Jeremy Warner describes it in The Telegraph, the current system is “a bit like the government taking out an overdraft to pay money into a savings account – not very sensible given that you pay a lot for the overdraft but get virtually nothing back from the savings account.”
And it only brings the UK in line with the other money-printing nations. The US and Japan do it like this already.
So – all you Weimar Republic scaremongers out there – what’s the big deal?
This is money printing to benefit the government, not the economy
Well, let me explain.
The point of QE – we’re told – is to get more money flowing around the economy somehow, and so prevent deflation. Whether you agree with that end goal or not is by the by. The point is, it’s just an extension of what the Bank of England tries to do with interest rates.
The Bank is swapping gilts for cash to clear a blockage, if you will. Gilts just happen to be the most sensible asset to buy. At some point in the future, when monetary policy tightens, the Bank will sell the gilts again.
What the Bank is explicitly NOT doing – we’re told – is writing the government a blank cheque to spend as it pleases. It’s not the Bank’s job to make it easier for the government to borrow money and repay its debts.
To use the jargon, monetary policy and fiscal policy have been kept separate.
There’s a good reason for that: if the Bank was simply printing money to fund future government spending, that would really be the road to Weimer or Harare.
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We’re at the start of a very slippery slope
The Treasury is trying to make out that this is still the case. The taxpayer stands behind the APF. If the Bank of England makes a loss on these gilts in the future, the government will have to make it good. So it’s just shuffling money around in a pot that it’s going to be responsible for in the end anyway.
But there’s a problem here. Firstly, the Bank of England didn’t make this decision, the Treasury did. So it shows that the idea that the Bank is independent of the government, and so acting as a responsible guardian of our currency, is a complete fiction.
Secondly, this is very convenient for Osborne. Having an extra £35bn will make it that bit easier to hit his targets for reducing Britain’s national debt. He still may not hit his target, but it’s going to be slightly less embarrassing when he delivers his autumn statement next month.
It’s clear that this government learned a great deal from Gordon Brown. Loudly set yourself important-sounding targets, then use underhanded accounting trickery when it looks as though you’ll fail to meet them.
Thirdly, the move is the same as doing more QE, as Mervyn King acknowledges. The private sector will hold fewer gilts and more cash as a result of these deals. So the Bank is effectively printing more money. But this time, it’s at the orders of the Treasury, not the bank’s rate-setting committee.
As Jens Larsen of RBC Capital Markets points out, “the fact is that these transactions will have a clear impact on debt and deficit, and materially impact the government’s debt management policy… it conflates monetary, fiscal and debt management policies.”
In other words, this move takes some pressure off the government’s efforts to cut the debt, and it’s driven by the Treasury. It’s money-printing done to benefit the government’s finances, not the economy.
You can’t trust the government to repay debts it can write off instead
More importantly, do you really believe the government will ever pay this money back? Of course it won’t.
If the APF makes a loss in the future, the government will just write it off. Who’s going to complain? Will the Bank of England call in the bailiffs? Of course not.
This is no accounting shuffle – it’s monetising the deficit, pure and simple.
It’s the start of a slippery slope. What’s the next step? Given the recent talk of cancelling the gilts the Bank of England owns altogether (‘helicopter money’), I’ll be interested to see what happens next year to the Bank’s current holdings as they mature.
You’d assume they’d roll it over – buy more gilts with the proceeds. But what if the government decides it could use that cash more wisely too? The Treasury could just pretend to add that to its tab at the Bank of England.
The yield on gilts fell on the news (ie prices rose) because there will be fewer of them around. But we suspect the pound’s reaction, when all this sinks in, won’t be at all positive.
We suggested last month that sterling is in for tougher times, since when it has fallen below $1.60. This seems likely to continue. And it still seems a very good idea to us to have gold in your portfolio. We’ll be looking at the implications of all this in more detail in the next issue of MoneyWeek magazine, out on Friday. If you're not already a subscriber, get your first three copies free here.
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