My friend and Green New Deal colleague Larry Elliott had an article in the Guardian last week on what he described as the return of the bond vigilantes.
The article is, I suggest, worth reading, and when commenting here I am going to assume those continuing to read this post will have done so. That prevents me from having to repeat all his arguments.
That said, his main points are:
- Central bank interest rates should be at their peak now given that inflation is falling and economies are clearly heading for a recession.
- Despite that, they are still rising in international financial markets.
- International stress is insufficient to explain this phenomenon.
I would add that the classic indicator of a forthcoming recession - which is the existence of the so-called inverted yield curve, which in plain English means that interest rates on two-year government bonds are illogically higher than those on ten-year bonds - is still being widely seen. This has been a classic indicator of a forthcoming recession for a long time.
Larry's explanation for what is happening is fairly straightforward. It is his suggestion that the chaos is not caused by stress about government funding - although there has never been a time when neoliberal financial markets have not said that governments are overreaching their spending capacity. Instead, he puts the blame for the bizarre situation on quantitative tightening (QT).
As I explain in the glossary to this blog:
QT represents the reversal of the quantitative easing (QE) process. As a consequence, a central bank pursuing a policy of QT will sell back to the financial markets some or all of the bonds that it acquired when undertaking quantitative easing.
QT can be motivated by a desire to:
- Force interest rates upwards. This is done by making more government bonds available to financial markets. That increased availability reduces the price of those bonds. Since the market rate of interest on govermment bond is inversely related to their price since the nominal rate on them is fixed for the duration of their life, forcing the price of these bonds down increases the market rate of interest earned on them. This can be used by a central bank to support a policy that keeps market interest rates above those that the market would otherwise settle upon.
- Reduce spending power in the economy by reducing the supply of government-created money in central bank reserve accounts. As a result QT can be described as an anti-inflationary policy.
- Draw funds away from private sector market-based investments, meaning that QT is likely to reduce growth in GDP.
- Reduce the size of the balance sheet of a central bank, which size is inflated by QE.
As Larry notes, central banks have liked to represent the QT process as a purely technical exercise. They argue it reduces the amount of government-created money in the economy and so reduces the size of their balance sheets. It is also claimed that the process increases the overall date of maturity of government debt. Both arguments are technically right, and simultaneously both disingenuous and dangerous.
That suggestion needs explanation, and I do not apologise for being a bit geeky in what follows.
The first thing to say is that the size of a central bank's balance sheet is almost utterly inconsequential, unless it is too small. All that the size in question indicates is the amount of money that the central bank has created on behalf of the government for whom it acts to support the functioning of the economy for which that government is responsible. Let's be clear: someone has to create that money. It is either the central bank or it is private sector banks that must do this, with the latter achieving this goal by advancing more loans, which increases the amount of private sector debt in the economy in question.
When deciding whether it is the central bank or private sector banks that will create the money the economy needs there are three issues to consider. One is the financial stability of the economy. Governments can always repay their debts in a country like the UK. Private borrowers cannot always do so. The more money the government creates the more stable an economy is likely to be as a result.
Then there is the need for a sufficient money supply to enable the transactions that need to be undertaken within an economy to take place. There is a basic liquidity need that must be met in an economy, not least between the banks themselves. Government must meet this need, and must most especially do so at a time when (as is the case now) private sector lending is likely to be falling because of falling house prices and lower business borrowing in a recessionary environment.
The other factor is managing the profile of supposed government debt, not that I accept that there is any such thing. Government debt his made up of three things:
- Government created money, or base money. This is in turn made up of two parts. One is notes and coins. The other is central bank reserve accounts held by the commercial banks with the Bank of England. Please follow the link on that term for an explanation if you are not familiar with what these are.
- Cash based savings, like funds members of the public hold with NS&I. Yes, owners of Premium Bonds really do just have a stake in the national debt.
- Government bonds. Again, please look at the glossary for more explanation on this issue, but in essence a bond is nothing more than a fixed term deposit account held with the government, usually by pension funds, life assurance companies, banks and others, all of whom are also looking for a safe place to save money.
In other words, the national debt is either money or savings, and nothing else.
There are, admittedly, some twists. Utterly bizarrely the Bank of England pays interest on the money it creates for commercial banks to use when they don't pay interest on notes and coins and those same banks charge interest when they create money for customers. This illogicality could be resolved by simply stopping all or most of that interest payment on central bank created money, which change would not even require a change to the law. And second, government bonds can be bought and sold, unlike most bank deposit accounts, but that doesn't alter the fact that they simply are money held on deposit for a fixed period.
So what is the obsession with the age of debt about? It assumes four things.
One is that people want their debt repaid. The reality is, that they do not. That is why the national debt keeps going up.
Another is that the government won't be able to repay its debt when the fixed term deposits held with it become due. But that's absurd, because the government ultimately regulates the creation of all money in the UK, so of course it can always create the money needed to repay any debt it might owe. That's why we rely on its £85,000 guarantee for our bank savings in commercial banks: we know the government can always pay even when other banks cannot.
And then there is an obsession that issuing new debt may cost more than that which it replaces. Here the assumption is that markets set interest rates and governments do not. This is absurd: we know that rates actually move in line with central bank wishes - as the last two years have proved - so this worry is utterly irrational: if governments want to bring down rates they can.
The final thing that this claim assumes is that the government debt represented by government created money, held by commercial banks in their central bank reserve accounts, is repayable on demand by those banks. This in turn presumes that the banks in question voluntarily deposited these sums with the Bank of England, when, in practice, the sums in question were created for them by the government, over which sum the UK's commercial banks have almost no commercial control, in aggregate.
This suggestion is important, because whilst it is entirely true that commercial banks may use the balances in question to make payment to each other, they cannot in aggregate make any request to the government that the total sum held on such accounts be repaid. Whether or not such repayment takes place is a matter for the government alone to decide, and is determined by the decisions the government alone makes on the scale of the deficit, QE policy, and QT policy, none of which are under the control of the commercial banks.
It is, therefore, actually the case that far from central bank reserve account balances being repayable on demand, as financial commentators suggest, they actually have no fixed repayment date at all, and for all practical purposes can be considered to be of indefinite age, unless the government decides otherwise.
To therefore suggest that it is necessary to undertake QT to reduce the overall age of government debt, so deferring the date on which repayment will take place, is absurd: QT actually achieve the exact opposite outcome by replacing central bank reserve account balances, for which there is no fixed repayment date, with bonds, for which a repayment date must always be fixed as (I think unwisely) we do not allow the issue of non-repayable government bonds, which we once did and could do again.
What to conclude from all this? Four things.
The first is that QT is forcing up interest rates.
The second is that QT is massively increasing the risk of a recession because it is seriously reducing financial stability, contrary to the mandate the Bank of England has to create stability.
Third, if the Bank of England do not know this they are not fit to undertake the task entrusted to them.
Fourth, if they do know this but are doing QT anyway they are also not fit to undertake the task entrusted to them.
In summary: QT need to stop, now. Our financial stability, the decline of inflation and the chance of avoiding recession all depend on it.
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Hi Richard,
A very interesting piece thanks.
On a much less technical note, it does seem bizarre for people to claim that QT is technical/inconsequential. If that were true then logically QE itself would have also been inconsequential!
QE itself may not have worked entirely as intended but it certainly had consequences!
Agreed
To say something is ‘technical’ is basically to say ‘Move on – nothing to see here’ – just ignore it. We are not being invited to think which is just what some people want.
The whole thing you describe above just sounds like a confection of obfuscation, meant to prop up the notion that ‘the Government has no money of its own’ (thank you Margaret Hilda) used as a statue of limitation to let the markets make hay and citizens to be exploited.
The notion though that the private banks are being paid interest on top of a credit facility to cover their mistakes makes me really angry though – as if just to prove the artificial point that Government is borrowing from Goldman Sachs etc., which is not the case.
It kind of sticks in my craw so to speak. Government largesse for the rich; austerity for the rest of us.
Openly known and disseminated, this fact alone has the potential to bring down a Government. An effective opposition party could reek havoc with this.
More’s the pity.
Another side effect of QT (perhaps it is THE intended effect) is that financial institutions will be able to buy gilts at knockdown rates, due to the over supply of them into the private market by the BoE. Which of course means that the yield on those gilts will be artificially high. But, due to the requirements of double entry book keeping, someone must be benefitting from this state of affairs.
Whom might that be? Well private bankers and other financial institutions I would suggest. Those who have just had the limits on their bonuses scrapped by the same government which issued those gilts in the first place.
But that’s just a coincidence, isn’t it?
New debt is not sold at knock down prices
It is sold at high interest rates, maybe
But not knock down prices
Richard…am I right in my understanding that burgeoning private debt directly increases the public debt? Commercial financial institutions can only create loans that attract interest and each and every day we pay £184 million, just shy of £67 billion a year (The Money Charity) in interest. The only source of debt-free money is what the government spends into the economy so the £67 billions must be a direct transfer from the public purse to the financial institutions?
I think your logic is wrong
Government interest paid is an injection of funds into the economy – but clearly not just to financial institutions
I’m not an economist and much of what you write about is pretty hard to follow but if you are right that suggests that all the regular media financial experts, the BoE, Treasury, Chancellor etc are wrong. So most political decisions about what we can afford and how we should pay are based on a falsehood and voted for by people who have no idea what they’re doing.
Yes
But remember QT is uncharted territory and at least I have bothered to think about it
Have they?
QE created lots of money. As i am sure you would agree. We then got inflation – the result of too much money. Which even MMT agrees is possible. Therefore, QT reduces the amount of money, reduces the inflation.
It’s entirely true that MMT suggests increasing taxes in order to reduce the amount of money. Run a bidget surplus (say) and cancel the money that way. But it’s still, at heart, the same thing. Reducing inflation by reducing the amount of money.
“We must stop QT in order to reduce inflation” is simply ignorant.
We did not get inflation because of QE
Note central bankers have not said that
We got inflation because of supply chain disruption after Covid and because of speculation on the impact of war
With respect, the ignorance would appear to be all yours.
I thought QE was first introduced to bail out the bankers in 2008? If you are right that inflation follows QE, why did it wait 13 years? Or is it fairly obvious that we got inflation for completely unrelated reasons?
Can we infer from this that the obsession with government/state debt is in fact part of a deception being peddled by neo-liberal politicians?
I do wonder where, in parliament, the reasoned voice will come from to illuminate this issue. I cannot, certainly at the moment, see the mainstream media being willing to give it air-time.
What I struggle with particularly is that what you are saying is factual, it is not like a government policy designed to change behaviours where there can be competing opinions. So where are the opposing voices? I appreciate that small parties like the Greens might feel that their time, and exposure, might be better spend elsewhere but surely this is at the root of everything. Sort this out and there may be more freedom to invest in a better future.
The problem is with the ‘Q’ in both QE and QT. The policy defines a quantity of either gilt sales or purchases without regard to price. So, during QE we saw 30 year gilts at 0.6% and the BoE still committed to buy.
Conversely they are now committed to sell at any yield.
This is absurd- they should be targeting rates in the real economy.
Agreed
I’ve noted this in the Guardian today as housing investment will be a victim of QT:
https://www.theguardian.com/society/2023/oct/30/councils-in-england-facing-bankruptcy-as-lack-of-housing-pushes-up-costs
The article does not really unpick these issues, tending to stick with the overly simplistic ‘we just need more houses’ narrative in keeping with Labour.
For example it’s obvious that Right to Buy has to stop; the reason why the issue is bankrupting Council’s is because temporary accommodation is paid for out of the General Fund (GF) NOT the Housing Revenue Account (HRA) which if the Council still has one might help; the fact that Councils are not legally allowed to interchange GF and HRA revenues and liabilities in a way that responds to local need – it is after all locally managed money; the way in which brownfield land is underused for redevelopment.
In the private sector – as I’ve said before – rent controls and offering more security to tenants so that they do not become victims of flipping is needed, as is more investment in private sector housing standards and the way housing associations are more likely to evict non-paying tenants than councils whose housing lists will swell.
And Council’s everywhere are still having to demolish un-decent affordable homes – usually crappy system build – from the late 60’s early 70’s. You’d think that was sorted now wouldn’t you? But it’s not. I know because I’m working on one such scheme! Only investment and commitment can make this problem go away.
Labour needs to do a lot more than just rip up the country and build more because all this will do is swell a very badly conceived housing market. Providing more of something without altering how it is managed and distributed now is totally dumb – that is the best I can say of it.
See my post PSR
What are those in charge of global (&BoE) finance health not telling us ?
Could this QT hysteria have anything to do with the acceptance of the ending of oil which has served to be an easy for cover a multitude of stormy economic waters in the past ? If so, it is an infantile knee jerk reaction to the inevitable energy paradigm shift.
Perhaps this is a wee bit off topic, but my obsession with getting our mutual ideas about public money into the political & media domains haunts me. I wrote online to the BBC (maximum 2000 characters allowed – what follows is about 30 or so short of that). Their standard reply is appended.
from me: BBC views on government spending & taxation issues enshrine a completely inaccurate description about how it all really works. There is no awareness of money creation (its introduction INTO circulation via government spending & licensed lending via banks) & destruction (subsequent removal over time FROM circulation via national taxation & loan repayment).
Politicians, Bank of England & all media (inc BBC) perpetuate the completely wrong idea that money for public spending & investment can only be sourced from a limited pot of money based on taxation, always in short supply + has to be borrowed + the absurd claim of “we have no money left”. Nothing could be further from the truth.
And in that one paragraph lies the root cause of decades of under-investment in public infrastructure & services + “Austerity” policy that clearly does not work & definitively CANNOT work. It is reflected in the parliamentary mantras of “where’s the money to come from” + “you are the party of tax & spend” etc. It leads to the ludicrous narrative of National Debt & the asinine concept of “Taxpayers’ Money”. It has also trashed our economy, compounded by the demolition wrecking ball of Brexit.
May I suggest that your reserchers/staff should become acquainted with the work of Professor Richard Murphy, co-founder of the “Green New Deal”, author of “The Joy of Tax” (a book of compelling & relevant content) & take a look at his “Funding the Future” site & blog? He is far from unique in this economics field but his work is a good place to start. Here are just 3 examples of his videos (< 10 mins each) which you can easily find on U-tube
How we make money + There is no such thing as Taxpayers' money + What part of the National Debt would you want to repay?
From JM Keynes: Anything we can actually do, we can afford
& JK Galbraith: The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it.
the BBC reply: Thank you for taking the time to send us your comments. We appreciate all the feedback we receive as it plays an important role in helping to shape our decisions. This is an automated message (sorry that we can’t reply individually) to let you know that we’ve read your comments and will report them overnight to staff across the BBC for them to read too (after removing any personal details). This includes our programme makers, commissioning editors and senior management. Thanks again for contacting the BBC.
BBC Audience Services. NB: Please do not reply to this email. It includes a reference number but comes from an automated account which is not monitored
By way of experiment, I also wrote a similar but longer version to other media & political commentators (some ex BBC), plus a few mayors like Khan, Burnham & Jamie Driscoll. Here's the one I sent to Jamie Driscoll, North Tyneside CA – his office reply is also appended.
from me:
Mr Driscoll,
I was sorry to hear of your fall-out with the Labour leadership for what are demonstrably & self-evidently spurious reasons on their part. Good luck with your re-election. Your work appears to be innovative, imaginative, & effective, even if somewhat hamstrung by the funding antics of central government. [OBVIOUSLY YOU HAVE TO "PERSONALISE" OR "TAILOR" THIS PARAGRAPH TO YOUR ADDRESSEE]
There seems to be, however, a missing element in your work relative to awareness of money creation (introduction of money INTO circulation via government spending & licensed lending via private banks) & destruction (its subsequent removal over time FROM circulation principally via government taxation & private loan/mortgage repayment): if you are indeed already aware of these points, then I apologise in advance. Let's move on.
Politicians, Bank of England (BoE), together with written & broadcast media (inc BBC) perpetuate the completely inaccurate & erroneous idea that money for public spending & investment can only be sourced from a limited pool or pot of money based on taxation, always generally in short supply, &/or has to be borrowed, &/or even the utterly nonsensical notion that "we have no money left". Nothing could be further from the truth.
And in that one paragraph we have the root cause of decades of under-investment in public infrastructure & services, & of "Austerity" policy that not only palpably does not work but CANNOT by definition work. It is reflected in the parliamentary mantras of "where's the money to come from"…"you are the party of tax & spend" etc…….it leads to the ludicrous narrative of erroneously-called National Debt & the equally ludicrous concept of "Taxpayers' Money"…It has also trashed our economy, compounded by the demolition wrecking ball of Brexit.
And in that one paragraph about misinformation, disinformation, culpable ignorance & outright lies, we see the fingerprints of Banking/Corporate Neoliberalism.
That's enough for now I think. May I suggest in the meantime that you acquaint yourself with the work of Richard Murphy, co-founder of the "Green New Deal", author of "The Joy of Tax" (the book content is compelling & relevant) & take a look at his "Funding the Future" site & blog? Here are 3 of his sample videos from U-tube, circa 10 mins each. Please take a look. Above all pass this on to all of your colleagues in the North Tyneside Combined Authority.
What part of the National Debt would you want to repay? + There is no such thing as Taxpayers' money + How we make money
From JM Keynes: "Anything we can actually do, we can afford"
From JK Galbraith: "The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it."
Jamie Driscoll's office reply: Hi Alan, Thank you for getting in touch. I'm a member of Jamie's team. The information you have shared is very interesting. I've passed it on to Jamie. Many thanks, Val Jamieson, JD Campaign Team
Would your followers be prepared to write on line to the BBC for starters in a similar vein? By all means use my version or a variant of it or indeed your readers' own individual version. Perhaps Richard you might want to adapt/change it to suggest what might be used as a common thread.
My idea is that if this can be done in very large numbers, we MIGHT be able to get the BBC to sit up & take notice.
Who knows? I (we?) live in hope.
Alan – might you format this in a Word document I can then put on the blog where it would be easier to follow?
My contact details or on the blog.