Ritchie on the National Debt

My, this is interesting.

Essentially, we don\’t have a girt big national debt because we can just ignore 20-30% of it.

However, it should be noted that the government has done something else at least as significant. Through the quantitative easing programme the Bank of England has repurchased or will be soon repurchasing near enough £275 billion of that debt (I’ve shown the last £75 billion as happening in Q3 of 2011 as that’s near enough when it was authorised).

Now the Bank of England is owned by the UK government so if, in accounting terms, a consolidated set of accounts were to be prepared the £275bn owed by the Treasury to the Bank of England would simply be crossed out, or ignored. The actual debt would only be £725 billion.

In static terms we could look at it this way, yes. BoE has printed money to buy gilts, that is what QE is. However, static ain\’t quite the way to look at it, dynamic is.

It’s all a matter of getting the story right and on this occasion it takes an accountant to do that.

That\’s where the problem is, yes. The national debt isn\’t quite as amenable to an accountant\’s take on it as the accountant thinks.

Nor is there any hint now of this QE causing inflation, all of which can safely be said to have had other causes, not least because as Government accounts also show, the M3 measure of money supply has fallen steadily since 2009, meaning there is no prospect of inflation in the future either as a consequence of this process.

It\’s here that we start to get into those problems. QE doesn\’t impact directly upon M3. Only indirectly. Now I get as lost as everyone else in these Ms, M0, M3 etc.

But roughly speaking the relationship is that M0 is what the BoE has been creating to buy the gilts. This is money if you like, printing the stuff (or calling it into existence on a computer). M3 is what the money supply is after we\’ve gone through the mulitplying effect of fractional reserve banking. You know, all that \”banks create credit for nothing\” stuff.

Which gives us something of a problem. Imagine, if you will, that the banking system starts to lend again. You know, like all of those plans that Ritchie has to make them lend again? So, that multiplier between M0 and M3 goes back to something like historic levels. At which time we do get inflation, because we\’ve got a lot more M0 to be multiplied into M3.

Which means, of course, that the BoE now needs to sell those gilts and cancel the money creation so as to reduce M0 and thus not have inflation.

Just to reiterate, it\’s true that M3 ain\’t surging: but as soon as the banking system is sorted out it will which is why we need to reverse QE when the banking system is sorted out.

So, we can indeed look at it in the static terms that Ritchie uses but we shouldn\’t. For the whole thing must be looked at in dynamic terms, not static.

This is the mistake he makes about Green QE as well: he misses that the whole point of QE is monetary and also needs to be reversible. Getting the BoE to print up £200 billion to go spend on real things doesn\’t have the same effect at all: we end up increasing M3 by whatever is the, currently low agreed, multiplier to M3.

As I said above, I can, like most, get lost in those M0 and M3 things. But even if I\’ve got the precise definitions of the monetary aggregates wrong the basic argument is still true. QE creates base money, base money is multiplied by the banking system. That mulitplier is currently low as a result of the credit crunch (low multiplier equals credit crunch in fact) and when the multiplier returns to normal we have to reverse the base money creation thing.

So while the BoE does currently own said debt it won\’t forever.

And then this, which is simply quite lovely:

And in this case that would be absolutely the right point of view. There is no hope at all that this debt will ever be sold back into the markets: there’s enough new debt to sell to meet all market demand for UK debt without ever re-selling this stuff.

Do you see what he\’s said there? We\’re already going to be issuing all the debt the market wants. On current plans. Which means that the borrow to do stimulus to get out of recession plan won\’t work, will it? Because that would mean issuing more debt: more debt which, as Ritchie says, would be more debt than the market wants. Which would mean that if that more debt (to do the stimulus which Ritchie says we should do) were issued then the price of the debt would fall, yields rise and we\’d find any nascent recovery being chocked off by higher interest rates.

Isn\’t that lovely? Part of Ritchie\’s proof that we\’re not in as much debt as we thought is the proof that we cannot issue any more debt than we already are?


Might be why we have bankers not accountants running Central Banks really.

14 comments on “Ritchie on the National Debt

  1. M3 has not been used as a measure of broad money in the UK for a decade or two, it’s M4 now, and really, “M4ex”. Even when M3 was used, the correct name was “£M3”. Just sayin’.

    He is kind of right, though. In an accounting sense, gilts owned by the BOE should not show up as part of the national debt. But you are right that case will not remain true forever.

    If you want to go all “accountant” on the state of government debt, then you should look at HM Treasury’s Whole of Government Accounts, which showed up a net liability of £1.2tn even at March 2010, mostly because of pension liabilities. So he is more wrong than he is right.

  2. “No hint of QE causing inflation”.

    He doesn’t go to the shops very often does he?

    Possibly just to the chemist to get his anti-psychotics.

  3. Notice he didn’t say that sometimes you need a marginally comptent accountant to figure things out? The omission is significant.

  4. It’s debatable. If and when M3 surges, they’ll have to to bring the resulting inflation down. That’s what open market operations are for, to control the money supply.

  5. A “surge” in M4 is not a problem per se, in fact, growing broad money it would be seen as a return to normality.

    If UK *demand* (spending, NGDP) surges and this results merely in rising prices, rather than rising output, that would be a problem. If (when) that happens they will probably first raise interest rates and later start selling gilts. The duration of the APF portfolio is quite long; if we never do reach the state where they need to sell down the gilts we are seriously fucked.

    At the moment we have rising prices without fast-rising demand, which is a problem but not one the BOE can (should) do much about.

  6. Tim, that was a great exposition of the money system and should be compulsory reading.

    Incidentally, I attempted a reductio as absurdum elsewhere, suggesting that QE could be used to extinguish the entire national debt, attain a quadruple A credit rating and use that to fund all the state’s unfunded liabilities. Unfortunately, several people took me seriously. Sigh.

  7. Asset purchases cannot be regarded as debt monetization as RM suggests. They are on the BoE’s balance sheet – segregated (so not in circulation) but not redeemed. As Tim says, if the gilts are not sold when the economy returns to growth, there will inevitably be inflation. Cynics above please note.

  8. Since the money supply has been mentioned, I think it is worth also mentioning that none of the various measures (M0…Mx) are the actual money supply, as in the famous MV=PQ equation.

    M in that equation isn’t the money available, it is the money which actually participates in transactions during a GDP cycle. That’s why attempts to calcuate V come out with absurdly low values between 1 and 2. Because most of the M3 (or Mx) isn’t transacting, and in fact it cannot all possibly transact at once for “bank run” reasons.

    This is one reason that inflation is so intrinsically unpredictable.

  9. if the gilts aren’t sold “when the economy returns to growth, there will inevitably be inflation. Cynics above please note”.

    The desirability of inflation for the govt is why we’re so cynical.

  10. Let’s put it this way – reductio ad absurdam:

    If we don’t need to count the 20% or so held by the BoE, it must mean that we have a magic way to find infinite resources – if the BoE bought all the government debt and using consolidation, it doesnt count, the government has NO debt. Wow. Amazing, call Merv and ask him to buy the remaining government debt immediately. No need for any cuts. Hell, we can spend money on new Ferrris for everyone and we can all live in huge mansions paid for by government debt held by the BoE. Hurrah!

  11. Oh, and I might as well point out that this is a rubbish consolidation anyway. It only consolidates BoE assets, not liabilities. The associated BoE liability is of course the expansion of base money that funded the asset purchases. There is no matching financial asset on the government side. On consolidation, therefore, the Treasury would acquire a large cash liability that exactly matches the amount of debt consolidated out of existence. Funny, that.

  12. Frances – Yes, but a cash liability doesn’t have to be repaid?

    Ken – I don’t think anyone’s saying it magically means Ferraris for everyone. It just helps reduce the debt burden for some at the expense of the asset value of others.

  13. Matthew,

    The “cash” liability is actually 6-month Treasury bills, so yes, it does have to be repaid or rolled over – in fact rather sooner than the gilts.

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