An interesting question for the Senior Lecturer

That said, this means that government bonds are an asset with very low inherent risk. As a consequence, gilts have the lowest interest rate paid in any market. Despite this they still have great appeal to pension fund trustees and insurance companies, both of which have an obligation to settle liabilities far into the future.

Despite isn’t the right word there, because might be. Assuming we leave aside the regulatory insistence that they hold gilts that is, a form of financial repression.

In particular, companies seeking to place millions and even billions of pounds on deposit overnight seek security for their cash. They achieve this security not by placing the funds in bank accounts, but by temporarily purchasing government bonds from banks. These they then sell back to government the following morning at a very marginally higher price to cover the interest earned. This is called the ‘repo’ market.

Repo involves purchasing from banks and selling back to the government, does it? Blimey, the things you find out in a policy briefing.

A growing economy requires general price increases, or inflation.

It does? Or perhaps this is to misunderstand the point, which is that a tad of inflation eases the relative price changes that come about from a growing economy. Need therefore being the wrong word.

Except under unusual circumstances, a general increase in prices requires an increasing money supply.

Not really, no.

A fiscal deficit is the only way in which money can be injected into an economy continuously.

Nope.

It follows that governments must run a near perpetual deficit or face the risk of creating a liquidity crisis due to a shortage in the money supply, which would then create a risk of deflation.

Sigh.

And now the set up for our question:

A government can never default on a bond that it issues in its own currency because it can always instruct its central bank to create the money required to make repayment of a bond when redemption is due. As a consequence the owners of gilts have an absolute guarantee that their funds are safe. This is fundamental to the financial security of an economy.

If you bought a consol in 1945, just to give a date, then held it until Osborne bought them in a couple of years back, were your funds safe?

Show your workings and define your terms.

My own intuition, without looking anything up, is that you might have got back a thruppeny bit on your £. As capital that is, not going to try and headwork the interest received….

39 comments on “An interesting question for the Senior Lecturer

  1. From memory, Consols carried 2 1/2%. As Government paper issued immediate post war tended towards 3% upward, a tad more than 3d.
    Monday pendantry.

  2. “Except under unusual circumstances, a general increase in prices requires an increasing money supply.”

    He means is caused by not requires.

  3. “A growing economy requires general price increases, or inflation.”
    Living in East Anglia, one supposes it’s possible that the knowledge the rest of the country had an industrial revolution might pass one by…

  4. “A fiscal deficit is the only way in which money can be injected into an economy continuously.”

    I read the other day that Germany’s budget surplus has recently hit a record high. One assumes that this means Germany is a barren wasteland, devoid of all economic activity, populated by the living dead alone?

  5. My favourite bit where the Spud is not even wrong:

    Tax fulfils two goals in this process. First, it controls inflation, and this role is now seen by many as the primary purpose of taxation. Second, in effect the government endorses the value of its own currency by requiring that tax be paid making use of that money it creates.

    Just who are these people who believe that the primary purpose of tax is to control inflation? And how does setting tax rates for a year or so in the future operate as this control?

  6. It is as if history never happened. The Weimar inflation has passed by without leaving a mark on Ely, therefore there never was hyperinflation in Germany, with money losing its value over the course of hours

  7. Diogenes

    Just who are these people who believe that the primary purpose of tax is to control inflation?

    Isn’t that the MMT fruitcakes?

  8. Simply in that it’s consistent with other MMT type bollocks about fiscal deficits being good because the other side of the coin represents savings.

  9. So The Egregious Tuber™ doesn’t know the difference between the repo market and the overnight market? In repo it’s the banks buying the bonds, not companies. Repo is not necessarily overnight (most US is, most Euro is not). And I wonder if he has even the foggiest idea why we want a repo market? It’s not primarily for security of overnight deposits, for god’s sake. It’s good for securely stashing liquid assets, yes, but also for, inter alia, increasing liquidity, hedging, broadening and funding and stabilising the money market, lowering yield volatility, and as a way for central banks to communicate monetary policy decisions to the broader economy. It’s also one of the ways banks actually do bail-outs rather than Spud’s fantasy of firing up the printing presses.

    Christ, I don’t even work in finance and I know this.

  10. PF if that is really what the MMT people think then it suggests that macroeconomic theorists ought to be locked in padded cells for everybody’s safety including their own. It is a bit like driving a car by remote control from an underground bunker while blindfolded. What sort of clown seriously thinks that inflation can be controlled in any meaningful way by adjusting tax rates and allowances? It might be a way of bringing an upsurge of inflation under control but that is about all it can do. It’s beyond most of us to regulate our household budget while guessing how much we will earn next year and how much tax will be incurred in all its forms. Apart, that is, from Captain Potato

  11. A government can never default on a bond that it issues in its own currency because it can always instruct its central bank to create the money required to make repayment of a bond when redemption is due. As a consequence the owners of gilts have an absolute guarantee that their funds are safe.

    Haha. Don’t worry, we can always pay you back in worthless, devalued currency. This is supposed to make the bondholders feel more secure?

  12. “Christ, I don’t even work in finance and I know this.”

    I don’t work in finance but had a rough idea that I wanted to confirm so I double-clicked the word (press and hold on iPad if I’m using that) and used the context sensitive menu to search. Less than five minutes later I’ve a better understanding than the fake prof seems to have. Amazing thing this Internet, someone should introduce the WGCE to it.

  13. A government can never default on a bond that it issues in its own currency because it can always instruct its central bank to create the money required to make repayment of a bond when redemption is due.

    Purely in terms of logic this is wrong. A government has the option of choosing to default.

    The battle that Varoufakis had and lost was a variant on this theme only that instead of printing money the choice for Greece was accepting a refinancing from the EU with all the onerous concomitant strings as opposed to defaulting on a tranche of deby falling due.

  14. And as defaulting was a worse option the government went with refinancing with strings.
    Maybe another election will get a different more popular government in and Greece can try living solely from its own money for a while.

  15. So HMRC collected around £4bn more than expected in January. Does this mean that the inflation outlook has changed at all? If tax is there to control inflation then surely this means that there is a reduced risk of inflation now and action should be taken…. Or is this another piece of spudnomics bullshit?

  16. Diogenes,

    Its asymmetric like Keynesian economics. The left are only interested in the bits of Keynes that says spend, never the bit that says save.

  17. Imagine a theory that worked climate science, macro economics and envy together. The macro theory of Dillow and Spud. They have the intellectual backing of Bob Ward, so maybe they are not as stupid as they seem

  18. “A growing economy requires general price increases, or inflation.”

    An egregious and economically iliterate statement.Why would producing more goods and services i.e. making them less scarce, result in an increase in the price level?

  19. A government can never default on a bond that it issues in its own currency because it can always instruct its central bank to create the money required to make repayment of a bond when redemption is due. As a consequence the owners of gilts have an absolute guarantee that their funds are safe. This is fundamental to the financial security of an economy.

    Wonderful. If he really does believe that I will be amazed.

    It’s odd though that if tax is there mainly to control inflation that he never calls for LESS tax

    Good point, especially as he is on record as wanting more inflation last year. So he wanted MOAR inflation and MOAR tax.

    Could it be that even the only believer in The Tuber Theory of Everything doesn’t believe it either?

  20. I don’t understand (and he has never explained) how tax is the primary weapon against inflation. Which taxes? How do you tax the people who have acquired most of the increase in the money supply and not tax the people who haven’t?

    If most of the increase in the money supply ends up in a property bubble (in the UK? NEVER!) how does a 5p in the pound income tax rise deal with that?

  21. BiND – “Amazing thing this Internet, someone should introduce the WGCE to it.”

    I beg to differ. He should never have been alerted to its existence.

  22. OT: Tim did you see the Tatler interview with our old friend James Stunt? Haven’t seen the original but some choice quotes in the Mail.

  23. The record of government defaults on bonds issued in their own currency is longer than my arm. The famous crisis caused by LTCM was triggered by a Russian default on bonds it had issued.

  24. @jgh Many countries have defaulted on their debts. There is an international market in highly distressed government debts traded at substantial discounts to their face values.

  25. The countries that have defaulted have defaulted on foreign currency debt, or are there exceptions to this?

  26. Yes countries do default on local currency debt, although it’s not as common as FX debt (which is surprisingly common!).

    Some examples:

    https://mobile.reuters.com/article/amp/idUSFit65645620130510

    There are a few reasons it might happen but don’t have time to type it out just now.

    Of course debasing the currency to monetise debt (and thereby paying back much less in real value terms) is just another strategy for defaulting.

  27. When do we get the blog back Tim?

    The “Forbes-as-a-weekly-freesheet” that you are spending all your time on isn’t cutting it.

  28. We’ll be back when Forbes as a freesheet is established and making a contribution to my living.

    We’re not a week in yet and revenue is £15 a day. Only an order of magnitude increase in traffic required therefore…..

  29. I am not clear on Internet commerce. You only seem to have one advert on the CT-the “Ready for Retirement?” one. Is it people clicking on that that gets the money? Cos I’ll go and click on it if that helps.

  30. TMB ;’The countries that have defaulted have defaulted on foreign currency debt, or are there exceptions to this?’

    Plenty of local currency defaults, because either the government wants to avoid the level of inflation needed and would rather take a holiday on its debt payments, or alternatively because of cross default provisions connected to foreign currency borrowings.

  31. I don’t have Adblocker but I still see only another half dozen little 2/3 line ads for financial stuff.

    I don’t know much about computers. Weaponising them against the left would be worth doing perhaps. And if you can even £15 a day for the CT I should find out more.

  32. @BiCR. Nice summary of repo. Very good for non market pro. Extra words you can throw in to look expert are “going special” and “remember 2016 year end rates”.

    Special has nothing to do with special needs. Much.

    I am continually amazed how, in all walks of life, people with limited or no knowledge but lots of confidence can get by and actually get paid. As a professional sceptic I am always worried there’s something I don’t know yet. There are left and right wing fact-free zones but I bet more on the sinister side.

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