Gary Stevenson – 25 Oct 2020

Recently I was asked to speak on LBC about the subject of the government debt.

As most people know, the government has had to spend a huge amount of money to help people and businesses who have been struggling during the Covid-19 epidemic.  This has led to a big increase in government debt this year, which has now gone above 100% of GDP for the first time since the 1960’s.

This has understandably led to a lot of concern, and many people are asking the questions that Tom Swarbrick asked me on LBC:  “How and when are we going to pay this debt back?”, “Are we saddling the next generation with unpayable bills?”

On the show, I explained that the new government debts are very unusual.  Unlike normal government debt, which is borrowed from pension funds, wealthy individuals and foreign countries, the new debt this year is being borrowed from the Bank of England.  The Bank of England is itself a government institution, so, in a very real sense, the government is borrowing this money… from itself.  To make things even more confusing, the Bank of England is getting this money…. also from itself, since the Bank of England is able and legally allowed to create its own money.  Since the government is borrowing the money from itself, and also creating it itself, it does not have to worry about paying it back.

This is confusing, and understandably I have received a lot of questions on social media from LBC listeners about it.  It is an important subject to understand I think, so I wanted to write this short piece to help people understand what is happening.

Where does money come from?

I think that for many people the most confusing part of this is that the money is ultimately being created by the Bank of England.  Ordinary people are obviously not able or allowed to “create” money, so this concept can seem very strange and alien to them.

The fact is, money has to originate somewhere.  Someone has to be able to make it, or it wouldn’t exist.  In this country, that responsibility is given to the Bank of England.  They have the legal right to create money, and in fact they are constantly creating new money every single month.  That is a key central fact about how our monetary system works.  There is a panel of economists, known as the “Monetary Policy Committee” (MPC), who work at the Bank of England, and each month they discuss and decide how much new money to create each month.

How can the government borrow money from itself?

Saying that the government borrows money “from itself” is a bit of a simplification.  The Bank of England is a government institution, but it is officially independent from central government.  There are many rules governing how the Bank of England can act, and, among them, is a rule that the Bank cannot simply give money to the government.  Under normal circumstances, the Bank of England does not lend money to the government either, but after 2008, the decision was made by the MPC (the bank’s panel of economists) to start lending money to the government, in an attempt to “stimulate” the weak economy.

Ever since then the Bank of England has been lending significant amounts of printed money to the government at very low interest rates.  The UK is not at all unique in doing this.  The national banks in Europe and the USA have been doing the same thing, and the Bank of Japan has actually been doing it since the 1990’s.

What does this mean about the borrowing?

The most significant implication of the fact that this government borrowing is printed money, borrowed from the Bank of England is, like I said on LBC, that the government does not have to pay this money back.

This, too, is a bit of a simplification.  Technically, these loans have end dates upon which these loans have to be paid back, from the government to the Bank of England.   But these loans have been happening since 2009 now in the UK, Europe and the USA, and since the 1990’s in Japan, and, so far, every single time these loans have started to reach maturity, the central banks have chosen to extend the loans.  In fact, not only have the central banks extended the loans, but they have actually chose to increase the loan amounts and decrease the interest rates charged.  It is an open secret amongst traders and economists that these loans will be extended indefinitely.

On the subject of interest, these loans do, technically, have interest payable.  However, since the UK government owns the Bank of England, the Bank of England returns any profit it makes to the UK government.  This means that the interest goes from the government, to the Bank of England, and back to the government again.  That means that these loans are, essentially, interest free.  Not only that, but the government pays the same rate of interest to the Bank of England as it does to private investors.  By making loans at such low interest rates to the government in this way, the amount of interest that the UK government has to pay to its private investors also falls.

OK, great, so why don’t we do this all the time then?

From what I’ve written so far, you might think that this strategy of printing money and borrowing it from yourself sounds fantastic.  It means the government can spend a lot of money, like it has done throughout Covid so far, and nobody, ever, has to pay for it.  That sounds like an amazing free lunch, so why don’t we do it more?

The answer to that is, there are a lot of problems that can come with this strategy, they are simply different problems from the classic “how do we pay it back?” problem.

When the government prints money and spends it into society, it increases the total amount of money in society.  It is different from tax and spending, where taxpayers lose money and other people gain money, or borrowing and spending, where borrowers lose money and other people gain money.  When you print and spend you push money into society with no-one losing money.  That means the total amount of money in society increases.

We can clearly see this increase in money in the data – richer and higher income people are really rapidly increasing the amount of money that they are storing in their bank accounts.  This is because richer people usually have very high spending, on things like holidays, hospitality and restaurants, that they have been unable to access during the covid lockdowns, so they are saving the money instead.  Poorer and more ordinary people, however, have not saved that much money, since their luxury spending in normal times is very low.  Not only that, but the jobs which have been lost have been mostly lower paid jobs.

This means that the increased money in society is causing a big inequality problem – richer people are benefiting massively from the newly printed money, stacking it up in their bank accounts.  Poorer people are not benefiting at all.

What does that mean?

As long as the richer people are happy to keep the money in their bank accounts, ordinary and poorer people will not be affected.  It does not hurt me if you have more cash and I don’t.  The problem will come when those people start spending that money.  So far in the crisis, many people are sensibly holding onto the cash because they are worried about the crisis and don’t know what is round the corner.  But when the crisis passes, that money will still be there.  At that point richer people will be likely to spend that money.  Some of that spending may be on things like restaurants and holidays, which may push up the prices of those things, but much will be on investments such as housing, which could lead to a really big rise in house prices, which we are already starting to see now.  That is why I predicted a big house price rise, right at the beginning of this crisis in April.

Ultimately the problem will be inflation, which may come in regular prices, but is more likely to come in house prices.  That will be ok for the richer people who have accumulated enough money to afford higher prices, but it is going to be a big problem for ordinary people, especially young people from poorer families who were already finding it very difficult to buy housing.

We must ask the right questions

Ultimately, “how will we pay the debt back” is asking the wrong question.  Everybody in financial markets is aware now that this debt will never be paid back, and will never have to be.  It is new money, created by the Bank of England and lent, permanently to the government.  Paying it back will never be a problem because it will never happen.  That is an open secret amongst economists and traders now.  Everybody knows it.

But that does not mean we don’t have a problem here.  The printed money is going to cause a crisis in inequality and home affordability that is already starting.  That will keep many families locked out of the housing market for generations. That is the real question that we, as a society, must face.