UK Sectoral balances and private debt levels - Q2 2011

Q2 Figures are out.

The external sector is pretty much balanced this quarter, which means that the government sector deficit is entirely down to domestic private sector saving desires..

Interesting reduction in private non-financial savings, down to capital formation according to ONS. Are private companies really investing? Or is this just a dangerous run up in inventories?

Private debt stays at 455% of GDP overall. The amount paid off by households and private companies has been lent out again within the financial sector.

Source: Office of National Statistics, tables RPZD, RPYN, RQAW, RPZT, RQCH, DJDS (Seasonally adjusted Net Lending/Borrowing per sector plus residual error) and YBHA (Gross domestic product at market prices, seasonally adjusted). Private sector debt based on tables J8XI, NLBC, NKZA, NNQC, NNRE, NNXI, NNXM, NNWK, J8XK, NLSY, NLUA, J8XM, NJCS, and NJBQ (Lending, securites and derivatives per sector) scaled by YBHA.

QE in the UK and the value of Sterling

No doubt on message boards across the globe you've encountered the Pavlov Dog response to any mention of Quantitative Easing. Here's a typical line of nonsense.

Personally, with further QE in the system and the possibility of further monetary stimulus we could see further devaluation

It all gets a bit irritating particularly when the reality is so easy to determine via the excellent Oanda historical forex prices site - which neatly shows the rate movements in percentage terms.

Here's the GBP rate during the initial Asset Purchase period (11 Mar 2009 to 26 Jan 2010) when according to the know-all wags and their money multiplier fantasies there were billions of new pounds desperate to flee the country.

GBP Forex % change during initial Asset Purchase period 11 Mar 2009 to 26 Jan 2010

Well that didn't fit the script did it. The value of the Pound rising against three major currencies during a period of 'monetary expansion'.

Even more amusing is what happens after the Asset Purchase programme was suspended.

GBP Forex % change during Asset Purchase suspended period 27 Jan 2010 to 6th Oct 2011

So no real change against our major trading partners and a substantial decline against the Yen. And that despite promises of Austerity, cut backs in public spending and a change of government. Surely that foreign investment should have been flooding in?

Clearly the foreign exchange relationship is much more complicated than simply interest rates and quantities of financial assets. There is a whole host of variables here defining a dynamic relationship that defies simple gut reaction analysis. It's complicated.

There is no evidence that the Asset Purchase function has caused any devaluation of Sterling. Another myth to file in the 'Neat, Plausible and Wrong' category.

QE design in the UK - where Fiscal and Monetary Policy collide

When is Fiscal Policy not Fiscal Policy? When the Bank of England decides to label it Monetary Policy by the look of it.

I've been looking into the accounts of the Bank of England Asset Purchase Facility Fund Ltd (BEAPFF), which is the vehicle by which the Bank of England is buying Government Gilts and Corporate Bonds so that it can be 'seen to be doing something' (as much it can see with ideological blinkers on). It's an interesting corporate setup as its effectively operates much like a trust fund.

The Bank of England is the nominal shareholder but has no financial stake in the profit or loss of the firm. As can be seen from the annual report:

...HM Treasury has indemnified the Company against any losses it may incur in connection with its operations. Any surplus from these operations after the deduction of fees, and any tax payable is due to HM Treasury...

...In view of the Indemnity from HM Treasury, the Company requires only nominal capital...

...The Company’s operations are fully indemnified for loss by HM Treasury, and any surplus for these operations after deduction of fees, operating costs and any tax payable are due to HM Treasury. As such, the Company is not exposed to financial risk, but manages credit risk and monitors market risk on HM Treasury’s behalf. The Company does not face liquidity risk...

The Bank supplies the personnel to run the company and charges fees for doing so. And the activities that it undertakes for monetary policy purposes (ie buying assets) are fully released as statistics under the 'Asset Purchase Facility' section of their site. And that is close to the previous £200bn limit (now £275bn).

Even the time series of the Gilts purchased are available. And what this tells you is that in the initial phase of QE (before they started buying again on the 10th October 2011), BEAPFF bought £177.735bn nominal of bonds for £198.275bn Sterling with an annual income of £8.676bn (2.3% of GDP, or half last year's growth).

Remember that gilt income paid to BEAPFF is government spending - fiscal policy at work. It's fairly simple to work out from the purchase spreadsheet that since QE1 started BEAPFF has (to date - 16th October 2011) received £19.850bn in gilt interest.

Theoretically the excess of that interest should be returned to HM Treasury. Otherwise, due to the matched funding nonsense, the Debt Management Office (who manage the cash stream for HM Treasury) will end up issuing more gilts than it needs to. That will draw down Bank Reserves and end up reversing the effects of the Asset Purchase operations (more gilt supply and the yields creep back up).

Yet when you look at the annual report of BEAPFF you see a very large cash balance and a very large indemnity owing to HM Treasury (£9.8 bn in February, or 2.6% of GDP). So I thought I'd ask them for the cash balance to date and what mechanism they had in place to return the surplus to HM Treasury. After all government spending and government funding is generally seen as Fiscal Policy. To which, after four weeks of waiting, I received this reply stating it was covered by the 'monetary policy' exemption the bank has to information requests.

So there you have it from the horse's mouth. The UK Fiscal Authority is issuing extra gilts draining the extra bank reserves put in place by the Bank of England so that it can give it back to the same bit of the Bank of England. HM Treasury is funding the Bank of England with the Bank's own money. Fiscal Policy as Monetary Policy. You couldn't make it up.

So the next time somebody whinges about the £140bn or so annual deficit, you can let them know that about 5% of that is down to the left hand not knowing what the right is doing. (Or is that the right not knowing what the left hand is doing...).

Of course this was all just confirmation. It's fairly easy to estimate what the value of the cash account is and the relentless decline in Bank Reserves on the face of the Bank of England balance sheet shows that HM Treasury hasn't received a windfall recently.

To 28 Feb 2011, BEAPFF had received £13,090.50 mn in Gilt interest and £52 mn in bank interest, whereas it has been charged £1,626.10 in bank interest on the loan and £9mn of expenses. That totals £11,507.70 mn which compares favourably to the £11,584 change in cash in the accounts (the difference attributable to the income from the corporate bond portfolio). So I reckon my estimation isn't far wrong.

To date I think there is about £18bn sat in the cash account at BEAPFF and it doesn't look like they're using it up for the next round of QE - as the balance sheet appears to be expanding again by the amount of the auctions. So what are they saving this money for? Are they legislatively barred from handing it back? Perhaps Uncle Merv is planning to dress up as Santa...

So why look into this. Well I wanted to know why Bank Reserves were falling over time. As we know this means they've been moved somewhere else on the Central Bank's balance sheet and I wanted to know where. Some can be explained by the commercial banks using bank reserves to offset their notes and coins allocation (where previously they'd used longer term repos), but some of it couldn't be clearly identified in the ever growing 'Other Liabilities' at the Bank of England.

This is what I've got so far. (Issue Dept is the one that issues notes and coins)
and that still leaves a bit missing - unidentified since QE1 completed at the end of Jan 2010. Any ideas what this could be? And what's that rise since March all about?

Musings on MMT - Another Soft Bit

The eminently readable John T Harvey points out a further bone of economic contention.

Our “problem” is that we can produce a sufficient quantity of goods and services without employing the services of all willing workers. 

That is the 'paradox of productivity' and is a central question to policy. Because if there is intrinsically insufficient demand in an economy then the private sector can never reach maximum output on its own. Even with a simple model the equilibrium falls short of maximum output.

If we do have a 'paradox of productivity' then there must be an active government sector keeping demand up so that the private sector will perform at maximum output. The public sector has to at least pay for some jobs. There is no choice in the matter.

Musings on MMT - Exposing the Soft Bits

These are exciting times. Steve Keen's Debunking Economics has been released in the UK and my copy is now on my desk. Steve has a good model of Horizontal Money (aka the Horizontal Circuit or 'Credit Money') and notes that he is currently working on integrating that with Vertical Money (aka 'Fiat Money').

Steve is sceptical about MMT and will be the only one likely to find any flaws in the existing formal MMT model. The convergence of those streams should be fascinating to watch. The basic framework is there and appears reasonably sound against the available evidence so we shall see.

We know that some of MMT's better defined policy suggestions are really good. Enhancing the automatic stabilisers is by far the best way of making sure that a mixed economy can return its private sector to its 'ignition' point after a slump - and importantly slow down when it starts to get full.

The Job Guarantee scheme allows private sector malinvestment to be resolved without throwing people into absolute destitution. And importantly there are no politicians in the middle who can screw up the spending decisions based on their desperate need for popularity.

For any country that already has a universal Health Care system it's an easy extension. You shouldn't have to die and you shouldn't have to starve just because the economy has gone a bit wobbly for a while. 

So now it is really time to move on the bits where MMT doesn't really venture and get those firmed up.

I see those falling into the following areas:

Quantity vs. Price Expansion

How does the economy responds to stimulus when it has spare capacity available? This is the old 'does the system quantity expand or price expand' argument which I've highlighted a couple of times before. Lord Keynes, on his blog, highlights the Cantillon Effects and dismisses them as an argument against Government spending. But while doing so he makes an important point: The Effects apply equally to private induced expansions in spending.

So how a particular economy behaves during a private sector expansion should describe roughly how it will behave in response to a government induced reflation - in terms of that economy's propensity to quantity expand over price expanding.

Beyond that there isn't much evidence supporting either position. Post Keynesians 'believe' that an economy will quantity expand while many others 'believe' the economy will price expand. Such faith is touching, but doesn't help the system design. The truth is somewhere in the middle no doubt.

And therefore in terms of policy design you have to factor in the uncertainty. So, for example, reflation has to be coupled with a threat to remove any 'rent' extracted with price expansion via the tax system.

Effect on the Exchange Rate

Central to the MMT system is the floating exchange rate system that provides the necessary degree of freedom allowing an economy to target low unemployment and stable prices at the same time.
 
Those who follow John T Harvey's blog on Forbes will know that the modelling the exchange rate is one of his research areas. And as he says it is 'complicated'.

I'm still not entirely sure which theory of exchange rate MMT subscribes to, which model that relates to and how much evidence there is for it. Certainly the straight linear relationship between interest rates and exchange rates is too simplistic to be of use (and should be challenged wherever it pops up).
 
For example, it is entirely possible in the current environment that any reflation proposals will be greeted with a surge in the currency rate - given the paucity of private investment opportunities in the world in general.
 
Policy design here is complicated. Surges in speculation in either direction will happen and need to be buffered somehow in the short term. One of the benefits of the zero interest proposals are that they get rid of the speculative money in an economy (or at least the cost to the government of that speculative money). But there is little data on what the effects will be over time. 

And yet any other system of controlling the exchange rate just stores up problems for later. It is generally better to have regular earthquakes than store up the pressure for one big one - as the current Eurozone mess demonstrates in spades.

Cost Push Inflation

Cost Push inflation is really a result of demand from outside your currency zone. So you can't control it with your policy variables. Nothing done in London is going to reduce the demand for Oil in Beijing. The issue here is how to dole out the resulting reduction in the standard of living equitably while the substitution goods and services get put in place.

I find the policy suggestions on this subject weak (Lord Keynes blog has a good overview). Probably because it is a tough problem to crack. Distributing pain is never going to be popular with the voters.

Perhaps the best suggestion is to have strategic buffer stocks of important materials and of course to ensure that the domestic economy is strong and diverse so that relies less upon the kindness of foreigners.

Wealth Concentration

The existing corporatist system has allowed a moneyed elite to, in essence, purchase the political system and use it for their own enrichment. Arguably all political systems in history have degenerated into a 'Big Man' situation of some sort over time.

MMT's approach to the hoarding of net-financial assets is to accommodate them rather than confiscate them. So the government sector has to top up the money stored in excess of that lent out to stop the economy shrinking and that causes non-government financial assets grow over time. Hoarding is discouraged as much as possible (with near zero interest rates) but not actively prevented with taxation measures.

Pragmatically that is probably the right approach. Who should have their savings confiscated after all? But it does lead to the risk of wealth concentration and with that comes the ability to subvert the system for wealth's own ends. In any system he who pays the piper calls the tune.

I don't believe I've read anything from the MMT economists on the subject. However Tom Hickey rightly and regularly mentions eliminating excess rents as a policy approach that should help prevent wealth build up in the wrong hands. And a recent post at Heteconomist covers the subject as well

Any others?

Those are the ones that come to me regularly. But they are no doubt not the only ones as we move on from the basic economic truths onto designing the political economy. 

So what troubles you? Let us all know below.