Wednesday, 15 August 2012

The UK Government's Rainy Day Fund

Piggy Bank!As you teach any child it is good to save for a rainy day. The UK Chancellor of the Exchequer appears to have taken that advice to heart and has a nice fat piggy bank set aside.

The question is: how much more rainy does it have to get before he spends it?

The fund in question is the cash account at the Bank of England Asset Purchase Facility Ltd, and on the current cash flow accounts there is £31,324m due to HM Treasury. Yes, you read that right. That's £31bn sat there doing nothing in an economy with negative GDP growth.

I first drew attention to this account in 2011 when it became clear to me that the Asset Purchase mechanism was slowly unwinding. That is when I discovered that the UK's version of Quantitative Easing, unlike any other QE system in the world, doesn't automatically sweep the interest paid on the government bonds back to the Treasury.

The evidence is in the accounts of the asset purchase fund company, where on the Cash flow statement on pp 6 you will see the line:

Due to HM Treasury    £31,274m
which is an increase of nearly £20bn over the previous year.

(Note 10 to the accounts on pp9 states what is due to HM Treasury under the indemnity the company has from HM Treasury. The difference in values is due to the imputed 'profit' the company would get if it sold all its Gilts. The price of them has gone up since the start of the Asset Purchase process - which of course has reduced the wealth of the private sector by that £10bn. So much for the 'wealth effect').

This is corroborated by the entry in the Bank of England Accounts, pp 94 where it states:

The financial statements of BEAPFF have not been consolidated as the Bank has no economic interest in its activities. BEAPFF’s operations are fully indemnified for loss by HM Treasury and any surplus for these operations is due to HM Treasury. [...]

At the year end BEAPFF held a deposit at the Bank of £20.7 billion (2011: £11.8 billion), which is included in other deposits (note 22). Interest on this deposit is payable at Bank Rate and totalled £85 million for the year ending 29 February 2012 (2011: £44 million).
This money needs spending urgently - either by direct government spending or by giving it back to the population so they can spend it. Holding it back is madness.


Nic said...

Neil, the balance sheet shows an amount owing to HMT of £41bn. Given this is much larger than the interest that would have been received on the gilts, would the remainder be made up of market to market adjustments?
Also what do you calculate current annual interest received to be?

Neil Wilson said...

It is. The profit is £41bn. The cash owed is £31bn. The difference is market adjustment imputed into the valuation.

I haven't done the exact interest analysis (yet). However last year on £200bn of Gilts the interest earned was about £9bn a year. Given we're nearly double that now I expect the interest earned a year is in the order of £16bn.

The nominal value of the current Gilt hoard is £299.751bn and the amount spent on them is £342,843 leaving a notional redemption gap of £43bn.

But just £43bn of that amount is due for redemption before the next election.

Neil Wilson said...

A bit on the high side it seems.

Based on today's Gilt totals the interest earned per annum is £13.477bn.

Nic said...

£31bn is the increase in the amount owed over 2012, not the amount owed. I.e the difference between the 41,105 on the 2012 BS and the 9,832 on the 2011 BS. It is 41,105 that must split into interest received and fair value adjustment.

Nic said...

Also £13.477bn seems too high, on £342,843 it would be an average yield of 3.93%? This seems to high given nothing has been done at a yield over 4% since Jan 2010. Where did you get the numbers from?

(On an aside, your robot blocker is the hardest I have ever had to use or my eyesight is getting bad!)

Neil Wilson said...

I took the nominal amount breakdown of Gilts BEAPFF owns (from the list on the BoE web site) and multiplied them by the coupon value on each Gilt.

Alex said...

Good work Neil. Have been trying to get this more widely known, but there seems to be little interest from the press. Am really frustrated by the left in the UK. They seem unable to see the macro picture and their solutions (e.g. tackling tax avoidance) are not really solutions at all.

Neil Wilson said...

Thanks for the help Alex. It's just a question of getting traction somewhere with those who have the money.

philippe said...


Do you know where I could get a good clear description of how the BoE and the UK money system 'works'? I want to be able to describe the uk system in MMT terms, but it seems quite opaque compared to the US system.


Neil Wilson said...

I find the US system opaque.

What are you struggling with?

The UK system seems fairly straightforward to me.

philippe said...

that's probably because I've researched the us system more... I don't really know where to start with the uk system. I'm looking for texts or websites which explain the whole thing in detail!

Can you recommend anything?

philippe said...

Why do you find the US system opaque?

philippe said...

Ok I've found some things on the Bank's own site.

Neil Wilson said...

The US jumps through more hoops to pretend the Fed is something other than a creature of government.

The UK doesn't bother with that.

BoE is split into an Issue Dept and a Banking Dept. The Issue Dept handles notes and coins and the Banking Dept the Bank reserves.

There is a consolidated balance sheet that gets rid of the artificial separation.

BoE offers accounts to suitably qualified institutions and that gets them access to the Discount Window.

HM Treasury has an account with the BoE (ways and means) which is the government's access to central bank money. Ideology stops that being used at the moment, but legislation exists to allow HM Treasury to use it whenever it wants to.

philippe said...

Bank of England notes are liabilities of the Bank. Do you know if they are also liabilities (or obligations) of the UK government?

Neil Wilson said...

No. Our system is set up properly ;)

Neil Wilson said...

Also be careful of using 'UK government'. The BoE is part of the 'UK government sector'

Best to use HM Treasury as the descriptor for the fiscal department.

BoE is a subsidiary of HM Treasury. The shares of BoE are held by the Treasury solicitor on behalf of HM Treasury.

philippe said...

In the current UK set-up, do you think it's possible for UK govt bond auctions to 'fail' (i.e. for there to be no non-government buyers), or for UK govt bond yields to reach 'unsustainable' levels?

Neil Wilson said...

Of course the auctions can 'fail', but that's operationally irrelevant. The alternative at that point is to leave the money on deposit at the BoE, where it can easily be 'lent' by BoE if needed via HM Treasury's Ways and Means account.

UK government bond yields can only go up if the Bank of England allows them to by permitting the price of bonds to fall.

philippe said...

I wrote to the BoE a while back about this. They were adamant that they would not act to hold down bond yields if the market "lost confidence" in the government's fiscal policies (and yields 'spiked').

At the same time however, if govt bond yields were to rise to 'unsustainable' levels, wouldn't this have a deflationary effect (?), meaning that the BoE would have to step in and buy more bonds in an attempt to hit its inflation target (?), thus bringing down yields?.

Neil Wilson said...


They were adamant they wouldn't issue lines of liquidity in 2008 either.

The pretence of the BoE being 'independent' can continue for as long as the UK economy is not threatened. As soon as it is then chains will be yanked.

philippe said...

Let's say the bond markets were to decide that UK government fiscal policy was 'unsustainable', and yields on bonds started to rise sharply towards 'unsustainable' levels.

The BoE might lower short term interest rates but in all likelihood wouldn't start buying extra bonds to bring yields down. Instead the government would be pressured into cutting spending or raising taxes.

Let's say that as a result of these spending cuts/tax rises things got even worse, as they have done in the eurozone.

As govt bond yields continued to rise (to very high levels) and the economy nose-dived, eventually the BoE, would have to step in to cap them.

However, by now the government would be commited to a program of'austerity' (as they are at present), so unemployment would be really high and everything would be really crap for a few years.


If, in contrast (in the above scenario), the government chose not to cut spending/raise taxes, and instead continued to spend at the same (or higher) levels, and either called on the BoE to buy its bonds or simply financed itself directly through 'ways and means', what do you think the effect might be?

Isn't it highly possible that the pound could depreciate sharply (or collapse), resulting in very high inflation?

This possibility strikes me as being a greater problem for the UK than it is for the US, given that (a) the pound is not the global reserve currency, and (b) the UK is highly dependent on imports.

What do you think?

Neil Wilson said...

The entire conclusion you put forward follows from the premise that the bond markets can decide things.

However if it is clear to the markets that the government believes it ultimately controls the Bank of England and the understanding is that the Bank of England will prevent yields from rising, then they will not rise.

Any bond that drops below par can be purchased by the Bank of England and cancelled. That means that the private sector gets less back than it paid out for the bond.

And that is a tax. Show me a financial person that will voluntarily queue up to pay a tax and I'll show you a unicorn.

So it matters not what the bond market thinks. It matters whether the government decides to voluntarily tie its hands.

What you put forward is a slippery slope logical fallacy.

philippe said...

I'm on your side, but I'm trying to work out what might happen as the result of different policy choices given the current institutional arrangements.

I'm also trying to figure out what the possible risks of alternative policies and institutional arrangements might be.

For example, given that pound sterling is not the global reserve currency, and given the UK's high (and real) dependence on imports, it seems to me that the UK is much more at risk of a 'currency crisis' (rapid and substantial currency depreciation) than the US is.

As such the combination of persistently large budget deficits and a large current account deficit could leave the UK very exposed. A currency crisis could result not only in very high inflation, but also in widescale bankruptcies, massive cutbacks in government deficit spending, and possibly government borrowing in foreign currency (to stabilise the exchange rate).

What's your opinion on this?

Neil Wilson said...

The UK is a reserve currency - otherwise its import deficit could not exist.

The idea that there is 'a' reserve currency is clearly madness. Check the central bank holdings of foreign currency.

Somebody foreign has to fund the GBP deficit first *before* it can exist.

So why are they funding the import deficit?

Capital flows come *first* and trade follows (contrary to neo-classical belief). See the work by John T Harvey.

Similarly 'large budget deficits' are meaningless on their own. They are a reflection of the state of savings in the private sector. You can't have them on their own. If budget deficits go up then either the domestic private sector is saving or the foreign private sector is saving (imports).

So I call it a slippery slope logical fallacy. The UK has already had a 25% drop in its currency value after the asset bubble popped and other than a few moans here and there nobody has really noticed.

What happens if you deploy MMT policies - using government spending to eliminate domestic unemployment and increase spending - is that financial speculators move off to find another economy to destroy and foreign investors interested in the increased profits of the domestic companies move in.

Randy wrote about the 'twin deficit myth' last week. Can't find where though.

Ultimately there are import controls and capital controls to dampen off any extremes. But I don't think you'll need them.

Nic said...

"Any bond that drops below par can be purchased by the Bank of England and cancelled. That means that the private sector gets less back than it paid out for the bond.

And that is a tax. Show me a financial person that will voluntarily queue up to pay a tax and I'll show you a unicorn."

The price of the bond reflects the net present value of the future cash flows that the government was committed to. It gains nothing by buying the bond, because to finance the bond buying it has to issue new bonds at the higher interest rate levels. Nor does the private sector lose anything, as the money received can no be invested at higher interest rates to generate the same cash flows as the bond offered.

Neil Wilson said...

"It gains nothing by buying the bond, because to finance the bond buying it has to issue new bonds at the higher interest rate levels."

It is the Bank of England buying the bond for cancellation using QE style techniques. HM Treasury is issuing nothing.

The Bank of England is a subsidiary of HM Treasury. Once it purchases a bond it no longer exists on the government consolidated balance sheet.

Study the transactions again to see how it works.

Nic said...

"The Bank of England is a subsidiary of HM Treasury. Once it purchases a bond it no longer exists on the government consolidated balance sheet."

Of course it still exists, it has merely been replaced by central bank reserves owed to the banking sector and paying base rate. And as base rate increases, it moves back to a point where there is no cost saving from doing it. Net financial assets of the private sector don't change with QE so net liabilities of the public sector can't either.

Neil Wilson said...

" it has merely been replaced by central bank reserves owed to the banking sector and paying base rate. "

So you agree that government doesn't have to issue new bonds.


Nic said...

"So you agree that government doesn't have to issue new bonds."

In order to buy a bond and cancel it, it needs to issue a new bond (unless of course it has the cash on hand). Using QE precludes it from being cancelled, as the bond is the asset on BoE balance sheet that backs the liability to the banking sector for the reserves used to purchase the bond. You can't just cancel one side of the BoE balance sheet!

It is immaterial if the government owes money in the form of bonds or reserves, it still owes the money and pays interest. and it still forms part of govt debt to gdp. You can't just magic away the govt debt as someone always owns the other side. At the moment debt in the form of reserves is cheaper than the gilts, but when the economy recovers and base rate needs to be pushed up, the BoE will need to do something about the massive amount of excess reserves, and how does it do that, but by selling bonds to the banks. And those will be the bonds it has bought under QE.

Neil Wilson said...

Ok, I'll run through this one more time to see if you can see the position.

HM Treasury owns the BoE and any dividend from BoE is due to HM Treasury. So the BoE is a subsidiary of HM Treasury.

Therefore you can apply standard group accounting techniques to form a group balance sheet. And on that balance sheet any 'intra-group' loans are eliminated by the consolidation process.

So the Gilts the BoE has disappear on that balance sheet as does the corresponding Treasury liability.

The cash fund of BEAPFF ends up added to HM Treasury's existing cash resources.

Consolidating that up with the rest of government function gives the 'government sector' which is what I refer to as 'government'.

HM Treasury owns and controls the BoE. It is perfectly within the right of HM Treasury, as owner, to request that the Gilts at BoE are paid to HM Treasury as a capital repayment on their shareholding. That would then cancel the Gilts completely. Hence why the consolidated position eliminates them.

"At the moment debt in the form of reserves is cheaper than the gilts, but when the economy recovers and base rate needs to be pushed up,the BoE will need to do something about the massive amount of excess reserves"

The BoE has completely dynamic control over the amount of interest paid on those reserves. There's no reason to change that position. The 'massive excess reserves' are just overnight bonds.

And The Bank of England is a bank. If it wants to fix money for some reason at an interest rate for a period of time then it can offer term accounts. Which has the advantage that it genuinely locks away reserves permanently for a period of time. No repos available.

BoE watcher said...

Nic is right Neil. You are writing as if money is free but it is not. It's a liability that bears a floating interest rate. At some point the rate will rise and servicing costs to the BoE (govt owned) will rise. The BoE cannot refuse to raise the rate when demanded by the market else other consequences will follow (run on the currency for example).

Neil Wilson said...

Yes it can. It has complete monopoly over the situation. The currency is a simple government monopoly.

If the market demands a rate then it does that by lowering the price of the bond. The BoE can then buy the bond below par and have it cancelled.

That is in effect an asset tax on the non-government sector reducing their spending power and income. They get less money back than they gave to the government in the first place.

Runs on currencies are another of those 'hellfire' ideas that are used to frighten small children. The rate of exchange of a currency is a complicated matter for which there is *no* sound or empirically validated economic theory. The work of John T Harvey shows that.

If financial types flee a currency because you are adopting a policy of promoting domestic businesses via a ZIRP (which is what MMT proposes via functional finance) then they will be replaced by those moving into the currency to take advantage of the superior profits and income streams offered by the *real* economy as it ups its investment levels.

Then you layer that with expectations on expectations and who knows where it will fall. So just let it fall there and adjust buffers to handle the situation.

It may help if you look at the system interactions in the round rather than just concentrating on interest rates as though that is all that matters.

Money is being moved around the system to do stuff. And ultimately it is the stuff that matters, not the money.

Stephen said...


Well done for spotting this. George Osborne's move shows up the 'debt crisis' for the charade it is.

Hope MMT gets recognition out of it.

Neil Wilson said...


All we need now is the Chancellor to learn how to create a consolidated balance sheet, and then perhaps he'll stop hyperventilating over something that isn't really there.