Against the rally against debt

Today’s “rally against debt” should be called the campaign against the UK’s pension fund industry.
What I mean is that government debt is not just a liability. It is also an asset, and a tremendously useful one.
Imagine that the rally’s aim were to be pushed to its logical conclusion and that government debt did not exist - which, given that that rally thinks such debt is “immoral” is not a wholly unreasonable imputation.
Pension funds and insurance companies - who hold £294.1bn of the £994.9bn stock of gilts (pdf)   - would then face an acute shortage of long-term sterling safe assets.  They could not transfer into corporate bonds, as this market is just not big enough.  Nor would cash be a good alternative, as this carries reinvestment risk - the fact that you can’t be sure of its future returns. And of course equities and commodities are just far too volatile. (Anyone who thinks gold is a safe store of value is just a prat.)
Worse still, fund would face a terrible shortage of inflation-proofed assets - as hardly any private sector companies issue index-linked debt.
Institutions which have long-term liabilities - such as pension and insurance companies - would then be in a terrible mess. They would not have the assets which offer a safe match for their huge future liabilities.
Government debt, then, is pretty much necessary for the existence of the pension industry.
Now, one might have two objections to this.
One is that as government debt falls, pension funds will switch into corporate bonds and this will encourage firms to issue more of them, with the result that private sector supply of safe assets  will replace government supply.
This is unlikely. I’m not sure that top-quality borrowers want to expand their balance sheets by £294bn; there just aren’t that many profitable investment opportunities for them. And if they issue debt to buy back equities, the increase in gearing means they won’t remain safe firms.
And it’s extremely unlikely that firms will issue index-linked bonds to replace government ones.
Another objection is that the rally doesn’t really want to abolish debt, but merely moderate its increase. You can, after all, have too much of a good thing.
But is there too much of this long-term safe asset? There’s one obvious test - to look at its price. If the price of government debt were low and falling the rally would have a point.
But it’s not. Yields on the debt are close to multi-year lows: 3.4% for nominal 10 year debt and 0.2% for its index-linked counterpart. The market, then, is telling us that this asset is still in short supply - that there’s not enough of it.
Which brings me to a paradox. Most of those who are marching today are, I suspect, supporters of the free market. They believe the market, in general, knows better than governments.
When it comes to government debt, though, they abandon this faith in the market, and expect the government to over-ride its wishes.
It’s enough to make me suspect today’s march might be just a silly stunt.

Comments

[Richard Gadsden]

I was listening to NPR's excellent Planet Money podcast recently and their latest episode is about Andrew Jackson paying off the US national debt (in 1835). It provoked the worst depression in the history of the United States of America - the Panic of 1837.

http://www.npr.org/blogs/money/2011/04/15/135423586/when-the-u-s-paid-off-the-entire-national-debt-and-why-it-didnt-last

[Phil]

"Another objection is that the rally doesn’t really want to abolish debt, but merely moderate its increase."

An objection to the promoters of the march is that they're quite happy to perpetuate the widespread confusion between government debt and the budget deficit (the rate of increase of government debt), pressing seemingly common-sense arguments about the evil of debt in general into service for a specific argument about how to address the deficit. Another would be that the deficit actually isn't that big a deal in historical terms; that budget deficits can be dealt with in a number of ways, not all of which involve large-scale government spending cuts; that it could be reasonably argued that we're suffering from the Labour government's response to the banking crisis, but only if the words "intelligent and effective" are inserted before the word "management"; and, in short, that they're either economically illiterate or lying through their teeth.

[Ralph Musgrave]

One person’s stock of Gilts and the interest they yield is some else’s obligation to pay taxes to fund the interest, and potentially pay A LOT MORE TAX if the national debt is wound down, i.e. there is a net repayment of national debt.

Thus providing one lot of people with what they want – a safe investment paying a decent rate of interest – is to impose a burden on another lot. And that cannot be right.

I’m not 100% sure what the answer to this paradox is, but I suspect the answer is that government just shouldn’t provide interest paying savings for the sake of it.

[Adam Lent]

Good post but I suspect the marchers today are largely motivated by a hatred of the state rather than any particularly sophisticated stance on sovereign debt. For them the fiscal arguments are simply a pretext to obtain a minimal state which would apparently usher in an era of unmitigated liberty for all.

[BenSix]

Ah well. The world shrugged at Atlas.

[Keith]

This is the importation of right wing lies as strategy from the USA where contriving bogus economic arguments has become a pastime for republican boosters see Prof. Delongs excellent website.

Mr. Musgrave is wrong thrice. There is nothing immoral about the Government providing any useful service to the public including a safe liqiid asset such as Guilts. Second the Debt is not a deadweight burden as it has helped to create public assets and increase consumption above the level Taxation would have allowed in the absence of borrowing so the interest is a reward to the lenders for accommodating this choice by the state, and finally the debt and the Market it creates allows the State to be more effective at promoting the public good by facilitating future borrowing. All our wars for three hundred years have been financed by this clever invention exploiting the unique features of the Political Sovereign, namely that it is an immortal legal person. This is all so elementary! Does no one get an Education these days or study British History?

[Jim]

@Keith: I'll happily pay the extra tax burden required to finance debt incurred in a war of self defence (such as WW2). I'm less happy to pay the interest burden incurred by invading various random bits of the globe for no sensible reason, and also to pay for lots of extra pointless public servants such as '5-a-day dietary advisers' and 'disability rights advocates'.

I'll tell you what, lets create a voluntary tax that can pay the interest on some debt, and those that volunteer can choose what to spend it on. After all if paying extra tax to borrow more is so popular, I'm sure it would raise billions.................

Or were you expecting 'someone else' to have to pay the extra tax so you can borrow loads more cash?

[Guido Fawkes]

Chris you know global bond rates are artificially low as a result of various QE programmes. Those of us at the rally would like to see the debt paid down but that would take decades. Alternative investment opportunities would present themselves. As for government versus corporate debt, it is not uncommon for corporate debt to be higher rated than government - McDonalds has had better rating than the US government for example and has been priced accordingly.

You are factually incorrect about the rally wanting to merely moderate the rate of debt increase - that is the government's position. On the rally we all wanted to eliminate the deficit and start paying down the debt.

[Nick]

Surely in such a situation the UK would just do what Norway does currently.

Norway has a $300bn oil wealth fund and also $300bn worth of long term government debt.

It could pay off the debt if it chose but doesn't.

Thus Norwegian pension funds get their long dated debt to invest in, despite the country being in surplus.

[BT]

@ Guido Fawkes

Credit = Debt, so reducing the national debt also reduces the national money supply.

If all debt, public and private, was repaid, the money supply would shrink to almost nothing.

Your campaign to eliminate the national debt is a campaign to sink the UK economy.

[windsock]

I think we can be glad there were only 350 "silly stunts" there.

[Mcfuckingduff]

. I'm less happy to pay the interest burden incurred by invading various random bits of the globe for no sensible reason, and also to pay for lots of extra pointless public servants such as '5-a-day dietary advisers' and 'disability rights advocates'.

Indeed, because disabled people don't have needs that governments both national and local should address.

I think the philosophy of "I don't personally benefit from it therefore I don't see why I should pay taxes" highlights precisely why this kind of thing is merely petty, harrumphing libertarianism. Infrastructure is more than roads and bullets, sir.

[Mcfuckingduff]

Ah, HTML fail.

[Ralph Musgrave]

Keith is wrong thrice. His first point simply glosses over the problem I referred to above, namely that if providing one lot of people with safe liquid assets involves imposing an unasked for debt or obligation to pay interest on another lot, the whole operation is questionable.

Second, Keith claims that “Debt is not a deadweight burden as it has helped to create public assets and increase consumption above the level Taxation would have allowed in the absence of borrowing…”.

The answer to that is that national debt is totally unnecessary for the purpose public sector investment, because even large public sector investments are a minute portion of total public sector turnover. It’s like me “borrowing” so as to buy a newspaper.

I’ve gone into this question in more detail here (see section headed “3. Borrowing to purchase assets”.

http://mpra.ub.uni-muenchen.de/23785/

Also, there is a Swiss academic who has come to the same conclusion. See:

http://econpapers.repec.org/article/eeepoleco/v_3a23_3ay_3a2007_3ai_3a4_3ap_3a1088-1104.htm

Re the idea that debt is needed to boost consumption, that is also not true. As Keynes pointed out, e.g. in a letter to Roosevelt, demand can be boosted by boosting EITHER debt or boosting the money supply. See 5th para here:

http://www.scribd.com/doc/33886843/Keynes-NYT-Dec-31-1933

As for Keith’s third justification for debt, namely that debt has financed wars, now that really is scraping the bottom of the barrel, isn’t it?

Guido Fawkes is wrong to say that paying off the debt would take decades. It could be paid off just a few years. See:

http://printingmoneyisgood.blogspot.com/

The claim by BT that reducing the national debt reduces the money supply is wrong. The national debt and the monetary base / high powered money / central bank created money (to use three names for the same thing) are entirely independent.

As to commercial bank created money, that is different. BT is right to say reducing private debt also reduces the volume of commercial bank created money. This has happened big time recently as a result of “deleveraging”. There is actually much to be said for expanding central bank money and contracting commercial bank money in that the latter varies in a pro-cyclical manner: hardly desirable. For those interested: Google “fractional reserve” and “pro-cyclical”.

[BT]

@ Ralph Musgrave

Government bonds purchased by primary dealer banks are placed on the asset side of the balance sheet, while newly created credit is placed on the liability side of the balance sheet. So government borrowing creates credit in the same way as private borrowing.

[Keith]

It is disturbing to see that Tories like jim think disabled people have no rights. Shame on him and all his kind. It is difficult to have a rational debate about economics with people who are motivated by a extreme right wing ideology that amounts to a kind of superstition rather than anything like a science.

As for the National debt being unasked for this is the same ideology. The Treasury asked for and received the Savings of the public in the form of Gilts. It is a Political choice what you spend the savings on, War or Disabled people or Tax cuts etc. When Demand is high it is preferable to finance War by Debt ( and Taxation ) to minimise the need to create money. War time saving is high during a big war ( full employment, high money wages ) and taping this is a useful tool. The Debt is performing a number of functions here and is an example of the complementary nature of public and private sectors. I do not deny that creating money or tax rises can be used to meet spending or manage demand; but the mix is both a political choice and involves a judgement about the relative effects of the choices the Treasury must make. If absorbing savings is less inflationary than creating money that is a valid choice, the choice the Treasury made between 1939 and 1945. To say that deficits should only be met by monetary expansion and not debt issuance is a radical departure from traditional ideas of public finance. Conservatives also seem to dislike that option too. And Taxes. So if the Community cannot print money, or borrow, or tax how is the state to spend? Oh I forgot, the Libertarian/ Tory of today lives in a fantasy world where we can have the advantages of a civilised society without any Government or Laws.

[Ralph Musgrave]

BT, I agree with your claim just above that government borrowing from commercial banks creates money. I forgot that point when writing my comment above. But I don’t think your point is much relevance and for the following reasons.

First, banks hold only a small portion of government debt: about 8.5% according to this Bank of England publication:

http://www.bankofengland.co.uk/publications/quarterlybulletin/public01.pdf

Second, commercial banks lend (and thus create money) when they see a viable lending opportunity. The total volume of such opportunities in the private sector is not influenced by the fact that those banks happen to be lending to government. At least where government borrows from commercial banks rather than creates and spends its own brand of money (monetary base), I don’t see why there should be much of a change to private sector economic activity.

In short, I agree with Guido Fawkes in that I don’t see any big problems stemming from reducing the national debt.

Why money has to be so effing complicated I don’t know. As Scott Sumner (economics Prof. at Bentley University) says at the top of his blog: “Welcome to a new blog on the endlessly perplexing problem of monetary policy”.

[BT]

@ Ralph Musgrave

You are correct that if the private sector was borrowing and investing sufficiently to drive economic growth, we wouldn't need large deficits.

But currently the private sector needs help, and government is the only option.

Regarding bonds: it's not the amount of bonds held by banks that matters, just that bond issues are first laundered through the banking system.