Reader's Letter Of The Day

Amazingly enough, CityAM published an edited down version of my rant from last Friday, it's the fourth letter down:

Accounting fiction

The idea that one department of HM Treasury owes another department of HM Treasury £350bn is an accounting fiction. We might as well cancel the gilts owned by the Bank and recognise the commercial banks' loans to the BoE as government debt instead.

Still, the taxpayer isn’t paying interest to the Bank, another department of the Treasury (the Debt Management Office) is. The accounting fiction nets off to precisely nil. The Treasury is not only paying interest to itself, it is receiving interest from itself, it is a zero-sum game.

Rather worryingly, the first letter is from a former member of the Bank of England's Monetary Policy Committee, i.e. somebody who ought to know what he's talking about, who kicks off his letter with this bold statement:

Cancelling the bonds would undermine the credibility and independence of the Bank and leave a huge hole in its balance sheet. It would leave the Bank technically insolvent because it would no longer hold assets to match the substantial sum of money (about 20 per cent of GDP) created under the quantitative easing (QE) programme.

FFS!

Until recently, gilts were issued, redeemed and interest payments organised by the BoE (a department of HM Treasury). In 1997, these functions were transferred to a new department of HM Treasury called the Debt Management Office, see page 26 here. This makes it easier to sustain the accounting fiction that the DMO still owes somebody that £350 billion, or that those £350 billion in gilts are still in issue - and that conversely the BoE holds real financial assets, but does not change the substance of the matter one iota.

Clearly, if the BoE as creditor were to waive/cancel the gilts, it would have a paper loss of £350 billion, but the DMO would have a paper gain of £350 billion, so for HM Treasury as a whole, the exercise is completely neutral, it would not affect the money supply (a giant fiction in itself) or the taxpayer or interest rates one little bit.

Furthermore, QE in itself did not 'create' money in itself, all that happened was that the UK government swapped its borrowing/repayment terms from long term to short term, it's the same as paying off a personal loan with a credit card on an introductory low-interest rate offer.

So as ever, the question is, is Andrew Sentance lying or stupid?

Death Sentance

Economist talking crap: shock

Andrew Sentance, a member of the Bank of England's interest-rate setting committee*, as reported by the FT:

Moreover, Britain is particularly sensitive to rising demand elsewhere because imports account for a much bigger percentage of gross domestic product than they do in the US or in the eurozone, where inflation readings are lower. British imports are about 32 per cent of GDP compared with 16 per cent for the US and eurozone.

“In a highly integrated global economy, demand pressures can be less easily contained within national borders,” Mr Sentance said. “They can spill over and affect neighbouring countries,” he added.

Well duh.

Of course imports (or exports) as a percentage of GDP are higher in the UK than in the USA or the Eurozone, because their economies are five times as big (five times as many people).

Think about it: if you looked at the import-to-GDP ratio of a single individual, it would be close to 100% because he spends all his cash income (from 'exporting' his labour) on stuff produced by somebody else (consumption of your own labour, like doing your own cleaning, cooking, changing your own light bulbs is not usually measured in GDP).

Conversely, the import-to-GDP ratio of the whole world is by definition 0% because we don't import anything from the Moon or from Mars (a physicist could argue that metal atoms were 'made' in the heart of distant suns, so when we mine them, they are thus imported from outer space, but let's gloss over that).

Somewhere in between the two extremes, the UK is only one per cent of the global population, so we can only make 68% of the stuff we want, whereas the USA or the Eurozone are five per cent of the global population, so they can make 84% of what they want, and so on.
--------------------------------
We also note that if his rule of thumb "Large economies don't have inflation" were true, then larger economies like the USA or China would never have inflation? Yeah right. In any event, the main reason that inflation in the UK is so high at the moment is because our currency fell by about a quarter a couple of years ago and higher import prices are still feeding through, end of.

Disclaimer: personally, I would love interest rates to increase and/or inflation to go down, but that's not the case for a lot of people.

* One day we'll look back and laugh at the idea that a small group of political appointees were given the power to decide the optimum interest rate is, and laugh even harder at people believing that they had the power to enforce it on the real world.