Friday 20 November 2015

No, this is not "creative accounting".

Simple question: if you remortgage at a lower interest rate, does your annual cost go down?

A: of course if does. So by definition, your annual surplus goes up (or your annual net loss goes down).

It is the same with QE. The government refinanced £350 bn of interest-bearing debt by replacing it with £350 bn* of QE money which costs it 0.5% interest.

If the government's interest costs go down**, then that reduces the deficit.

* Let us assume, for simplicity, that the £350 bn old debt was not bought redeemed at a premium i.e. £350 bn nominal of high interest debt was bought back for £375 bn or something.

** There is a good argument and plenty of evidence to show that governments don't need to pay interest at all, separate topic. But 0.5% is pretty close to zero.

It is a mystery to me why 'financial journalists' find this so difficult to understand and pretend it is more complicated than it is.

From yesterday's Evening Standard:

The Chancellor is also going to get a handy leg-up from Robert Chote’s watchdog on the public finances over the next few years — cutting his borrowing bill with the wave of a magic wand.

How so? It all comes about through the change in the OBR’s assumption about the Bank of England’s Asset Purchase Facility (APF), the vehicle in which Threadneedle Street holds the £375 billion of government bonds it bought under its money-printing programme.

"Osborne will paint this as fiscal rectitude, when he’s being rewarded for economic failure." [says] Russell Lynch.

Explaining the mechanics of this without needing to put a wet towel over your head is difficult, but here’s the gist of it.

All those bonds bought by the Bank under quantitative easing (QE) rack up “coupon” or interest payments from the Government — say of between 2% and 2.5% — most of which is now transferred back to the Treasury, after the Chancellor changed the rules a couple of years back***. But the Bank bought the bonds with the newly created QE money on which it pays interest set at Bank rate, which is just 0.5%.

Broadly, the difference between the two rates is now returned to the Treasury. The details of these arcane transactions have been relegated to supplemental fiscal tables in recent publications and this transfer —which looks like very (ahem) “creative” accounting — gets much less attention. But it has a big impact. For example, this financial year, the APF is forecast to generate £14.1 billion in coupon payments less £2 billion in interest paid out on the QE cash — £12.1 billion.


The "creative accounting" is pretending that the original bonds still exist and making two sub-departments of HM Treasury pay interest to each other, but such is life.

*** Not clear how the rules would ever have been any different. Governments pay interest on their bonds. The holder of the bonds receive the interest. If the UK government holds German bonds, the German government pays the UK government interest. If the UK government holds UK government bonds, it pays itself interest i.e. nothing happens.

11 comments:

Dinero said...

So the deficit would rise by 12 Billion if the QE policy was reversed at a later date.

Mark Wadsworth said...

Din, read the post and understand it.

You cannot "reverse QE" there was no"QE".

All that happened is that the government replaced longer term, higher interest debt with shorter term, lower interest debt.

The original longer term debts are meaningless, apart from in the minds of fevered bureaucrats, deceitful politicians and gullible voters, they no longer exist. ALl that remains is the short termbt.

Like remortgaging from fixed rate mortgage at 4% to SVR at 0.5%.

The original longer term debts are meaningless, apart from in the minds of fevered bureaucrats, deceitful politicians and gullible voters, they no longer exist. All that remains is the short term debt of the same amount.

I am sure that you will understand that if the government "does the opposite of what it just did" then the opposite will happen.

If you remortgage from SVR 0.5% to long term fixed rate 4% then your interest costs go up.

Dinero said...

If the APF sold the gilts , reversed QE, then the Treasury would then be paying Gilt holders the 12 Billion . so thats an increase in the deficit. 12 billion.

Mark Wadsworth said...

Din, exactly. Your understanding and terminology are all wrong*, but the end effect is of course to increase the government's interest costs.

* The APF would not "sell" gilts it would "issue" them.

And it need not be exactly the same "gilts" as the ones that were bought back and cancelled either.

It is far easier to look at it as a refinancing operation.

If you have refinanced your mortgage from 10-year fixed rate 4% to SVR 0.5%, then what happened to the original fixed rate debt?

It no longer exists, does it?

All that exists is the new, SVR mortgage.

Dinero said...

You're surmising isn't correct, you description is not the operational reality of process, ie the APF cannot conduct a Gilts issue, and your missing out the change of the private sector's assets from Gilts to cash.

Mark Wadsworth said...

Din, yes it is. You are falling for the smoke and mirrors.

I am telling you what actually happened it you net off all transactions between government departments and look at "the government as a whole".

The APF is part of Bank of England which is part of HM Treasury which is part of UK government. Anybody who pretends that these are separate and independent bodies clearly needs psychiatric treatment and I cannot help them.

I am not missing anything.

I repeat: it is exactly like remortgaging.

If you want to look at the private i.e. non-government side of the bookkeeping…

BEFORE the bank has a financial asset i.e. a mortgage with a ten year fixed interest rate.

AFTER the bank has a financial asset i.e. a mortgage with a low, variable interest rate.

See?

Easy isn't it?

As I have also said a zillion times

"For every financial asset there is an equal and opposite financial liability".

So what happens on the "government" side is the mirror image of what happens on the "private" side.

If you understand one half you already understand the other.

Dinero said...

I agree , there's no need for the
Evening Standard to call it creative accounting.
but the mechanics of the APF and the Treasury and the Private sector are not comparable to remortgaging because for example circa 2009 the APF assets included private sector bonds and the Treasury was receiving a deficit reducing income from those

Cheers

Din.

Mark Wadsworth said...

Din, if the AFP owns a small amount of private sector bonds, then the situation is different .

But nearly all of the QE operation was the government buying back i.e. redeeming its own bonds and issuing low, variable interest rate debt instead and that is what we are focussing on here.

Random said...

Mark is precisely right. I use this analogy all the time.

It's a simple refinance from the commercial banks to the Bank of England.

Loans at commercial banks go down. Loans at Bank of England go up.

It's just like remortgaging. But of course if you remortgaged to a bank you owned outright, then any interest you paid would come back to you as the bank dividend. In other words your net cost would be effectively zero.

Also to note when someone asked earlier:
"If banks had a bottomless pit then how come a number of them became insolvent? Surely this would have been impossible on your reckoning."

Because the Bank of England prevents them from refinancing themselves via balance sheet expansion. They have to cycle it via the economy and draw interest instead.

The Bank of England reserves the self-refinancing trick for its own purposes.

Random said...

"So the deficit would rise by 12 Billion if the QE policy was reversed at a later date."
The only thing wrong with this thread is this. Spending generates tax as it is spent and "respent". Bond interest is just like spending on cigarettes by people on welfare or any other type of spending. We can't know the effect on the "deficit" - because it depends on private sector decisions to spend and save.

It's utterly fascinating to watch the number of people who cannot differentiate between the total tax take and the distribution. I see it all the time.

Changing the taxation alters the distribution and arguably makes it 'fairer', but it won't eliminate the deficit or even change it substantially. And that's because the deficit is caused by the savings desires of the private sector. The government has little influence on it. It is what it is.

This Neil Wilson article explains it well:
http://www.3spoken.co.uk/2014/04/taxation-government-investment-each.html

See these morons at the Guardian talking about 'shock' new figures. Haha:
http://www.theguardian.com/business/2015/nov/20/worst-uk-deficit-figures-six-years-george-osborne

Random said...

Hey Mark. You may find this article interesting:
http://www.3spoken.co.uk/2014/03/scottish-independence-myths-national.html
It is about Scottish Independence and the "National Debt"

"The APF is part of Bank of England which is part of HM Treasury which is part of UK government. Anybody who pretends that these are separate and independent bodies clearly needs psychiatric treatment and I cannot help them."
In Information Systems this is known as white box and black box testing. With white box you can see the internals and with black box you can't - requiring you to conform to that modules interface in your testing.