By accident rather than design, the way governments and their central banks around the world have funded Covid programmes has opened the door to a new paradigm in the way we run our economies. The pipe dream of direct financing by sovereign money—or debt-free government funding of social needs—has become an overnight reality. Here is the story of how it happened in the UK, and how it could bring about a very different future for public services and life opportunities.
UK government expenditure on the various Covid programmes—including furlough, self-employed support, emergency benefit increases and all manner of other reliefs and supports—tots up to around £400bn. In parallel, all sorts of tax receipts have taken a knock in the locked-down economy.
The resulting hole in the books has largely been funded by government debt, which exceeded £2trn by January 2021, not far off 100 per cent of GDP. That may sound a lot, but most informed observers judge this as manageable, since interest rates are historically low and other broadly comparable economies have long sustained a larger national debt relative to GDP—notably Japan, where the ratio currently stands at well over 200 per cent.
The question is whether we simply accept this debt, seek to repay it using tax increases or still more austerity which sucks further demand from the economy, or look to more radical solutions. The recent Budget chose a grim mix of options: based on a forecast of high debt for as far as the eye can see, it compounded our woes by announcing stiff tax rises and, yet again, retrenchment in day-to-day public service spending.
A subtle technical change with immense implications has taken place in the structure of that £2tn government debt. Normally, a government borrows to fund its expenditure by selling bonds to pension funds, insurance companies, and selected brokers through its Debt Management Office (DMO).
But just as the government was issuing new bonds to pay for the Covid relief, a range of mutual funds, hedge funds and foreign central banks, themselves struggling with investor flight, had to refinance by selling their huge existing public bond holdings. With a great glut of bonds suddenly on the secondary market, the price fell, or—equivalently—each pound invested in bonds was now giving a higher income, or “yield.” Unchecked, this market movement would have required higher yields (and so borrowing costs) on all the new government bonds being issued, and higher interest rates more broadly, which was exactly opposite to the intention of government policy.
In response to this threat, the Bank of England (BoE) intervened by purchasing these bonds on the secondary market, keeping their price up, and—equivalently—the yield and so borrowing costs low. It worked, but has left the BoE with a staggering £875bn holding of government debt, equal to some 40 per cent of total government debt. Similar moves have taken place in the US and the eurozone. This has two major implications: one ethical, and the other structural.
Ethically, the system needs an overhaul to avoid certain financial institutions being gifted unwarranted gains. As things stand, the BoE is only allowed to buy bonds in the secondary market, not directly from the DMO. This stricture means that brokers, insurance companies and pension funds with unique access to direct DMO bond sales not only benefitted from an increased value in their existing portfolios of bonds going up in price, but also made high margins on their sales to the BoE. They enjoy a locked-in role as middlemen on the new debt the Bank is buying, with guaranteed margins on a high volume of transactions at zero risk. This needs to change.
The main structural outcome, however, is even stranger than this anomaly. Although the Bank is “independent” in setting interest rates to control inflation, it is still wholly owned by the Treasury, its sole shareholder. The huge chunk of the national debt which is now represented by the Bank’s bond holdings therefore amounts to the government owing money to itself.
The philosopher Ludwig Wittgenstein mused on the absurdity of the left hand trying to give the right hand money. Why? Because it lacked the “further practical consequences” associated with a real transaction. There might seem to be something of the same absurdity in the government owing so much money to itself, but it could nonetheless have important practical consequences.
To see this, recall that the Bank is buying the debt through digital money creation or, in the jargon, quantitative easing. That phrase became almost familiar during the banking crash, when tanking revenues also left the government scrambling to borrow at the same time as attempting to keep borrowing costs low. The twist this time is that the government is borrowing from itself in order to allow itself to do huge new things—like running the furlough scheme. An unintended consequence of the oddities of Covid funding has thus been to legitimise the idea of putting such “debt-free sovereign money,” ie directly created digital money, to different uses. The increasingly naked way in which the right hand of the Treasury is borrowing from the left hand of the Bank neatly demonstrates that this is, in effect, already happening.
This offers us the opportunity of an epiphany, towards a radically new economic paradigm. Instead of the above complex and circuitous route, imagine that the government made the £72bn furlough payments of £24,000 a year to three million employed people directly and digitally to their bank accounts, by the direct issue of Central Bank Digital Currency. This would achieve the same macroeconomic outcome, and would not obviously be any more inflationary. Remember millions of people are getting this money, and that this has indeed effectively already been paid for by the issuing of debt which is, in turn, being financed by made-up digital money.
So what does doing things more directly achieve? It would avoid the creation of government debt and bond sales. It would avoid, too, the coming years of political economy being dominated by painful tax and public spending choices about “how to pay” for Covid.
The myth of a national debt equal to GDP would disappear into reality. The debt servicing cost of £41.6bn a year, and the great threat that this would increase by £25bn a year for every 1 per cent future increase in the interest rate, would be attenuated—and depending on how far the process is pushed, even eliminated.
The government would be able to channel necessary income to households, including through widely proposed basic income schemes, allowing them to avoid private debt and thus avoiding the threat of further economic crises like the one that hit in 2007/8. Austerity cuts could be reversed, and the health service properly funded.
Insofar as this restructuring simply replaces debt, it would remain non-inflationary. The indebtedness and excessive “financialisation” of the economy would at last be reduced, rather than merely lamented.
It’s time to grasp the nettle, the bull by the horns. Carpe diem!