Is the government making a profit on its debt?
The Bank of England’s inflation report was out yesterday. It says that there’s a good chance that inflation will hit 5% before the end of the year. The Consumer Price Index is currently sitting at 4%. Keep those numbers in your head.
Now look at this one. The government is currently paying around 3.75% interest on its debt. That’s very low. This is, of course, no surprise. As the rest of the world goes to the dogs, investors looking for a safe bet see British bonds as a steady place to store their money. Funds looking to play it safe want to leave their cash with the UK government because there is a very low risk we will default.
Now look at these two numbers together. Our interest payments are lower than inflation.
When debt interest is lower than inflation, the lender is losing money – and the borrower is in effect making it. Imagine if you lent me £10 in 1950, with no interest. I pay you back with £10 today. Then, in real terms, you have lost money, and I have gained it. Because you can buy less today with £10 than you could in 1950. The money I pay back to you is worth less than the stuff I got with it 60 years ago.
If we, like the Tories, were to use household analogies to talk about British Government debt, then we would say this: inflation is higher than the interest being paid. The Government is therefore making a profit on its debt. And this is, as I understand it, true in a sense.
Of course, Tory household analogies are never fully honest. While it may be true, it is much more complex than this. Because we have to ask this – what is this debt shrinking in comparison to? Ultimately, it isn’t the size of our debt that matters, it is the size of our external debt in comparison to the size of our economy.
Let’s unravel that a little. First, let’s look at the government’s debt when compared with the size of our economy, measured in GDP. It’s lower than it’s been for 200 out of the last 250 years. That’s why the Tories don’t like to use that figure. Because any realistic measure of our debt shows that it’s nothing to worry about.
Of course, even that figure isn’t relevant. Because this isn’t external debt. Almost all (70%-80%) of it is owed to people within the UK – our pension funds, and the like. Saying Britain is in debt would be like saying a household is in debt because a mother has lent her son a tenner – the household isn’t in debt overall because while the son is down £10, the mother is in credit by the same abount – it all evens out.
Essentially the British private sector has wanted somewhere safe to store their money until the economic storms subside. And the government has provided a safehaven – a place to store what Keynes called this “wealth as such”.
No. Anyone used to campaigning on developing world debt knows that what matters is external debt – the debt we, Britain, owe to other countries – our national balance sheet. Have you ever heard the Tories talk about that? No. Because there is, in Britain, nothing to worry about. The amount of money owed to the rest of the world is tiny.
And so the Tories don’t talk about our debt to GDP. Because that shows that we don’t have a problem. And they don’t talk about net foreign debt. Because that too shows there is no need to cut.
No. They talk about the debt left by Labour, and the cost of interest payments on this debt. Well, according to the latest figures, we are now making an effective profit on this debt.
And so the final argument that remains is the deficit – the amount that the debt grows by each year (or, put another way, the amount that the private sector wishes to deposit in government bonds each year). Well, after the biggest financial collapse in a century, and at a time when we are making a profit on our debt, what’s the problem with borrowing a little extra to keep the economy afloat? After all, looking at the final set of figures out yesterday – where growth projections were revised down – it’s not like the government’s cuts are helping close a deficit caused by unemloyment.
Seems others have noticed this – the Government have just re-introduced inflation protected bonds: http://bbc.in/ilafPD
I congratulate you on your sleight of hand. Bernie Maddof could not have done better. The govt is in fact ‘profiting’ from it’s debt. Well let’s lay on some more then!!! Bring it on.
Because you know people, the idea that debt is a problem and not in fact a profit making industry is just your own plebeian stupidity talking.
Or…..maybe, just maybe debt does come home to roost, for example when interest rates rise. You may also remember they fell when the Conservatives put in their first budget leading to this wondrous situation we are in.
Don’t be taken. If it sounds too good to be true it damn well is.
Yours Bernie M
Adam,
A couple of points.
The debt is not really the issue, it’s the deficit. Currently around £145Bn a year, one year’s deficit adds around £5.5Bn to the annual interest payments (without even paying any of the capital). That £5.5Bn has to come from somewhere, and deficits on this scale are clearly unsustainable.
So it’s clear we need to get that down pretty smartly. Where I part company from the Coalition is how fast and in what way – much of what it’s doing will save far less if it chokes the economy, not to mention the impact on the most vulnerable.
Doing nothing means bigger interest bills and a much bigger debt in the long term. The ‘fix’ will indeed be inflation – and those with frozen salaries (two years = 10% pay cut) and savings will be hit very hard. Governments have traditionally used inflation to erode big debts and they’re doing it here. I have no doubt Mervyn King’s monthly letters are received with glee by George Osborne.
My second point is your analogy with me lending my son a tenner is false. Unless of course he’s going to pay me back and at the same time I can take it off him to pay for some of the groceries. Lending to UK based institutions at a rate below inflation indeed benefits the Government, but why lenders are willing at that rate is beyond me, unless (as I suspect) they can’t get a better rate with guaranteed security elsewhere, so it’s probably our pension funds taking the hit. For oversees lenders they may feel protected by an anticipated fall in Sterling as inflation rises.
I actually briefly considered taking out a student loan when I was at uni, sticking it in a bank account for the 4 years, and then paying the main sum back and keeping the interest. In the end it would have been a) slightly amoral and b0 too much hassle, so I didn’t
Ali,
yes, good point – though that doesn’t mean the broader point doesn’t still stand – if we use a crude household analogy, then the debt Labour left is getting smaller (obviously the total debt is getting bigger because of the deficit). As you say, ‘smaller’ is a relative term, and what we compare it to depends to a certain extent on what the conversation we are having is.
Johm, as Ali says, the interest rate we pay is defined by the willingness of markets to re-finance our debt. The latest re-finance figures show that they are more than delighted to – in fact, they are more happy to than they normally are. Bond markets, though they are not entirely rational, are not completely irrational. In other words, there is less reason to be worried about them now than there has been in most of the years in the last century…
Alasdair: agree with all that, and that the dangers of reaching some distant puke point have been talked up for nakedly political reasons.
Just thought it worth stressing that “we can afford the debt” is not the same is “the debt is not a problem”. They’re overlapping, but not identical.
Interesting piece, a lot of stuff I hadn’t considered before.
One thing, though – the key point, though, is not the cost of the debt, it’s whether the markets will keep funding it. If the bond markets stop buying, we’re screwed.
The bond markets might be idiots to stop buying. UK government debt might be the best long-term bet out there. Nonetheless, if they won’t buy it, we get screwed.
We’re basically being held captive by their irrationality. But even if their reasons for nervousness are fictitious, the impact they can have is very real.
That’s true Jonn, but there’s not really any evidence that the bond markets will stop buying our debt, as Adam points out it’s at a historically cheap price at the moment, which means lots of people are buying, and in fact it’s become cheaper since the last MPC report in February. Market’s aren’t efficient (in their meaning of that word) and they’re not rational, but they’re not entirely stupid either, most of the price in government bonds at the moment looks pretty sensible.
Your analogy is only half right, if I lend you £10 at no interest and you pay me back in 10 years, I’ve lost money, but you haven’t necessarily made money. If you kept that £10 in a box then gave it back to me, you have exactly the same money at the end. So it depends what you do with the loan, which is why you have to look at GDP, for example.
So if we borrow at 3.5% to invest in education or renewable energy, that probably does make us money. So in fact it’s not even the GDP growth rate we have to compare with the interest rate we’re paying, it’s the marginal GDP growth rate of that investment, which is hard to determine. Basically we need to know if investing £1 in some government programme increases GDP that year by more or less than £1.035.