Paying for the ‘magic money tree’ – Birmingham Post article 18.02.2021

The Government has been borrowing staggering sums to pay for the coronavirus crisis. December alone came in at £34.1 billion, £28.2 billion more than in the same month in 2019. It is estimated that borrowing could reach £393.5 billion by the end of the financial year in March. In December, the national debt stood at £2.13 trillion, up £333.5 billion since the start of the financial year. It is now above 100 per cent of the UK’s gross domestic product (GDP), the value of goods and services produced in the economy. There has even been speculation that the bill could hit £3 trillion before the economy is fully back up and firing. These are unimaginable sums for the average person, and not seen since the 1960s. No wonder then that so many people are spooked and asking how we can possibly pay it back. Is the UK bust? All things being equal, it certainly isn’t the case that we will be asked to cough up as soon as the pandemic is over. Much of the borrowing is long-term debt and at very low interest rates. The imperative is for the Government to service the interest payments, not repay the capital. So, where are all these loans coming from? The Government borrows money by selling bonds. The buyers of these bonds, or “gilts”, are mainly financial institutions, like pension funds, investment funds, banks and insurance companies. Some of this debt is bought up by the Bank of England as part of its attempts to boost spending and investment, a policy known “quantitative easing” (QE). The Bank has so far acquired £875 billion of government bonds. Prospect magazine described the process thus: “This is not a magic money tree. Resources are not conjured from nothing. It is a system that relies on governments not debasing the money (too much, anyway) and not abusing their privilege to issue bonds. “While everyone has faith that the authorities will not mess with the promises encoded in the money and bonds, there should be no anxiety about whether borrowing can continue at this pace, or when paying down the debt needs to occur. In theory, the debt can be “rolled over” indefinitely. When government bonds fall due, governments can simply issue more to a new cohort of savers, and use the funds to pay back the old cohort who now want to cash in. “This is not to say that there is no limit to how far the bond and money issuance can go on. There is a fiscal limit. As we and other economies have cruised safely past 100 per cent (Japan is currently at about 250 per cent), we have learned that the fiscal limit is further away than we thought. But there is a limit nonetheless, and it is bound up in people’s views of the ability of the Government and the economy to make good on the claims savers hold. “If the Bank of England’s creation of money isn’t calibrated to be consistent with its inflation target, or even if it was but people panicked that it wasn’t, the financing plan would start to unravel. And if the real value of debt gets too far out of line with the economy’s capacity to pay the interest on it, likewise the demand for those government bonds will fall and rolling over the debt will get more expensive, and ultimately prove impossible.” A reckoning of sorts is coming. That will mean higher taxes at some point – the question is ‘when’. Chancellor Rishi Sunak will surely want evidence of recovery and growth before he acts.