Why The UK Issues Bonds Mystery

Why is it that we still run a national debt with interest payments when we are the monopoly issuer of our own currency and effectively borrowing back what we alone can create? The short answer is we do no such thing, the UK sells bonds so swaps one asset for another, we will issue bonds to any holder of GBP. No other currency is ever accepted for treasuries (bonds) sometimes known as gilts. The difference between the two is the schedule of interest payments. So if the government receives money it means it has more right? No. That money is paid back with interest known as the coupon and therefore appears as the national debt. Many argue that debt interest payments are nothing more than corporate welfare as the bonds are essentially risk free, the UK government can never run out of pounds to pay debt and interest. So why is the system still in place?

In days gone by we had the Gold Standard, all notes in circulation could be swapped back into gold, this is why to this day every note in your pocket has the words “I promise to pay the bearer” printed on it, all fiat money is based on a faith in that promise. This is from Investopedia “From 1871 to 1914, the gold standard was at its pinnacle. During this period near-ideal political conditions existed in the world. Governments worked very well together to make the system work, but this all changed forever with the outbreak of the Great War in 1914″. The system proved hopeless during more turbulent times and huge imbalances occurred, for example, at the end of WWII America held 75% of all the gold in the world, but this rapidly drained to pay for surging imports and rebuilding after the war. It’s purpose of restraining state spending failed.

The first ever bond issued by the Bank of England in 1693 was to raise money to fund a war against France, a worthy cause I’m sure we’ll all agree. (Note to self: Edit that last bit!) It was thought that rather than printing money to infinity, as is possible with fiat, borrowing money would instill discipline as it had to be paid back with interest. As the Gold Standard prevailed gold production was rarely in step with the economy’s need, so bonds were used to finance shortfalls. Today pension funds especially rely on bonds as a safe way to hold assets on our behalf as bonds are considered safe. To emphasise how important this is Look at this chart. The national debt is other people’s savings or money that hasn’t been taxed yet.

Introducing the Bond Monster, that mythical beast that will overthrow governments unless they deliver austerity on demand, which basically means more for them and less for us. The MMT economist Bill Mitchell has a scathing view of the bond monster and reasons thus.

1. The private bond markets have no power to stop a currency-issuing government spending.
2. The private bond markets have no power to stop a currency-issuing government running deficits.
3. The private bond markets have no power to set interest rates (yields) if the central bank chooses otherwise.
4. AAA credit ratings are meaningless for a sovereign government – they can never run out of money and can set whatever terms they want if they choose to issue bonds.
5. Sovereign governments always rule over bond markets – full stop.

He has a complete library of blog posts on central banking here.

In a way this is actually is an argument for bonds as they can be used as tool to hit a target interest rate as they currently do through QE, but QE is for another blog. It doesn’t have to be this way but it just is.

We now turn once again to Positive Money and the very knowledgable Ralph Musgrave with whom I have often crossed swords. He too is very firm on the subject of a sovereign government borrowing, “it’s pointless”.  In this very detailed paper, (21 page pdf) he says “Abba Lerner is widely credited with being one the first to claim that government borrowing is pointless in that funding government expenditure is not the main purpose of government borrowing”.

We are all familiar with the phrase tax and spend but this is very misleading, a government needs neither taxes or borrowing to spend, it simply shakes the Magic Money Tree,  otherwise known as the public purse. The state can create money at will so it spends first then balances the borrowing and taxes after, these are political decisions and little to do with economics. We all know that if a government just keeps on spending inflation will occur so the state reduces this risk via taxation and “borrowing” money. The aim of both these devices is to destroy the amount of money in circulation. Tax taken is money you can’t spend and by offering high interest rates to bondholders that money is not invested elsewhere, this is intentional crowding out of the private sector by the state.

The retention of bond issuance is therefore a matter of politics, especially so since 1971, the abandonment of the Gold Standard by the USA and the rise of Neo-Liberalism. The story runs that the government that the government must be restrained from buying votes with excessive spending by the rigour imposed by the private sector. What has actually happened is that the private banks now issue 97% of all money as debt and get to say where it is spent giving first mover advantage. How has this worked out for national debt levels? Not well.

So much for the private banks and Conservative’s reputation for fiscal prudence, it’s a myth and has been since 1979 and Neo-Liberal order took over, credit where it’s due, they talk a good game. I will hand over to Bruce Hornby and the Range to explain why we still issue bonds paying around £40 billion a year for the privilege.

That’s just the way it is
Some things will never change
That’s just the way it is
That’s just the way it is, it is, it is, it is

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