So in #1 you've "invented" QE. I particularly like the idea that the BofE may fund gilt purchases with an interest rate in excess of the bond coupon! That would really incentise investing!
In #2 you've "invented" stockbrokers. See for example ii.co.uk. Others are available....
OK, let's think about what QE is, and its implications. The cashflows are these: BOE gifts commercial banks reserves to buy government bonds. The banks then forward that cash to the government, which in turns forwards the cash to h'holds for the necessary pandemic-related supportive spending. Quick, easy and cheap, and with no initial drag on the banking system's provision of other financing. What's not to like?
The problems only arise when/if the music stops. If/when BOE stops expanding its support for bank reserves, the banking system potentially has a problem. It can either hang on to its bond portfolio, or it can dump them. If it hangs on, then that proportion of its balance sheet gets frozen indefinitely. Which compromises its ability to keep growing other assets. In extreme cases, this paralyses the system. You can see this in action in Japan, where the banking system has become decorative rather than functional, with savings/investment mediation now being done primarily by BOJ itself and corporate (via vendor financing).
If it dumps the bonds, yields rise sharply, with banks taking mark-to-market losses which in turn inhibit subsequent asset growth.
No central bank has yet finessed this end-game problem. The Fed is trying to do it by massive - absolutely massive -repo/reverse repo operations. Last count, the Fed had a reverse repo book of $2.45tr, equivalent to just under three quarters of reserves balances! With Japan, it just goes on and on and on.
By contrast, if you sold the bonds to the public, the govt gets the cash (though it takes more work), which it then recycles back in supportive spending. The difference? The h'hold sector financial balances are strengthened, and you don't have the hangover problem. I think this is an improved solution. More, I think the financial & social benefits justify the degree of fiscal 'encouragement' which the cheap financing represents. You're right, of course, it would seem an unbelievably good offer you'd have to be crazy to spurn. If you want to change the weather, that's the sort of thing you're going to have to do.
Second: I'm not inventing stockbroking, I just think there's benefit and opportunity in making it massively more available and competitive. You think it's competitive now? Recently I got an email from Saxo which told me they were going to double their quarterly fees for holding accounts (from £50 a quarter to £100 a quarter). We live in inflationary times, but seriously, fees to be doubled? It hardly smacks of a competitive industry. But thanks for pointing me to II - maybe I'll migrate. Meanwhile, I think the point stands: if there's a benefit in broadening financial participation, then there's an argument that stockbroking needs to get more like DFS or SportsDirect. Why not?
Third: you're right. It's just an observation. I get fed up with commentators confining themselves to 'cryptos are a pointless and valueless potential fraud' without stopping to think why they exist at all.
You did ask for it…. 😊 and I appreciate your response.
On point #1: I don’t think you’ve got the QE mechanism right. BofE buys gilts from commercial banks in return for reserves, there’s no direct govt-commerical bank cashflow.
You are right that QE has a “when the music stops” issue which is why it’s been so hard to stop everywhere it’s been implemented, including Japan, but it’s a government debt problem rather than a banking problem. Banks often don’t mark their government debt holdings to market in any case and it’s not usually (ex extreme cases like the GFC) a lack of reserves that’s holding back bank lending – it’s credit risk concerns or lack of borrower demand.
Of course, QE doesn’t address your issue which is to increase household savings in order to boost investment.
Trouble is, neither does your suggestion.
Cashflows from your suggestion:
- Person borrows £90 from BofE at e.g. 1% (not sure how BofE will deal with individuals, will probably have to go via banks adding costs but let’s ignore that for now)
- Person uses that £90 plus £10 of their own to buy £100 of eg 10yr gilts, currently yielding 2.4%. For simplicity, let’s assume that’s all coupon.
- So person gets £2.40 income with 90p interest cost => £1.50 net on £10 upfront => 15% yield ! WOW!
Plenty of people would like a 15% government backed return so you’d get plenty of take up.
BUT even ignoring how BofE funds the 140bp per year below market loan, or the fact that net the government is paying 15% on funds, this doesn’t do what you want. You want more saving to cause more lending. The government doesn’t lend. Commercial banks do. So you need to encourage people to put more into savings in the banks (and not into fx, or crypto which don’t lead to investment either). Your suggestion doesn’t get a penny more into the banking system.
A good exchange. First, I think your point about the gilts/reserves exchange is a chicken/egg problem which isn't materially important in that it doesn't alter the cashflows, except perhaps for the nanosecond between BOE's receipt of gilts and its disbursement of reserves. Still, I may be wrong.
I think the problem about holding all that govt debt on your balance sheet to maturity (usually in order to avoid the mark-to-market losses) does matter, because it freezes that part of the balance sheet. And this can get material, not just in Japan, but potentially now also in the US, where securities holdings account for exactly a third of commercial bank credit. Exaggerating for effect: in Japan QE has turned the banks into bond funds, leaving them will little incentive or ability to create/buy other assets.
As for the buy now/pay later proposal for gilts, I do think you do misunderstand the point of it. The point is to kickstart a change in the spending/saving culture by evening up the incentive and cost structures which support spending whilst discouraging saving. So this is a shock tactic - the Tell Sid moment. Ultimately, the aim is to raise the level of saving in order to support a higher level of investment. The change in the culture and/or expectations is the important point. (I think I should also add that the proposal isn't entirely novel - the Federal Reserve did something similar as part of the effort to fund WW2.)
As for wanting more bank lending. . . well, not really, since banks have everywhere and always proved themselves rather poor asset-allocators. (f you gave them more savings, they'd only plough it into more London property.) So the secondary aim is to expand the savings ecology with the ultimate aim not just of more investment, but of more diverse, and more economically efficient investment. Am I prepared to tolerate 'leakages' along the way (ie, fx, crypto), then the answer is, if those leakages are part and parcel of changing the terms of trade between spend and save, then yes, I'm prepared to tolerate that.
PS. If you want to drop me a line giving me the big reveal about who emjaytee is, I'd be grateful. Right now, people may think I'm merely talking to myself. Understandable perhaps, but not actually the case.
I certainly agree that offering people a levered government-backed return will get more people to buy government bonds. Whether or not that is worth doing is something that we will perhaps have to disagree on.
Very interesting point on labour flexibility, almost an argument for going for continental type inflexibility to get the higher productivity they enjoy albeit with the higher unemployment that goes with it. Although the US has flexibility and high productivity but crucially seem to be able to invest heavily and successfully. Some great ideas on how to encourage longer term employment contracts. While they’re about it maybe they can fix the ridiculous NI contribution employers have to make and the subsidisation/encouraging of companies not paying people enough given income support from the govt. Re our manufacturing capabilities Nissan did actually come to mind when I was writing but I couldn’t think of anyone else, not that means much given I’m no expert on U.K. companies.
Great article Michael. In terms of improving business investment, how do we do that? Hasn’t experience shown that we just aren’t very good at making things (maybe with the exception of some high end cars, engineering parts, stereos) and maybe will always be a service exporter rather than much else
This is one of the key questions I was hoping someone would ask, because I do smuggle in an underlying assumption that if you get savings right, investment will follow. In the long run, that's an assumption I'm happy to make. But in the short/medium term, more is needed.
So I suggest one more sacred cow needs to be led to the slaughter: the belief that your labour markets can never be too 'flexible'. When labour markets become too flexible, they will prove a barrier to business investment.
This happens in two ways. First, it skews the capital / labour choice at the corporate level. Imagine a company gets a 'demand surprise' and wants to raise production to meet it. Often the choice is a) do I invest in a new machine, which will be on my balance sheet for at least the next 10yrs, or b) do I ship in a bunch of temporary workers on short-time contracts who will disappear if the demand surprise wanes? Obviously, b) is the more attractive choice if you can do it. (NB, this is not a theoretical possibility, I've seen it happen in my local town.)
The second way it happens is that, over time, reliance on short-term contracts breaks down the basic mutual commitment/loyalty which must exist between management and staff for investment to be made. If the management has never committed to long-term employment contracts, why should it invest in training for its staff? It will, after all, only be training up his competitor's likely workforce.
There's a whole other point, which is also important: an economy based on short-time insecure contracts breeds a wider set of insecurities. For example, short-time workers will find it hard to get a mortgage (or sometimes even a bank account), and the costs of that will inevitably be born one way or another by the taxpayer.
So I view super-flexible labour markets as a problem which not only inhibits business investment, but imposes external costs on the rest of the community. For these reasons, what I've suggested elsewhere (https://sdp.org.uk/the-end-of-indifference/#section_11) is that corporate taxes should include an element of 'polluter pays' taxes for those companies whose business model depends on, or merely encourages, heavy staff turnover.
If you audit for the median time an employee has been with the company and lower/raise corporate tax rate in response, you introduce a fiscal incentive for companies to have a lower staff turnover. In turn that will give them an incentive to retain and develop staff, which in turn will mean an incentive to raise productivity in order to raise earnings, which in turn will demand more investment in the company, in the workforce.
The mutuality upon which all cooperative businesses depend (and all businesses are in the end cooperative ventures) is strengthened. Zero-hours dependent companies get penalized, companies committed to long-term development get rewarded.
Finally, there's no reason to believe that 'we just aren't very good at making things': Nissan seems to get along OK.
So in #1 you've "invented" QE. I particularly like the idea that the BofE may fund gilt purchases with an interest rate in excess of the bond coupon! That would really incentise investing!
In #2 you've "invented" stockbrokers. See for example ii.co.uk. Others are available....
In #3 you've said nothing.
Well done!
Ha, incoming! Well, I asked for it.
OK, let's think about what QE is, and its implications. The cashflows are these: BOE gifts commercial banks reserves to buy government bonds. The banks then forward that cash to the government, which in turns forwards the cash to h'holds for the necessary pandemic-related supportive spending. Quick, easy and cheap, and with no initial drag on the banking system's provision of other financing. What's not to like?
The problems only arise when/if the music stops. If/when BOE stops expanding its support for bank reserves, the banking system potentially has a problem. It can either hang on to its bond portfolio, or it can dump them. If it hangs on, then that proportion of its balance sheet gets frozen indefinitely. Which compromises its ability to keep growing other assets. In extreme cases, this paralyses the system. You can see this in action in Japan, where the banking system has become decorative rather than functional, with savings/investment mediation now being done primarily by BOJ itself and corporate (via vendor financing).
If it dumps the bonds, yields rise sharply, with banks taking mark-to-market losses which in turn inhibit subsequent asset growth.
No central bank has yet finessed this end-game problem. The Fed is trying to do it by massive - absolutely massive -repo/reverse repo operations. Last count, the Fed had a reverse repo book of $2.45tr, equivalent to just under three quarters of reserves balances! With Japan, it just goes on and on and on.
By contrast, if you sold the bonds to the public, the govt gets the cash (though it takes more work), which it then recycles back in supportive spending. The difference? The h'hold sector financial balances are strengthened, and you don't have the hangover problem. I think this is an improved solution. More, I think the financial & social benefits justify the degree of fiscal 'encouragement' which the cheap financing represents. You're right, of course, it would seem an unbelievably good offer you'd have to be crazy to spurn. If you want to change the weather, that's the sort of thing you're going to have to do.
Second: I'm not inventing stockbroking, I just think there's benefit and opportunity in making it massively more available and competitive. You think it's competitive now? Recently I got an email from Saxo which told me they were going to double their quarterly fees for holding accounts (from £50 a quarter to £100 a quarter). We live in inflationary times, but seriously, fees to be doubled? It hardly smacks of a competitive industry. But thanks for pointing me to II - maybe I'll migrate. Meanwhile, I think the point stands: if there's a benefit in broadening financial participation, then there's an argument that stockbroking needs to get more like DFS or SportsDirect. Why not?
Third: you're right. It's just an observation. I get fed up with commentators confining themselves to 'cryptos are a pointless and valueless potential fraud' without stopping to think why they exist at all.
You did ask for it…. 😊 and I appreciate your response.
On point #1: I don’t think you’ve got the QE mechanism right. BofE buys gilts from commercial banks in return for reserves, there’s no direct govt-commerical bank cashflow.
You are right that QE has a “when the music stops” issue which is why it’s been so hard to stop everywhere it’s been implemented, including Japan, but it’s a government debt problem rather than a banking problem. Banks often don’t mark their government debt holdings to market in any case and it’s not usually (ex extreme cases like the GFC) a lack of reserves that’s holding back bank lending – it’s credit risk concerns or lack of borrower demand.
Of course, QE doesn’t address your issue which is to increase household savings in order to boost investment.
Trouble is, neither does your suggestion.
Cashflows from your suggestion:
- Person borrows £90 from BofE at e.g. 1% (not sure how BofE will deal with individuals, will probably have to go via banks adding costs but let’s ignore that for now)
- Person uses that £90 plus £10 of their own to buy £100 of eg 10yr gilts, currently yielding 2.4%. For simplicity, let’s assume that’s all coupon.
- So person gets £2.40 income with 90p interest cost => £1.50 net on £10 upfront => 15% yield ! WOW!
Plenty of people would like a 15% government backed return so you’d get plenty of take up.
BUT even ignoring how BofE funds the 140bp per year below market loan, or the fact that net the government is paying 15% on funds, this doesn’t do what you want. You want more saving to cause more lending. The government doesn’t lend. Commercial banks do. So you need to encourage people to put more into savings in the banks (and not into fx, or crypto which don’t lead to investment either). Your suggestion doesn’t get a penny more into the banking system.
Or have I misunderstood your idea?
Best wishes
A good exchange. First, I think your point about the gilts/reserves exchange is a chicken/egg problem which isn't materially important in that it doesn't alter the cashflows, except perhaps for the nanosecond between BOE's receipt of gilts and its disbursement of reserves. Still, I may be wrong.
I think the problem about holding all that govt debt on your balance sheet to maturity (usually in order to avoid the mark-to-market losses) does matter, because it freezes that part of the balance sheet. And this can get material, not just in Japan, but potentially now also in the US, where securities holdings account for exactly a third of commercial bank credit. Exaggerating for effect: in Japan QE has turned the banks into bond funds, leaving them will little incentive or ability to create/buy other assets.
As for the buy now/pay later proposal for gilts, I do think you do misunderstand the point of it. The point is to kickstart a change in the spending/saving culture by evening up the incentive and cost structures which support spending whilst discouraging saving. So this is a shock tactic - the Tell Sid moment. Ultimately, the aim is to raise the level of saving in order to support a higher level of investment. The change in the culture and/or expectations is the important point. (I think I should also add that the proposal isn't entirely novel - the Federal Reserve did something similar as part of the effort to fund WW2.)
As for wanting more bank lending. . . well, not really, since banks have everywhere and always proved themselves rather poor asset-allocators. (f you gave them more savings, they'd only plough it into more London property.) So the secondary aim is to expand the savings ecology with the ultimate aim not just of more investment, but of more diverse, and more economically efficient investment. Am I prepared to tolerate 'leakages' along the way (ie, fx, crypto), then the answer is, if those leakages are part and parcel of changing the terms of trade between spend and save, then yes, I'm prepared to tolerate that.
PS. If you want to drop me a line giving me the big reveal about who emjaytee is, I'd be grateful. Right now, people may think I'm merely talking to myself. Understandable perhaps, but not actually the case.
Thanks.
I certainly agree that offering people a levered government-backed return will get more people to buy government bonds. Whether or not that is worth doing is something that we will perhaps have to disagree on.
And no, you're not talking to yourself!
Very interesting point on labour flexibility, almost an argument for going for continental type inflexibility to get the higher productivity they enjoy albeit with the higher unemployment that goes with it. Although the US has flexibility and high productivity but crucially seem to be able to invest heavily and successfully. Some great ideas on how to encourage longer term employment contracts. While they’re about it maybe they can fix the ridiculous NI contribution employers have to make and the subsidisation/encouraging of companies not paying people enough given income support from the govt. Re our manufacturing capabilities Nissan did actually come to mind when I was writing but I couldn’t think of anyone else, not that means much given I’m no expert on U.K. companies.
Great article Michael. In terms of improving business investment, how do we do that? Hasn’t experience shown that we just aren’t very good at making things (maybe with the exception of some high end cars, engineering parts, stereos) and maybe will always be a service exporter rather than much else
This is one of the key questions I was hoping someone would ask, because I do smuggle in an underlying assumption that if you get savings right, investment will follow. In the long run, that's an assumption I'm happy to make. But in the short/medium term, more is needed.
So I suggest one more sacred cow needs to be led to the slaughter: the belief that your labour markets can never be too 'flexible'. When labour markets become too flexible, they will prove a barrier to business investment.
This happens in two ways. First, it skews the capital / labour choice at the corporate level. Imagine a company gets a 'demand surprise' and wants to raise production to meet it. Often the choice is a) do I invest in a new machine, which will be on my balance sheet for at least the next 10yrs, or b) do I ship in a bunch of temporary workers on short-time contracts who will disappear if the demand surprise wanes? Obviously, b) is the more attractive choice if you can do it. (NB, this is not a theoretical possibility, I've seen it happen in my local town.)
The second way it happens is that, over time, reliance on short-term contracts breaks down the basic mutual commitment/loyalty which must exist between management and staff for investment to be made. If the management has never committed to long-term employment contracts, why should it invest in training for its staff? It will, after all, only be training up his competitor's likely workforce.
There's a whole other point, which is also important: an economy based on short-time insecure contracts breeds a wider set of insecurities. For example, short-time workers will find it hard to get a mortgage (or sometimes even a bank account), and the costs of that will inevitably be born one way or another by the taxpayer.
So I view super-flexible labour markets as a problem which not only inhibits business investment, but imposes external costs on the rest of the community. For these reasons, what I've suggested elsewhere (https://sdp.org.uk/the-end-of-indifference/#section_11) is that corporate taxes should include an element of 'polluter pays' taxes for those companies whose business model depends on, or merely encourages, heavy staff turnover.
If you audit for the median time an employee has been with the company and lower/raise corporate tax rate in response, you introduce a fiscal incentive for companies to have a lower staff turnover. In turn that will give them an incentive to retain and develop staff, which in turn will mean an incentive to raise productivity in order to raise earnings, which in turn will demand more investment in the company, in the workforce.
The mutuality upon which all cooperative businesses depend (and all businesses are in the end cooperative ventures) is strengthened. Zero-hours dependent companies get penalized, companies committed to long-term development get rewarded.
Finally, there's no reason to believe that 'we just aren't very good at making things': Nissan seems to get along OK.