HM Treasury sets the price, not The Market

I’m thinking of instigating a new series called “Warner Watch” which will catalogue, and debunk, the increasingly deranged ramblings of mainstream economic commentators - as exemplified by Jeremy Warner of the UK Telegraph.

If you spot any particularly egregious examples of UK-related economic quackery in the press, let me know on Discord¹.

Jeremy’s article ‘Trussonomics’ has put the PM on a collision course with the Bank of England has the usual shibboleths in it:

All of sudden, the Debt Management Office (DMO) finds itself with an extra £180bn of government debt to issue over and above the £131bn it has already got pencilled in for this financial year. Without the Bank of England to lend a hand, and with international confidence in the UK economy at a depressingly low ebb, it’s a big ask.

It’s only a big ask if you don’t understand how the monetary system works. Since there is now a detailed description of the way the system works, there is no excuse for misrepresenting the process.

If there is £180bn of debt to issue, there will be an additional £180bn of cash savings assets remaining in the system from prior government spending. That will generate more than £180bn of demand for the longer-term debt because banks and depositors may bid against each other using the same claim over the underlying cash asset. There are still vast quantities of excess cash assets in the system due to QE. Why would they not want a higher interest rate?

The UK relies instead not so much on what Mark Carney, former Governor of the Bank of England, has called “the kindness of strangers”, as a cold minded calculation by investors of how much money they can make lending to us, and whether there are not better opportunities elsewhere.

This is where the fixed exchange rate thinking creeps in. Sterling is a closed system with a floating exchange rate. All you can do if you hold Sterling is swap it with somebody else who will then hold the Sterling instead - with the same internal choices you had. Since you can’t use Sterling to buy US Treasuries, there are no opportunities for that Sterling elsewhere. The only way to get rid of it is to swap it for something else issued by the UK government sector.

Just how high an interest rate will they end up demanding? So far the DMO has had little difficulty raising debt as required, with all its recent auctions subscribed in line with the historic average of around 2.5 times.

But if inflation doesn’t come down quickly, then things will begin to crack.

Why will things begin to crack? The only other thing you can do with Sterling is put it in a bank, at which point the bank will swap it for the higher rate on offer from the DMO. Since there are vast quantities of cash assets, demand is going to be greater than supply for some considerable time.

It is only the policy choice of HM Treasury to continue using the Full Funding Rule that stops the price from dropping further. Now we are outside the EU we have the option to drop that and go back to using the Ways and Means account like we always used to. That would eliminate any excess supply of Gilts and drive the yield down.

As it is, the Government is about to have its fiscally profligate plans for growth severely tested by markets.

Ah, the final appeal to the Old Testament-style God of the Markets who will viciously punish all non-believers.

The Market is servant, not master because Sterling is a public monopoly and monopoly rules apply. Whether the government pays interest is entirely a policy choice. There is no reason at all for government to continue to issue Gilts or Treasury Bills, nor pay interest on them. Stopping interest payments will eliminate the interest income and forward pricing channels, causing inflation to decline faster. Moreover, it would make the implementation of a Central Bank Digital Currency that much easier. After all, there are no interest payments on physical cash. So why should there be any with digital cash?