Austerity is improving the UK Public Finances

As we head towards the weekend we have the opportunity to not only look at an area  where there has been good news but also inject a little humour. The latter was unintentionally provided by the OBR or Office for Budget Responsibility earlier this week.

second, we look at the potential fiscal impact of future government activity, by making 50-year projections of all public spending, revenues and significant financial
transactions, such as government loans to students.

No your eyes do not deceive you it really has forecast our fiscal future out towards 2068. This is from an organisation that in its eight years of existence has shown amazing consistency in being wrong. Sometimes it has been wrong pretty much immediately and at other times we have has to wait but usually not for too long. If we look back to its early days then let me give you two examples of its forecasting arrows not only missing the target but soaring out of the stadium with the crowd ducking for cover. Wage growth was forecast to be around 4.5% now and that is being nice to them as you see they got unemployment wrong too and so if we apply their “output gap” style analysis they would have wage growth at 5% or more. Also they would have Gilt yields up towards 5% as well whereas all are below 2% and the ten-year yield is 1.24%.

For newer readers that is the road which led to this.

The first rule of OBR Club is that the OBR is always wrong.

Putting it another way here is how something which is very good what is called the Whole of Government Accounts which as you can see below is sadly converted into laughing-stock status.

The net present value of future public service pension payments arising from past employment was £1,835 billion or 92 per cent of GDP. This is £410 billion higher than a year earlier, with the rise more than explained by the use of a lower discount rate to convert the projected flow of future payments into a one-off net present value and by other changes to assumptions underpinning the value of the liabilities.

The saga starts really well as I regularly get asked for an estimate of the UK’s pension liabilities but as you can see an enormous change has happened due to “a lower discount rate” . So the interest-rate or more specifically yield has been changed by an establishment that has consistently got yields not only wrong but very wrong. This also happened in the insurance world where this sort of blundering in the dark caused a lot of changes and costs.

The NHS

The OBR weighed in on this subject earlier this week and as a reminder this is the issue as described by the BBC.

Last month, the Prime Minister announced that the NHS in England would get an extra £20bn a year by 2023.

The £114bn budget will rise by an average of 3.4% annually.

In itself this is simple as government’s plan to spend more all the time and actually the OBR feels it needs to do so as the demographics of an ageing population bites. Yet we ended up with more heat than light and I could write a whole post on the “Brexit Dividend” so let us instead look at the overall position. There are three ways this can be paid for.

The easiest is that the economy grows by enough to finance it via higher taxes and lower social spending. After all we live in an era of Black Swan events but even in these days they happen only from time to time so the other choices are higher taxes or borrowing more. As you are about to see the public finances data have been pretty good over the past 18 months or so ( something else the OBR got wrong as it predicted a pretty substantial rise for the fiscal year just gone). So as we stand we could borrow the money quite easily and as I explained earlier we can do so cheaply in fact extremely cheaply in historical terms. Just for clarity as these issues get heated I am not advocating such a move simply saying that as we stand we could and probably quite easily. That seems to have got lost as at least some of the media looks for examples of higher taxes in response to the extra spending.

This whole issue makes me look back over the last issue and something stands out so let me put it in italics.

Over the credit crunch era we have borrowed a lot when it has been (relatively) expensive and not it is cheaper we are borrowing much less.

Some of that was forced on us but not all of it.

Today’s data

This continues to be good.

Public sector net borrowing (excluding public sector banks) decreased by £0.8 billion to £5.4 billion in June 2018, compared with June 2017;

As is the picture with a little more perspective

Public sector net borrowing (excluding public sector banks) in the current financial year-to-date (April 2018 to June 2018) was £16.8 billion; that is, £5.4 billion less than in the same period in 2017; this is the lowest year-to-date (April to June) net borrowing since 2007.

So we are back to pre credit crunch levels in this regard and the trajectory is lower. If we look into the detail then we see this about revenues.

In the current financial year-to-date, central government received £169.4 billion in income, including £125.0 billion in taxes. This was around 3% more than in the same period in 2017.

Looked at like that we get a confirmation of the slowing of the housing market as Stamp Duty revenues have fallen by £300 million to £3.1 billion and the QE operations of the Bank of England contributed £600 million less.

But on the other side of the ledger we do for once see some outright austerity.

Over the same period, central government spent £184.2 billion, around 1% less than in the same period in 2017.

Before we get too excited debt interest fell by £2.2 billion which will be mostly if not entirely the impact of lower ( RPI ) inflation on index-linked Gilts. Also the numbers for local councils have swung too so allowing for that we do not have outright austerity but we do on the measure compared with inflation.

National Debt

There is good news here too at least in relative terms.

Public sector net debt (excluding public sector banks) was £1,792.3 billion at the end of June 2018, equivalent to 85.2% of gross domestic product (GDP), an increase of £33.0 billion (or a decrease of 1.0 percentage points as a ratio of GDP) on June 2017.

There are also numbers excluding the Bank of England but sadly the numbers published are inconsistent. This happened a few months ago as well, There are also wider numbers for what previously I would have said was something of a gold standard but after the pension revision we looked at above I will merely say they are worth a look.

The overall net liability in the WGA was £2,421 billion or 122 per cent of GDP at the end of March 2017, up £435 billion on the previous year’s restated results ( OBR)

Comment

We have been on quite a journey with the UK public finances and to some extent it has been this sort of Journey.

It goes on and on and on and on

We have also seen that

Some will win some will lose

Because until this phase a lot of the austerity has been from one group to another as for example comparing the Triple Lock for the Basic State Pension with its 2.5% minimum with the 1% per annum for other social benefits and pay rises. But with the better news can we say this?

Don’t stop believing
Hold on to that feeling

We can to some extent but that does not mean the sky is pure blue. The clouds come from all the efforts to manipulate the numbers which would take an article in their own right and also the way the national debt has risen. Which allows me one more example of OBR Club unless of course we find an alternative universe where the national debt peaked at below 70% of GDP and then fell primarily due to us being in surplus for the last couple of years……

 

 

 

 

 

 

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The UK Public Finances are improving fast

A feature of the credit crunch era is the way that the same or similar stories get recycled and this is what I was thinking of when the proposed NHS ( National Health Service) spending boost was announced by Theresa May at the weekend.

There has been a change of Chancellor as George Osborne was removed and replaced with Phillip Hammond and it looks as though the new government will be fiscally looser.

That was from October 3rd 2016 and you may recall it was in tune with the mood music as even the IMF which had helped impose so much austerity on Greece had come out in favour of fiscal stimuli. However like with so much about the current government it never really happened on any scale. In fact if we look at the numbers I quoted then we see that the UK has continued to reduce its deficit and as ever confound the forecasts of the Office of Budget Responsibility or OBR.

In the financial year ending March 2016 (April 2015 to March 2016), the public sector borrowed £76.5 billion. This was £18.9 billion lower than in the previous financial year and less than half of that in the financial year ending March 2010 (both in terms of £ billion and percentage of GDP).

That was the picture then and it has been replaced by a deficit more like £40 billion in the fiscal year just completed. So whilst there has been an ongoing stimulus as we have had a persistent deficit the annual amount has been reduced partly due to growth in the economy which has made the national debt situation look more contained and to some extent better.

Public sector net debt (excluding public sector banks) was £1,777.3 billion at the end of April 2018, equivalent to 85.1% of gross domestic product (GDP), an increase of £56.8 billion (or 0.3 percentage points as a ratio of gross domestic product (GDP)) on April 2017.

As you can see it is rising in amount but the growth in the economy means that relatively it has changed much less.

Today’s data

This morning has brought borrowing figures which are very good.

Public sector net borrowing (excluding public sector banks) decreased by £2.0 billion to £5.0 billion in May 2018, compared with May 2017; this is the lowest May net borrowing since 2005.

Of course monthly data can be erratic but the fiscal year so far seems set fair as well.

Public sector net borrowing (excluding public sector banks) in the current financial year-to-date (April 2018 to May 2018) was £11.8 billion; that is, £4.1 billion less than in the same period in 2017; this is the lowest year-to-date (April to May) net borrowing since 2007.

Should we continue on anything like such a trajectory this year will see a solid fall in the fiscal deficit.

The NHS Proposal

If we skip the foaming at the mouth over the phrase “Brexit Dividend” it was reported like this by the Financial Times.

The NHS financial settlement — which could be unveiled as soon as next week, ahead of the taxpayer-financed system’s 70th anniversary — is expected to provide increases to the £150bn UK health budget of at least 3 per cent above inflation every year.

As you can see implementing such a policy would be a boost in real terms as at least 3% is circa £5 billion a year. The Institute for Fiscal Studies puts it like this.

Yesterday’s announcement implies that day-to-day spending by NHS England will increase by £16 billion in real terms between now and 2022–23 (with a further £4 billion in 2023–24).

Paying for it

There are three routes. One is simply higher economic growth which in the short-term is problematic as we are in a soft patch which the monetary numbers are signalling will remain through the autumn. Taxes could rise but this government ha shad trouble with that as the debacle over national insurance for the self-employed showed. This leaves borrowing more which in the circumstances seems feasible.

In terms of amount we are borrowing less as discussed above and the cost of our borrowing remains cheap. The UK ten-year Gilt yield is a mere 1.3% and the more relevant for these purposes thirty-year yield is 1.77% . This is of course more expensive than in the late summer of 2016 when Bank of England Governor Mark Carney spent £60 billion on in this respect kamikaze style purchases driving the market to all-time price highs and yield lows including in the madness some negative ones. But it is in terms of the thirty-years I have been following this market certainly low and in fact ultra low.

The Institute of Fiscal Studies is rather dismissive of this route.

But a significant increase in forecast borrowing would mean that the government was not taking its stated commitment to eliminate the deficit by the mid-2020s seriously. The deficit is already forecast to be £21 billion in 2022–23, implying further consolidation measures – in the form of tax rises or spending cuts –would need to be implemented.  The Government could decide to abandon its fiscal objective, as its predecessors have frequently done in the past.

Actually the recent fiscal data suggests that they probably would not have to do that as we see yet another Ivory Tower lost in the clouds of its own rhetoric.

What has today’s data told us?

For all the talk of a fiscal stimulus something of a squeeze has been going on.

In the latest financial year-to-date, central government received £112.9 billion in income, including £82.6 billion in taxes. This was around 3% more than in the same period in 2017.

Over the same period, central government spent £123.6 billion, roughly equal to that spent in the same period in 2017.

In terms of controlling public spending we have come to learn that this is about as good as it gets. We are mostly incapable of reducing it in nominal terms but we do have phases of reducing it in real terms.

Also the receipts data hint at the economy having been stronger than we thought. What I mean by this is that income tax receipts have risen by £2,5 billion to £25,5 billion in the latest couple of months. Indeed even the much maligned retail sector may be getting some support as VAT ( Value Added Tax) receipts rose by £1.1 billion to £23.2 billion. In case this seems like over explaining the rise the numbers are influenced by Bank of England QE from which dividend or coupon payments are taken as receipts and that was a -£0.9 billion influence.

Oh and the spending numbers have been boosted by a fall in debt costs as the rise in ( RPI) inflation washes out of the system.

Comment

There is a lot to consider here so let us start with the UK public finances. Back in October 2016 they were disappointing in the circumstances and now they are good in the circumstances. As some tax receipts represent past activity there may be at least some logic at play as it takes time for the numbers to reflect it. If the data carries on like this then those who use tax receipts as a measure of the economy may feel it is out performing what the GDP data tells us and fits the employment numbers.

The catch is the current slow down and the one we expect from the money supply data which will weaken the above trends. However we find yet another situation where the first rule of OBR Club has hit the cricket ball for six.

 and £5.7 billion less than official (Office for Budget Responsibility) expectations;

So as we stand the UK Public Finances might shrug off a fiscal boost for the NHS although as ever recession would change that. As to how much of a good idea it is remains open to question. On a personal level Frimley Park Hospital gave good care to my father and on less serious matters my mother and I am grateful to Chelsea and Westminster for the work on my knee. Yet there is also an institutional problem.

An expert on hospital mortality data has said scandals such as the deaths at Gosport War Memorial Hospital could be being replicated elsewhere in the NHS.

Prof Sir Brian Jarman told the Today Programme he thinks “it is likely” similar situations are happening in other hospitals.

An inquiry found doctors at the hospital gave patients “dangerous” amounts of powerful painkillers.

More than 450 older patients’ lives were shortened as a result. ( BBC)

 

Better news for the UK Public Finances but at what social cost?

Last week some new data emerged which gave us a slightly different perspective on the UK government finances.

General government deficit (or net borrowing) was £39.4 billion in 2017, a decrease of £19.0 billion compared with 2016; this is equivalent to 1.9% of GDP, 1.1 percentage points below the reference value of 3.0% set out in the Protocol on the Excessive Deficit Procedure.

We look regularly for a deeper perspective and those numbers reveal several realities. Firstly the simple fact that the number is much lower at just over £39 billion and secondly that relative to our annual economic output it is now a small amount. In fact so small we pass one of the Maastricht criteria.

This is the first time the government deficit has been below the 3.0% Maastricht reference value since 2007, when it was 2.6% of GDP.

The latter quote provides some food for thought as we see that in annual fiscal terms we are now better off than in 2007. Also these are numbers we can compare internationally as for example the French fiscal deficit was 2.6% of GDP and the Spanish one was 3.1%. Spain is an interesting example as it has of course seen strong economic growth over the past couple of years or so but still has such a deficit leading us to mull whether Euro area austerity was followed or whether more realistically in my opinion it has oiled the economic wheels with a fiscal stimulus? Especially if we note to continue the same analogy that the fiscal wheels themselves have been oiled by the bond buying of the European Central Bank or ECB which now totals some 238.5 billion Euros of Spanish government bonds and rising. This means that Spain has a ten-year bond yield of a mere 1.31% a far cry from the heady days of the Euro area crisis.

However the lost decade in fiscal terms for the UK has led to this.

General government gross debt was £1,786.3 billion at the end of December 2017, equivalent to 87.7% of gross domestic product (GDP), 27.7 percentage points above the reference value of 60% set out in the Protocol on the Excessive Deficit Procedure.

So we find that the national debt has increased considerably as a result of the ongoing fiscal deficits. We were supposed under the original Coalition government plan to reach a balance and head into surplus around 2016 albeit under a dubious current expenditure definition but instead we still have a deficit. However we are doing better than France ( 97%) and Spain ( 98.3%). Let me throw in something rarely raised, is this the real reason for all the QE bond buying we have seen? To make the national debts and fiscal deficits more affordable via lower bond yields?

Gilt Yields

These are as discussed above something which have boosted the UK fiscal numbers. It is not possible to say exactly how much they have helped by but we do know that without £435 billion of purchases by the Bank of England the ten-year Gilt yield would be a fair bit higher than the present 1.51%. I still recall when hitting 2% was considered extremely low and of course the panic-stricken Sledgehammer QE purchases of late summer 2016 drove it down to 0.5% as the market picked them off. Interestingly some numbers have been calculated for Germany but I would take them as a broad sweep rather than precise.

Latest data suggest Germany has saved €162bn in government interest expenditure since the start of the crisis, thanks to the ECB. ( @fwred )

As to the annual cost we see that in the last fiscal year UK debt costs were up by £6 billion to £54.7 billion mostly driven I would think by the higher costs of our RPI linked debt.

Today’s data

They opened with some good news. From the Office for National Statistics.

Public sector net borrowing (excluding public sector banks) decreased by £0.8 billion to £1.3 billion in March 2018, compared with March 2017; this is the lowest March net borrowing since 2004.

Looking into the detail adds more smoke than insight because we had better taxes from income plus a fall in debt costs that was not offset by higher spending. So let us move to the figures for the latest fiscal year for a better perspective.

Public sector net borrowing (excluding public sector banks) decreased by £3.5 billion to £42.6 billion in the latest financial year (April 2017 to March 2018), compared with the previous financial year; this is the lowest net borrowing since the financial year ending March 2007.

Thus we see better news again and the size of the reduction is likely to increase as revisions are made if last year was any guide.

 the estimate has been revised downward by £5.8 billion, from £52.0 billion to £46.2 billion.

As ever my first rule of OBR club has worked a treat. From a year ago.

The deficit is now forecast to come in at £51.7 billion this year, down from the £68.2 billion we forecast in November (Chart 1.1). We now expect the deficit to increase by £6.5 billion next year rather than shrinking by £7.2 billion (adjusted for a change in how the ONS records corporate taxes).

Even by their low standards this is an especially poor effort. Time for a few more Knighthoods I think to restore at least a veneer of respectability.For newer readers my first rule of OBR club is that it is always wrong. On that basis you may like to know that it forecasts next years deficit at £37.1 billion.

Ch-ch-changes

If we look at the numbers we see that broadly we improved even allowing for the fact we spent an extra £6 billion on debt interest-rate and that VAT receipts only increased by 2.4%. The latter does not really even match the inflation we have seen. If you wished to pin it to one factor the amount collected from National Insurance rose by 5.4%.

Oh and there is another area where the government has reason to be grateful to the Bank of England. Stamp Duty receipts from property transactions rose by just under 10% to £13.6 billion.

Comment

This has been a long slow grind and we are already two years or so late on the original plans. But there is good news in the continuing improvement albeit that as ever we see plenty of disinformation.

Of this £42.6 billion of public sector net borrowing excluding public sector banks (PSNB ex), £42.7 billion related to capital spending (or net investment) such as infrastructure, while the cost of the “day-to-day” activities of the public sector (the current budget deficit) was in surplus by £0.1 billion. This current budget deficit surplus is the first annual surplus since the financial year ending March 2002.

Those who have followed my analysis will no doubt already be thinking that there is a world of difference between the way the numbers were calculated in 2002 and now. I would also love to see how they define and calculate investment.

The real issues are whether we can continue to grow as economic growth is always the main player here in the long run? On that front there has been another hint of a slowing in the German economy this morning. Next is the recurring issue of whether this has been stimulus or austerity or even more confusingly both? A pointer towards austerity can be seen from this earlier.

Between 1st April 2017 and 31st March 2018, The Trussell Trust’s foodbank network distributed 1,332,952 three-day emergency food supplies to people in crisis, a 13% increase on the previous year. 484,026 of these went to children.

Perhaps the main government change has been a redistribution which if we add in the shift towards the asset rich driven by the Bank of England suddenly puts a dark cloud over the data.

 

 

The IMF debt arrow warning misses the real target

Yesterday brought the latest forecasts from the IMF ( International Monetary Fund). Don’t worry I am not concerned with them as after all Greece would be now have recovered if they were right. But there is a link to the Greece issue and the way that it has found itself trying to push an enormous deadweight of debt which meant that Euro area policy had to change to make the interest-rates on it much cheaper. Here is the ESM or European Stability Mechanism on that subject.

1% Average interest rate on ESM loans to Greece (as of 28/04/2017)

That is a far cry from the “punishment” 4.5% that regular readers will recall that Germany was calling for in the early days and the implementation of which added to the trouble. Also if we continue with the debt theme there is another familiar consequence.

That is because the two institutions can borrow cash much more cheaply than Greece itself, and offer a long period for repayment. Greece will not have to start repaying its loans to the ESM before 2034, for instance.

So in the words of the payday lenders Greece now has one affordable monthly payment or something like that. As we note the IMF research below I think it is important to keep the consequences in mind.

The IMF Fiscal Monitor

Here is the opening salvo.

Global debt hit a new record high of $164 trillion in 2016, the equivalent of 225 percent of global GDP. Both private and public debt have surged over the past decade.

Later we get a breakdown of this.

Of the $164 trillion, 63 percent is non financial private sector debt, and 37 percent is public sector debt.

That is a fascinating breakdown so the banks have eliminated all their own debt have they? Perhaps it is the new hybrid debt being counted as equity. Also the IMF quickly drops its interest in the 63% which is a shame as there are all sorts of begged questions here. For example who is it borrowed from and is there any asset backing? In the UK for example it would include the fast rising unsecured or consumer credit sector as well as the mortgaged sector but of course even that relies on the house price boom for an asset value. Then we could get onto student debt which whilst I have my doubts about some of the degrees offered in return I have much more confidence in young people as an asset if I may put it like that. So sadly the IMF has missed the really interesting questions and of course is stepping on something of a land mine in discussing government debt after its debacle in Greece.

Government Debt

Here is the IMF hammering out its beat.

Debt in advanced economies is at 105 percent of
GDP on average—levels not seen since World War II.
In emerging market and middle-income economies,
debt is close to 50 percent of GDP on average—levels
last seen during the 1980s debt crisis. For low-income
developing countries, average debt-to-GDP ratios have
been climbing at a rapid pace and exceed 40 percent
as of 2017.

If we invert the order I notice that there are issues with the poorer countries again.

Moreover, nearly half of this debt is on
nonconcessional terms, which has resulted in a doubling
of the interest burden as a share of tax revenues
in the past 10 year.

This gives us food for though as you see one of the charts shows that such countries have received two phases of what is called relief, once in the 90s and once on the noughties. Is it relief or as Elvis Presley put it?

We’re caught in a trap
I can’t walk out
Because I love you too much baby

Next time I see Ann Pettifor who was involved in the Jubilee debt effort I will ask about this. Does such debt relief in a way validate policies which lead such countries straight back into debt trouble?

Advanced Countries

Here the choice of 2016 by the IMF is revealing. I have a little sympathy in that the data is often much slower to arrive than you might think but the government debt world has changed since them. Any example of this came from the UK only this week.

General government deficit (or net borrowing) was £39.4 billion in 2017, a decrease of £19.0 billion compared with 2016; this is equivalent to 1.9% of GDP, 1.1 percentage points below the reference value of 3.0% set out in the Protocol on the Excessive Deficit Procedure.

It is hard not to have a wry smile at the UK passing one of the Maastricht criteria! But the point is that the deficit situation is much better albeit far slower than promised meaning that whilst the debt soared back then now prospects are different.

In truth I fear that the IMF has taken a trip to what we might call Trumpton.

In the United States—where
a fiscal stimulus is happening when the economy is
close to full employment, keeping overall deficits above
$1 trillion (5 percent of GDP) over the next three
years—fiscal policy should be recalibrated to ensure
that the government debt-to-GDP ratio declines over
the medium term.

I have quite a bit of sympathy with questioning why the US has added a fiscal stimulus to all the monetary stimulus? I know it has been raising interest-rates but the truth is that it has less monetary stimulus now rather than a contraction. Those of us who fear that modern economies can only claim growth if they continue to be stimulated or a type of economic junkie culture will think along these lines. But also they lose ground with waffle like “full employment” in a world where the Japanese unemployment rate is 2.5% as to the 4.1% in the US. Oh and whilst we are at it there is of course the fact that Japan has been running such fiscal deficits for years now.

What about interest-rates and yields?

There was this from Lisa Abramowicz of Bloomberg yesterday.

While U.S. yields may still be rising, the world is still awash in central-bank stimulus. The amount of negative-yielding debt has actually grown by nearly $1.4 trillion since February, to about $8.3 trillion: Bloomberg Barclays Global Aggregate Negative Yielding Debt index

My point is that for all the talk and analysis of higher interest-rates and yields we get this.

Comment

There is a fair bit to consider here and let me open with a bit of tidying up. Comparing a debt stock to an income/output flow ( GDP) requires also some idea of the cost of the debt. Moving on an opportunity has been missed to look at private-debt as we note that US consumer credit has passed the pre credit crunch peak. Of course the economy is larger but there are areas of troubled water such as car loans. This matters because the last surge in government debt was driven by the socialisation of private debt previously owned by the banks.

If we note the debt we have generically then there are real questions now as to high interest-rates can go? Some of you have suggested around 3% but in the end that also depends on economic growth which is apposite because the slowing of some monetary indicators suggests we may be about to get less of it. Should that turn further south then more than a few places will see an economic slow down that starts with both negative interest-rates and yields. These are the real issues as opposed to old era thinking.

• First, high government debt can make countries
vulnerable to rollover risk because of large gross
financing needs, particularly when maturities are
short

In reality that will be QE’d away if I may put it like that and the real question is where will the side-effects and consequences of the QE response appear? For example the distributional effects in favour of those with assets. Perhaps the real issue is the continuing prevalence of negative yields in a (claimed) recovery………From the Fab Four.

You never give me your money
You only give me your funny paper
And in the middle of negotiations
You break down

Me on Core Finance TV

How soon will the US national debt be unaffordable?

It is time to look again at a subject which has been a regular topic in the comments section. This is what happens when national debt costs start to rise again? We have spent a period where rises in national debts have been anesthetized by the Quantitative Easing era where central bank purchases of sovereign debt have had a side effect of reducing debt costs in some cases by very substantial amounts. Of course  it is perfectly possible to argue that rather than being a side effect it was the real reason all along. Personally I do not think it started that way but once it began like in some many areas establishment pressure meant that it not only was expanded in volume but that it has come to look in stock terms really rather permanent or as the establishment would describe it temporary. Of the main players only the US has any plan at all to reduce the stock whereas the Euro area and Japan continue to pile it up.

So let us take a look at projections for the US where the QE flow effect is now a small negative meaning that the stock is reducing. Here is Businessweek on the possible implications.

Over the next decade, the U.S. government will spend almost $7 trillion — or almost $60,000 per household — servicing the nation’s massive debt burden. The interest payments will leave less room in the budget to spend on everything from national defense to education to infrastructure. The Congressional Budget Office’s latest projections show that interest outlays will exceed both defense discretionary spending and non-military discretionary spending by 2025.

The numbers above are both eye-catching and somewhat scary but as ever this is a case of them being driven by the assumptions made so let us break it down.

US National Debt

It is on the up and up.

Debt held by the public, which has doubled in the past
10 years as a percentage of gross domestic product
(GDP), approaches 100 percent of GDP by 2028 in
CBO’s projections.

Those of you who worry we may be on the road to World War III will be troubled by the next bit.

That amount is far greater than the
debt in any year since just after World War II

As you can see the water has got a bit muddled here as the CBO has thrown in its estimates of economic growth and debt held by the public so let us take a step back. It thinks that annual fiscal deficits will rise to above US $1 Trillion a year in this period meaning that from now until 2028 they will total some US $12.4 billion. That will put the National Debt on an upwards path and the amount held by the public will be US $28.7 Trillion. Sadly they skirt the issue of how much the US Federal Reserve will own so let us move on.

Deficits

These have become more of an issue simply because the CBO thinks the recent Trump tax changes will raise the US fiscal deficit. The over US $1 Trillion a year works out to around 5% of GDP per annum.

Bond Yields

These are projected to rise as the US Federal Reserve raises its interest-rates and we do here get a mention of it continuing to reduce its balance sheet and therefore an implied reduction in its holdings of US Treasury Bonds.

Meanwhile, the interest rate on 10-year Treasury notes increases from its average of 2.4 percent in the latter part of 2017 to 4.3 percent by the middle of 2021. From 2024 to 2028, the interest rate on 3-month Treasury bills averages
2.7 percent, and the rate on 10-year Treasury notes,
3.7 percent.

Currently the 10-year Treasury yield is 2.83% so the forecast is one to gladden the heart of any bond vigilante. If true this forecast will be a major factor in rising US debt costs over time as we know there will be plenty of new borrowing at the higher yields. But here comes the rub this assumes that these forecasts are correct in an area which has often been the worst example of forecasting of all. For example the official OBR forecast in the UK in a similar fashion to this from the CBO would have UK Gilt yields at 4.5% whereas in reality they are around 3% lower. That is the equivalent of throwing a dart at a dartboard and missing not only it but also the wall.

Inflation

This comes into the numbers in so many ways. Firstly the US does have inflation linked debt called TIPS so higher inflation prospects cost money. But as they are around 9% of the total debt market any impact on them is dwarfed by the beneficial impact of higher inflation on ordinary debt. Care if needed with this as we know that price inflation does not as conventionally assumed have to bring with it wage inflation. But higher nominal GDP due to inflation is good for debt issuers like the US government and leads to suspicions that in spite of all the official denials they prefer inflation. Or to put it another way why central banks target a positive rate of consumer inflation ( 2% per annum) which if achieved would gently reduce the value of the debt in what is called a soft default.

The CBO has a view on real yields but as this depends on assumptions about a long list of things they do not know I suggest you take it with the whole salt-cellar as for example they will be assuming the inflation target is hit ignoring the fact that it so rarely is.

In those years, the real interest rate on
10-year Treasury notes (that is, the rate after the effect of
expected inflation, as measured by the CPI-U, has been
removed) is 1.3 percent—well above the current real rate
but more than 1 percentage point below the average real
rate between 1990 and 2007.

Economic Growth

In many ways this is the most important factor of all. This is because it is something that can make the most back-breaking debt burden suddenly affordable or as Greece as illustrated the lack of it can make even a PSI default look really rather pointless. There is a secondary factor here which is the numbers depend a lot on the economic impact assumed from the Trump tax cuts. If we get something on the lines of Reaganomics then happy days but if growth falters along the lines suggested by the CBO then we get the result described by Businessweek at the opening of this article.

Between 2018 and 2028, actual and potential real output
alike are projected to expand at an average annual
rate of 1.9 percent.

The use of “potential real output” shows how rarefied the air is at the height of this particular Ivory Tower as quite a degree of oxygen debt is required to believe it means anything these days.

Comment

The issue of the affordability forecast is mostly summed up here.

CBO estimates that outlays for net interest will increase
from $263 billion in 2017 to $316 billion (or 1.6 percent
of GDP) in 2018 and then nearly triple by 2028,
climbing to $915 billion. As a result, under current law,
outlays for net interest are projected to reach 3.1 percent
of GDP in 2028—almost double what they are now.

This terns minds to what might have to be cut to pay for this. However let me now bring in what is the elephant in this particular room, This is that if bond yields rise substantially pushing up debt costs then I would expect to see QE4 announced. The US Federal Reserve would step in and start buying US Treasury Bonds again to reduce the costs and might do so on a grand scale.. Which if you think about it puts a cap also on its interest-rate rises and could see a reversal. Thus the national debt might remain affordable for the government but at the price of plenty of costs elsewhere.

 

 

 

 

What is the state of the UK Public Finances?

This afternoon the UK Chancellor of the Exchequer will stand up and give what is now called the Spring Statement about the UK public finances. It looks set to be an example of what a difference a few short months can make. But before we get to that let me take us back to yesterday when we were looking at the issue of falling house prices in London. That would have an impact on the revenue side should it be prolonged and the reason for that is the house price boom in the UK which was engineered back the Bank of England back in the summer of 2012 led to this. From HM Parliament last month.

In 2016/17 stamp duty land tax (SDLT) receipts were roughly £11.8 billion, £8.6 billion from residential property and £3.2 billion from nonresidential property. Such receipts are forecast to rise to close to £16 billion in 2022/23, or around £14.5 billion after adjusting for inflation.

That is a far cry from the £4.8 billion of 2008/09 when the credit crunch hit and the £6.9 billion of 2012/13 when the Bank of England lit the blue touch-paper for house prices. Although of course some care is needed at the rates of the tax have been in a state of almost constant change. A bit like pensions policy Chancellors cannot stop meddling with Stamp Duty.

Indeed much of this is associated with London.

Around 2% of properties potentially liable for stamp
duty were sold for over £1 million – these properties
accounted for 30% of the SDLT yield on residential
property.

In fact most of the tax comes from higher priced properties.

In 2016/17 the stamp duty yields on residential property
were split nearly 45:55 between those paying the tax for
purchases between £125,000 and £500,000, and those
paying for properties purchased at over £500,000.

So there you have it the London property boom has brought some riches to the UK Treasury as has the policy of the Bank of England.

The Bank of England part two

Yesterday brought something of a reminder of an often forgotten role on this front.

Operations to make these gilt purchases will commence in the week beginning 12 March 2018……..The Bank intends to purchase evenly across the three gilt maturity sectors.  The size of auctions will initially be £1,220mn for each maturity sector.

This is an Operation Twist style reinvestment of a part of the QE holdings that has matured.

As set out in the Minutes of the MPC’s meeting ending 7 February 2018, the MPC has agreed to make £18.3bn of gilt purchases, financed by central bank reserves, to reinvest the cash flows associated with the maturity on 7 March 2018 of a gilt owned by the Asset Purchase Facility (APF)

So the Bank of England’s holdings which dropped to a bit over £416 billion will be returned to the target of £435 billion. So the new flow will help reduce the yields that the UK pays on its borrowings which has saved the government a lot of money. The combination of it and the existing holdings means that the UK can currently borrow for 50 years at an interest-rate of a mere 1.71%. Extraordinary when you think about it isn’t it?

The Office for Budget Responsibility ( OBR)

If we continue with the gain from the QE of the Bank of England then the OBR forecast that the average yield would be 5.1% and rising in 2015/16 back when it reviewed its first Budget. This gives us a measuring rod for the impact of QE on the public finances which is a steady drip,drip, drip gain which builds up over time.

If we bring in another major forecast from back then we get a reminder of my First Rule of OBR Club.

Wages and salaries growth rises gradually throughout the forecast, reaching 5½ percent in 2014.

For newer readers that rule is that the OBR is always wrong! I return regularly to the wages one as it has turned out of course to be the feature of modern economic life as the US labour market reminded us last Friday. If you take the conventional view as official forecasts find compulsory then at this stage of the cycle non-farm job creation of 313,000 cannot co-exist with annual hourly earnings growth fading from 2.9% to 2.6%. At this point HAL-9000 from the film 2001 A Space Odyssey would feel that he has been lied to again. Yet today and tomorrow will see a swathe of Phillips Curve style analysis from the OBR and others regardless of the continuing evidence of its failures.

The Bank of England has kindly pointed this out yesterday.

The accuracy of such forecasts has come under much scrutiny.

Here for a start! But ahem and the emphasis is mine…..

Gertjan Vlieghe explains how forecasting is an important tool that helps policymakers diagnose the state and outlook for the economy, and in turn assess – and communicate – the implications for current and future policy. So achieving accuracy is not always the sole aim of the forecast.

For best really in the circumstances I think. Oh and as Forward Guidance turned out to be at best something of a dog’s dinner as promised interest-rate rises suddenly became a cut I think Gertjan’s intervention makes things worse not better.

Employment

Embarrassingly for the Forward Guidance so beloved by Gertjan Vlieghe this has been an area of woe for the credibility of the Bank of England but good news for the UK economy and public finances. This is of course how the 6.5% unemployment rate target which was supposed to be “far,far away” to coin a phrase turned up almost immediately followed by further declines leading us to this.

There were 32.15 million people in work, 88,000 more than for July to September 2017 and 321,000 more than for a year earlier…….The employment rate (the proportion of people aged from 16 to 64 who were in work) was 75.2%, higher than for a year earlier (74.6%).

As we look at that we can almost count the surge into the coffers directly via taxes on income and also indirectly via excise duties and VAT ( Value Added Tax). According to The Times more may be on its way.

Hiring confidence among British companies has reached its highest level in more than a year and recruitment is set to pick up as businesses shrug off downbeat economic projections, according to a closely watched study.

Manpower’s quarterly survey recorded that net optimism had climbed to +6 per cent in the latest quarter.

Comment

If we look for the situation I pointed out on the 2nd of this month that we are being led into a land of politics rather than economics. From the IEA ( Institute of Economic Affairs ).

New data shows that the Conservative government has finally hit its original target to eliminate the £100bn day-to-day budget deficit they inherited in 2010.

We get all sorts of definitions to make the numbers lower but whether they are cyclical or day-to day they are open to “interpretation” which of course is always one-way. But we have made progress.

the UK’s achievement of sustained deficit reduction over eight years should not be taken for granted.

This has been a fair bit slower than promised which leaves us with this.

The problem is the financial crisis and its aftermath saw public debt balloon from 35.4 per cent of GDP in 2008 to 86.5 per cent today – far higher than the 35 per cent average since 1975.

The consequences of that have been ameliorated by Bank of England QE and to some extent by QE elsewhere. Also it is time for the First Rule of OBR Club again.

The Office for Budget Responsibility projects that public debt will shoot up to 178 per cent of GDP in the next 40 years on unchanged policies, as demands on the state pension, social care, and healthcare rise.

The state of play is that public borrowing has finally benefited from economic growth and particularly employment growth. We are still borrowing but we can see a horizon where that might end as opposed to the mirages promised so often. There are two main catches. The first is that we need the view of The Times on employment to be more accurate that the official data. The second is that for debt costs not to be a problem then QE will need to be a permanent part of the economic landscape.

The certainty today is that the OBR forecasts will be wrong again. The question is why we have been pointed towards better numbers by the mainstream media? The choice is between more spending and looking fiscally hard-line ( which also usually means more spending only later….).

 

 

 

What is the true story behind the UK Public Finances being in surplus?

This week has brought news that should be far from a surprise to readers of my work. So without further ado let me present you this from the Financial Times.

Improvement in public finances puts day-to-day budget into surplus.

My regular reports on the machinations here will hopefully have had you all zeroing in on the “day to day” bit!

Britain has eliminated the deficit on its day-to-day budget, the target originally set by George Osborne when he imposed austerity on public services in 2010. The rapid improvement in the public finances over the past six months means that the former chancellor’s ambition for a surplus on the current budget, which excludes capital investment, has been met, albeit two years later than planned.

So one swerve is the way that capital investment is excluded as we mull how much current spending has been relabelled? Also there is the issue of the Financial Times being forgetful of what the original target was. From the Office for Budget Responsibility or OBR.

the cyclically-adjusted current budget deficit of 5.3 per cent of GDP in 2009-10 to be eliminated by 2014-15 and reach a surplus of 0.8 per cent of GDP in 2015-16.

Or of course the “day to day” bit might be relying on the Beatles arithmetic.

Eight days a week
I love you
Eight days a week
Is not enough to show I care

The OBR

The report by the Financial Times backfires in this respect as it is a fan of the OBR but sadly something has hit the fan as we have not one but two clear examples of my first rule of OBR club. For newer readers this is that it is always wrong.

The first is easy as if we avoid the ways a deficit is redesigned into a surplus above we still have one as opposed to the surplus we were supposed to have around 3 years ago. Next comes a more recent example of the genre. From the FT.

The rapid improvement in the public finances over the past six months

Was forecast by the OBR in March 2017 to be this.

So much so, in fact, that borrowing is now forecast to rise in 2017-18 before returning to a very similar downward trajectory to that we anticipated in November……….. We now expect the deficit to increase by £6.5 billion next year rather than shrinking by £7.2 billion (adjusted for a change in how the ONS records corporate taxes).

As you can see they made a policy change in that the improvement in the public finances was going to stop and get worse just as the numbers in fact got better! Actually they are still at this game as they forecast a rise in the UK deficit of £4.1 billion in the fiscal year which ends in April whereas according to the Office for National Statistics this is the present state of play.

Public sector net borrowing (excluding public sector banks) decreased by £7.2 billion to £37.7 billion in the current financial year-to-date (April 2017 to January 2018),

Misrepresenting spending

In my opinion this from the Financial Times is disappointing.

Paul Johnson, director of the Institute for Fiscal Studies, said the deficit reduction was “quite an achievement given how poor economic growth has been. They have stuck at it, but deficit reduction has come at the cost of an unprecedented squeeze in public spending”.

The reason why I think that is explained by the latest figures from the ONS which are for the fiscal year so far.

Over the same period, central government spent £598.3 billion, around 3% more than in the same period in the previous financial year.

As you can see the “unprecedented squeeze in public spending” is in fact a 3% increase. If we allow for inflation Paul Johnson is the man who wrote the review recommending CPIH which in January was running at an annual rate of 2.7% so there is a real terms increase albeit a small one. At this point it seems appropriate to remind you of my warning that it is a mistake to treat the IFS in the way that the media does as its reports are not the tablets of stone you might think.

Also if we step back for a moment we see my theme that the words Austerity and Stimulus are much more flexible for some than they should be. The truth is that we have had both as austerity has been represented by falling deficits but stimulus by the fact we continue to have deficits.

The actual data on public spending mean that the quote below is opinion dressed up as fact.

That squeeze is now showing up in higher waiting times in hospitals for emergency treatment, worse performance measures in prisons, severe cuts in many local authorities and lower satisfaction ratings for GP services.

Yes there are problems in the NHS and elsewhere but it is far from as simple as presented. The truth is due to factors such as the high rate of medical inflation such services require rises in real spending to stand still.

What about revenue?

This must be something that the Financial Times economics editor typed with gritted teeth!

The main reason for the sudden improvement in the public finances has been that revenues this financial year have greatly exceeded expectations, particularly in the most important month of January when self-assessment bills for income tax and capital gains tax generally fall due.

the reason for this is that Chris Giles has told us time and time again that the UK economy is about to fall off the edge of a cliff. Yet if we stick with his own words those who use tax revenue as a measure of economic growth will be seeing this as evidence that we may have done better than the official measure which recorded a 1.7% rise in GDP between 2016 and 17.

Also I am unclear how the official data shows things “greatly exceeded expectations” unless your expectations were for an unexplained plunge.

Self-assessed Income Tax and Capital Gains Tax receipts (combined) were £18.4 billion in January 2018, which is £0.9 billion less than in January 2017: ( ONS).

Is up the new down again?

The details

The exact situation is described by the FT below.

Official figures show that in the 12 months ending in January, the current budget showed a £3bn surplus and it moved into the black on an annual rolling basis in November………No British government has run a surplus on the current budget since 2001-2002 and last had a surplus in any 12-month period since the year leading up to July 2002.

Comment

We have seen many attempts to misrepresent the UK Public Finances over the credit crunch era, for example the way only the assets but not the liabilities of the Royal Mail pension fund were counted initially. More recently we had the circa £60 billion hokey-cokey with the Housing Associations. Thus the numbers are open to quite a few questions and that gets quite a bit worse when you impose an opinion like current spending as the FT has done. If it includes any of the original “cyclically adjusted” then we are again grateful to Lewis Carroll for some advice.

Why, sometimes I’ve believed as many as six impossible things before breakfast.

Meanwhile I guess the FT will be hoping people do not go back to November 22nd 2016.

The Financial Times could not wait and told us this at the end of last week.

Philip Hammond will admit to the largest deterioration in British public finances since 2011 in next week’s Autumn Statement when the official forecast will show the UK faces a £100bn bill for Brexit within five years.

So in summary the UK public finances have improved steadily and we are now in better shape in terms of the fiscal deficit but we are still a way short of a surplus. We may be growing faster than we thought but the picture is complex especially for the OBR which serves one purpose which is to make anyone who agrees with them extremely nervous. Oh and here is something completely missing from the FT to complete the picture.

Public sector net debt (excluding public sector banks) was £1,736.8 billion at the end of January 2018, equivalent to 84.1% of gross domestic product (GDP), an increase of £55.7 billion (or 0.4 percentage points as a ratio of GDP) on January 2017.

Norway

Let me congratulate its Finance Ministry on recognising reality and reducing its inflation target from 2.5% per annum to 2% today. Especially as up in the clouds many Ivory Towers want inflation targets raised as they continue their attempts to square their circles.