Japan gets paid to issue debt and yet it has just tightened its fiscal policy!

Today I am looking east to the country which is hosting the rugby world cup and let me congratulate them on their victory over Ireland. But there is another area where Japan is currently standing out and that is the arena of fiscal policy. The current establishment view is that it is time that fiscal policy took up the slack after years and indeed in Japan’s case decades of easy monetary policy. One feature of that type of thought is seen by the cheapness of public borrowing in Japan where the ten-year yield is -0.22% and the thirty-year is a mere 0.35%. So Japan is either paying very little or being paid to borrow right now.

Consumption Tax

Last week it did this.

After twice being postponed by the administration of Prime Minister Shinzo Abe, the consumption tax on Tuesday will rise to 10 percent from 8 percent, with the government maintaining that the increased burden on consumers is essential to boost social welfare programs and reduce the swelling national debt. ( The Japan Times )

This is an odd move when we note the current malaise in the world economy which just gets worse as we note the fact that the Pacific region in particular is suffering. We looked at one facet of this last week as Australia cut interest-rates for the third time since the beginning of the summer.

Things get complex as we note that there are offsetting measures.

The 2 percentage point boost is estimated to inflict about a ¥5.7 trillion burden on households. However, making preschool education free of charge, keeping the 8 percent rate for food and nonalcoholic beverages and beefing up social welfare are expected to lessen that burden to around ¥2 trillion — about a quarter of the ¥8 trillion cost of the 2014 hike, according to the government and the Bank of Japan. ( The Japan Times )

As you can see this takes away a lot of the point of making the change in the first place! According to the government the net effect will be a bit more than a third of the gross. Also it means the government interfering in more areas leafing to transfers of cash from one group to another. Now whilst free preschool education is welcome we have seen extraordinary transfers in the credit crunch era via policies such as negative interest-rates and QE bond buying.

As ever the numbers seem in doubt as NHK News thinks the impact will be larger.

Half the revenue will be spent on making preschool education and childcare free of charge, easing the financial burden of higher education, among other things. The rest will go to restoring the country’s fiscal health.

The economic impact

The very next day Japan’s Cabinet Office released this bombshell.

The Consumer Confidence Index (seasonally adjusted series) in September 2019 was 35.6, down 1.5 points from the previous month.

The Japan Times covered it like this.

A Cabinet Office survey showed earlier this week that consumer sentiment in Japan weakened for the 12th straight month in September, hitting its lowest since the survey started in April 2013……….The index was lower than the 37.1 marked during the first stage of the hike in April 2014.

The last sentence is especially ominous if we consider the impact of the 2014 Consumption Tax rise. If we return to the survey we see from the series that it has been falling since some readings above 44 in late 2017 and the fall has been accelerating. In terms of detail there is this.

Overall livelihood: 33.9 (down 0.9 from the previous month)
Income growth: 38.7 (down 0.8 from the previous month)
Employment: 41.5 (down 0.7 from the previous month)
Willingness to buy durable goods: 28.1 (down 3.6 from the previous month)

So all elements fell and the employment one is particularly significant when we note this.

 The number of unemployed persons in August 2019 was 1.57 million, a decrease of 130 thousand or 7.6% from the previous year…..  The unemployment rate, seasonally adjusted, was 2.2%. ( Japan Statistics Bureau )

As an aside this makes the various natural and equilibrium levels of unemployment look laughable. For newer readers that is demonstrated by the Bank of England thinking it is 4.25% when Japan has an unemployment rate around half that.

This morning has brought news that things have gone from bad to worse.

TOKYO (Reuters) – A key Japanese economic index fell in August and the government on Monday downgraded its view to “worsening”, indicating the export-reliant economy might face slipping into recession.

The outlook was mostly driven by this.

The separate index for leading economic indicators, a gauge of the economy a few months ahead that’s compiled using data such as job offers and consumer sentiment, dropped 2.0 points from July, the Cabinet Office said.

Fiscal Policy

The other side of this particular coin was illustrated by the response of Fitch Ratings to the Consumption Tax hike.

Japan’s consumption tax hike supports medium-term fiscal consolidation efforts, and the country’s sovereign credit profile, Fitch Ratings says. We estimate it will lower Japan’s debt ratio by about 8pp of GDP by 2028; however, very high public debt will remain a key credit weakness.

They further crunched the fiscal numbers here.

Total annual revenue from the tax hike is estimated by the government at about 1% of GDP, half of which is earmarked to reduce debt (the remainder will be used to permanently increase spending for education and long-term care). This would result in Japan’s gross general government debt-to-GDP ratio falling to just over 220% by 2028, from 232% at present.

It hardly seems worth it when it is put like that. Also perhaps unwittingly they let the cat out of the bag as to why Abenomics is so keen on raising the level of inflation.

We estimate that Japan’s public debt dynamics have stabilised due to the resumption of nominal GDP growth in recent years.

Nominal GDP growth includes inflation.

Comment

This is a story with several facets so let us open with the driving force of this which was the IMF or International Monetary Fund and the case it made in the earlier part of this decade for Japan to improve its national debt to GDP ratio. Here is the IMF Blog after the 2014 Consumption Tax rise.

Japan’s GDP declined by almost 7 percent in the second quarter, more than many had forecast including us here at the IMF.  Many cite the increase in the sales tax this April for this decline.  But that is not the full story.

That opening suggests there were other reasons for the fall but fails to state them as it then discusses general rather than specific issues. Oh and it does not day but it means annualised fall in GDP. The impact was so great that the 2015 rise was delayed to now rather ironically because of the recession risk. What it means is that Japan ends up doing this at a very risky time if we look at the world economic outlook.

We now find also that IMF fiscal conservatism is being applied just as it has switched to expansionism. That is quite a mess! No wonder Christine Lagarde shot out of the door. After all Japan can borrow quite cheaply mostly due to the fact that The Tokyo Whale ( Bank of Japan for newer readers ) owns so much of it. The IMF has just published a Working Paper on this so let me give you some numbers from 2017.

As shown in the Fiscal Monitor, Japan’s PSBS stands out as one of the largest PSBS in the world, with assets and liabilities of 533 percent of GDP in 2017. Japan’s
PSBS also includes cross-holdings of assets and liabilities within the public sector, exceeding 210 percent of GDP in 2017—the largest in the IMF’s PSBS database. Much of these come from public corporations’ financing of central government liabilities. ( PSBS = Public Sector Balance Sheet)

Next let me help the author out as the situation below is explained by world wide trends accompanied thsi decade by the enormous purchases of The Tokyo Whale.

Several previous studies considered it puzzling that the stock of Japanese Government Bonds (JGBs) has been increasing but their yields have been declining
for the last three decades.

Next we get a higher estimate for the national debt.

However, these may not fully explain why Japan has been able to build up 288 percent of GDP in public sector borrowing.

Also it is not only The Tokyo Whale that has bought this.

In 2017, the public sector finances 150 percent of GDP of public sector borrowing,

In some ways it has been buying off other parts of the public-sector.

For example, the Post Bank
reduced allocations to public sector financing from 95 percent of its total assets at its peak in
1998 to 33 percent in 2017. The social security funds also reduced asset allocations to public
sector financing from 77 percent at its peak in 1998 to 34 percent in 2017.

Oh what a tangled web we weave……

Meanwhile it would appear that even extraordinary fiscal expansionism has not done much good.

Borrowing of general government ballooned in the 1990s and 2000s. It was 60 percent of GDP in 1990 and
increased to 226 percent of GDP in 2017.

The ordinary Japanese may have a job but real wages are falling again and fell at an annual rate of 1.7% in August.

Podcast

 

 

The UK public finances finally accept that many student loans will never be repaid

The present UK government seems to be much keener on public spending than its predecessor. From the Evening Standard.

Up to £1 billion of the aid budget will be made available to scientists inventing new technology to tackle the climate crisis in developing countries, Boris Johnson is to announce……..Putting an emphasis on technology’s potential to answer the climate emergency, he will also announce a further £220 million from the overseas aid budget to save endangered species from extinction.

Although of course as so often there is an element there of announcing spending which would have happened anyway. Also the government did avoid bailing out Thomas Cook which seems sensible as it looked completely insolvent by the end as Frances Coppola points out.

Dear@BBC

, you should not believe what you read in corporate press releases. The rescue plan for Thomas Cook was not £900m as the company said. It was £900m of new loans PLUS new equity of £450m PLUS conversion of £1.7bn of existing debt to equity (with a whopping haircut).

It is very sad for the customers and especially the workers. Well except for the board who have paid themselves large bonuses whilst ruining the company. Surely there must be some part of company law that applies here.

UK Public Finances

There have been a lot of significant methodological changes this month which need to be addressed. They add to the past moves on Housing Associations which had an impact on the National Debt of the order of £50 billion as they have been in and out of the numbers like in the Hokey Cokey song. Also there was the Royal Mail pension fund which was recorded as a credit when in fact it was a debit. Oh well as Fleetwood Mac would say.

Student Loans

For once the changes are in line with a view that I hold. Regular readers will be aware that much of the Student Loans in existence will not be repaid.

This new approach recognises that a significant proportion of student loan debt will never be repaid. We record government expenditure related to the expected cancellation of student loans in the period that loans are issued. Further, government revenue no longer includes interest accrued that will never be paid.

This brings us to what is the impact of this?

Improvements in the statistical treatment of student loans have added £12.4 billion to net borrowing in the financial year ending March 2019. Outlays are no longer all treated as conventional loans. Instead, we split lending into two components: a genuine loan to students and government spending.

Whether the £12.4 billion is accurate I do not know as some of it is unknowable but in principle I think that this is a step in the right direction.

Pensions

There are larger changes planned for next month but let me point out one that has taken place that will be impacted by Thomas Cook.

We now also include the Pension Protection Fund within the public sector boundary.

Other changes including a gross accounting method which means this in spite of the fact that the PPF above will raise the national debt or at least it should.

These changes have reduced public sector net debt at the end of March 2019 by £28.6 billion, reflecting the consolidation of gilts and recognition of liquid assets held by the public pension schemes.

I will delay an opinion on this until we get the full sequence of changes.

The Numbers

The August figures were better than last year’s

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in August 2019 was £6.4 billion, £0.5 billion less than in August 2018.

There was a hint of better economic performance in the numbers too.

This month, receipts from self-assessed Income Tax were £1.7 billion, an increase of £0.4 billion on August 2018. This is the highest level of August self-assessed Income Tax receipts since 2009……..The combined self-assessed Income Tax receipts for both July and August 2019 together were £11.1 billion, an increase of £0.7 billion on the same period in 2018.

At first the numbers do not add up until you spot that the expenditure quoted is for central government which is flattered by a £900 million reduction in index-linked debt costs. Something which inflationoholics will no doubt ignore. Also local government borrowed £1 billion more. So I think there was some extra spending it is just that it was obscured by other developments in August.

In the same period, departmental expenditure on goods and services increased by £1.8 billion, compared with August 2018, including a £0.5 billion increase in expenditure on staff costs and a £0.9 billion increase in the purchase of goods and services.

If we switch to the fiscal year so far the picture looks broadly similar to what we have been seeing in previous months.

In the latest financial year-to-date, central government received £305.4 billion in receipts, including £226.0 billion in taxes. This was 2.1% more than in the same period last year……Over the same period, central government spent £325.1 billion, an increase of 4.1%.

The essential change here is that central government has spent an extra £9.1 billion on goods and services raising the amount spent to £121.5 billion in a clear fiscal boost.

The Past Is Not What We Thought It Was

Although it does not explicitly say it we were borrowing more than we thought we were, mostly due to the new view on student loans.

In the latest full financial year (April 2018 to March 2019), the £41.4 billion (or 1.9% of gross domestic product, GDP) borrowed by the public sector was around a quarter (26.1%) of the amount seen in the FYE March 2010, when borrowing was £158.3 billion (or 10.2% of GDP).

We know last year was affected by £12.4 billion but the effect is smaller the further we go back in time. For example on FYE March 2010 it was £1.5 billion.

The National Debt

This continues to grow in absolute terms but to shrink in relative terms.

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of August 2019 was £1,779.9 billion (or 80.9% of gross domestic product, GDP), an increase of £24.5 billion (or a decrease of 1.5 percentage points of GDP) on August 2018.

However the Bank of England has had an impact here.

Debt at the end of August 2019 excluding the Bank of England (mainly quantitative easing) was £1,598.7 billion (or 72.7% of GDP); this is an increase of £37.4 billion (or a decrease of 0.6 percentage points of GDP) on August 2018.

For those of you wondering my £2 billion challenge to last month’s data on Bank of England transactions has not been resolved as this from Fraser Munroe of the Office for National Statistics from earlier highlights.

We should have some APF detail for you soon. Sorry for the delay.

Comment

We travel forwards although sometimes it feels as though we have just gone backwards. Although there is one constant which is the first rule of OBR club ( for newer readers it is always wrong).

These March 2019 OBR forecasts do not include estimates of the revisions made in September 2019 for student loans and pensions data. The OBR intends to reflect these changes in their next fiscal forecast.

In a way that is both harsh although they should have know of the plans and fair in that their whole process is always likely to be wrong and frankly misleading.

Next we are reminded that things we really should know in fact we do not.

The error mainly relates to the treatment of Corporation Tax credits, which are included within total Corporation Tax receipts as well as within total central government expenditure.

In terms of impact that peaked at £3.8 billion in 2017/18 declining to £1.9 billion in the last fiscal year. That is a lot in my opinion.

As to more fiscal spending well that just got harder as we conclude we were spending more anyway. But it remains very cheap to do so as the UK thirty-year Gilt yield is back below 1%.

 

 

Lower Gilt yields should drive the UK Budget Statement

These are extraordinary times and let me bring you up to date with this morning’s developments. Bond markets have surged again with that of Germany reaching an all-time high. One way of putting that is that there are discussions this morning of the futures contract going to 180 which provides food for thought when you have traded it at 80. In more prosaic terms Germany is being paid ever more to borrow with its ten-year yield -0.73%. Why? Well let me throw in another factor from @ftdata.

Why Germany’s bond market is increasingly hard to trade: Shortage of tradable Bunds reflects huge ownership by banks and central banks

This is having all sorts of impacts as for example the bond vigilantes were supposed to be all over Italy like a rash and instead its ten-year yield has fallen below 0.9%. It reminds me of this from Shakespeare.

All the world’s a stage,
And all the men and women merely players;
They have their exits and their entrances;
And one man in his time plays many parts,

That gives us an international context to the fact that the UK Gilt market has soared this morning such that it has created something of a new reality. This is very different to past political crises because if we were in an episode of Yes Prime Minister right now it would be talking about the Gilt market collapsing rather than soaring. For once up genuinely is the new down. If we look at tomorrow’s Budget Statement then it needs to address the fact that the UK can borrow for fifty-years at an annual interest-rate of 0.8% Whatever your views on fiscal policy we should do some and views on fiscal policy should be changed by this. Let me give you a comparison as back in the day the Office for Budget Responsibility suggested the medium-term UK Gilt would yield 4.5% and rising now so the fifty-year would be say 6%. In other words we have something of a new paradigm.

Why?

Much of this comes from the policy of the Bank of England and the rest comes from the tightening of fiscal policy. As the economy has recovered we have done this in terms of fiscal policy.

In the latest full financial year (April 2018 to March 2019), the £23.6 billion (or 1.1% of gross domestic product, GDP) borrowed by the public sector was less than one-fifth (15.4%) of the amount seen in the FYE March 2010, when borrowing was £153.1 billion (or 9.9% of GDP). ( UK ONS)

Whatever your view on the concept of austerity we are now borrowing much less. So the irony is that we borrowed a lot when it was expensive and much less as it has become much cheaper.

Next let me address the Bank of England. It can do all the open mouth operations it likes and offer its Forward Guidance about higher interest-rates. But markets and potential Gilt investors note that not only did it originally buy some £375 billion of UK Gilts its knee-jerk response to perceived trouble was to buy another £60 billion. So they expect more purchases in any crisis and whilst we are not in the same position of an outright shortage of sovereign debt as Germany we are not issuing much and the Bank of England would likely buy way more than that.

Thus the two factors above are driving the UK Gilt market higher and as it happens there is another addition. This is that some pension funds find they have to buy more Gilts to match their liabilities as the market rallies and at a time of low supply that just adds to the issue. You may choose to call this a bubble but whatever you call it a number of factors are elevating the market.

Fiscal Rules

These are one of the fantasies of our times. Gordon Brown had one as did George Osborne and Phillip Hammond. Let us remind ourselves of the latter via the Resolution Foundation.

Deteriorations in the public finances and economic outlook, alongside spending commitments the Prime Minister has already made, lead us to conclude that far from any further headroom to spend, the Treasury is already on course to break the ‘fiscal mandate’ of borrowing less than 2 per cent of GDP in 2020-21. In addition, with spending
commitments building in subsequent years, it’s likely that borrowing will only further overshoot this limit in the years after 2020-21.

Kudos to them for remembering what the UK fiscal rules are. But the catch is that nobody including the politicians issuing them takes them seriously, in the UK anyway. As recently as the 21st of last month I was pointing out this on here.

As you can see in the fiscal year so far the UK government has opened the spending taps. Whilst the report does not explicitly point this out much of the extra spending has been in the areas mentioned above, as we see expenditure on goods and services up by £7.2 billion and staff costs up by £2.4 billion.

As you can see spending has risen although that was by the previous version of the current government. However the underlying trends and forces have not changed much if at all.

National Debt

This is something of a mixed bag as if you think we have a problem measuring the fiscal situation ( Hint we do..) it gets worse here. Let me give you an example of this via the Office for Budget Responsibility.

Public employment-related pension schemes and the Pension Protection Fund will be moved within the public sector boundary. This would reduce public sector net debt in 2018-19 by £30.9 billion (1.4 per cent of GDP), reflecting the gilts and liquid assets they hold. The liabilities of these schemes are not ‘debt liabilities’ – they are accrued pension rights – so do not add to the liabilities side of public sector net debt.

Yes you do have that right. A liability and maybe a large one will improve the numbers in the same way that the Royal Mail pension scheme did a few years ago. With that context here is the current situation.

Debt (public sector net debt excluding public sector banks) at the end of July 2019 was £1,807.2 billion (or 82.4% of gross domestic product, GDP), an increase of £29.6 billion (or a decrease of 1.3 percentage points of GDP) on July 2018.

As you can see debt has been rising but in relative terms it has been falling as the economy has grown faster than it. There will be other reductions next month via the pension scheme misrepresentation above but also due to past revisions to GDP.

Above is the number which will be used tomorrow. If you wish to compare us internationally then add around 3% to it.

Comment

The context is clearly that the UK can afford to borrow. Let me specify this to avoid misunderstandings. We can choose to invest in infrastructure or elsewhere and lock in very cheap 50 year borrowing costs. Back on July 29th I suggested that we could borrow £25 billion easily and it would be more than that now,maybe much more. Personally I would also do something about the benefits freeze which has hit many of our poorer citizens.

As for other factors then do not place much faith in precision here. Regular readers will know I have challenged our national statisticians over the £2 billion fall in Bank of England QE remittances in July. Neither out statisticians nor HM Treasury can explain this and frankly I an explaining it to them! Without going into detail in my opinion at least £1.6 billion is without explanation and is singing along with Men At Work.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

Is it a bad time to remind you that the way the Bank of England constructed its QE operations ( mostly the Term Funding Scheme ) has added around £180 billion to the recorded level of the national debt?

Now let me return to the issue of a pension recalculation improving the public-sector numbers. How is that going in the private-sector?

Pension deficits at 350 of the UK’s largest listed companies widened by £16bn in August, as the increasing prospect of a #NoDealBrexit drove down gilt yields, according to analysis from Mercer. ( @JosephineCumbo )

 

The UK government has opened the spending taps

Today we open with some good news as the UK Office for National Statistics has been burning the midnight oil and has come up with this.

The total package of current price GDP improvements increases the size of the economy in 2016 by approximately £26.0 billion, around 1.3% of GDP……Average growth of volume GDP over the period from 1998 to 2016 has been revised up 0.1 percentage point to 2.1% per year.

Actually they have also decided the credit crunch impact was not quite as bad as previously thought.

The peak-to-trough fall of the 2008 economic downturn in GDP has been revised from 6.3% to 6.0% and the UK economy is now estimated to have returned to its pre-downturn levels one quarter earlier in Quarter 1 2013.

Those who can remember back then will recall that it was a period when the labour market data signalled an upturn in the economy a year or so before the output or GDP data. You may recall there were fears of a “triple-dip” back then and from back then ( January 2013) here is Howard Archer in The Guardian.

While we believe the economy is essentially flat at the moment, it is worrying to note that GDP in the fourth quarter of 2012 was 3.3% below the peak level seen in the first quarter of 2008. We suspect that GDP will not return to the level seen in the first quarter of 2008 until the first half of 2015 – a gap of seven years.

As you can the perception is very different now. This takes us back to all of yesterday when we noted that the opening of 2018 in Germany is now thought to be very different to what we think now.

Also there was something to make supporters of nominal GDP targeting follow the advice of Iron Maiden and run for the hills.

 In the decade leading up to the financial crisis, average nominal GDP growth remains unchanged at 5.0%, while there has been a slight upward revision from 3.6% to 3.7% in the period following the financial crisis.

For those unaware there are more than a few around who argue that targeting a nominal GDP growth rate of 5% would produce something of an economic nirvana. The theory is that if we then get the inflation target of 2% per annum then economic growth would be 3%. Or if you prefer Hallelujah we are saved! Meanwhile they got it and the economy then collapsed. You could not make it up. The more subtle point is to wonder if the Bank of England was actually targeting this? This seems unlikely as let’s face it they so rarely hit any target on a consistent basis. Oh and I do not expect this to deter supporters of nominal GDP targeting as there are other problems as you may have already spotted which they choose to look away from.

Also I note that these revisions support my view that the service sector is larger than our statisticians have told us.

Service industries has been revised upwards in both the pre- and post-crisis periods, and accounts for 90% and 85% of total GVA growth in these periods respectively.

If we now move onto today’s news then we see that the consequence of the UK economy being recorded as larger is that our national debt to GDP ratio has been lower than we thought it was. We will have to wait for the full chained volume data set to discover exactly how much.

Also I can specify now something I mentioned before which was the boost to UK GDP by switching from using the RPI to the CPI as it was in the 2011 Blue Book which had average upwards revisions to GDP of 0.23%.

Today’s Data

Let me get straight to the crucial point which is that the spending taps have been opened by the UK government.

Central government receipts in July 2019 decreased by £0.4 billion (or 0.5%) compared with July 2018, to £67.9 billion, while total central government expenditure increased by £4.1 billion (or 6.5%) to £67.6 billion.

Please ignore the receipts numbers for now as I will explain later. But as you can see expenditure has risen again as we saw this in June. Here is some further detail on this.

In the same period, departmental expenditure on goods and services increased by £1.6 billion, compared with July 2018, including a £0.7 billion increase in expenditure on staff.

We need a deeper perspective and it is provided by this.

In the latest financial year-to-date, central government received £246.5 billion in income, including £182.5 billion in taxes. This was 2.3% more than in the same period last year.

Over the same period, central government spent £260.3 billion, an increase of 5.3%.

As you can see in the fiscal year so far the UK government has opened the spending taps. Whilst the report does not explicitly point this out much of the extra spending has been in the areas mentioned above, as we see expenditure on goods and services up by £7.2 billion and staff costs up by £2.4 billion.

This has had a consequence for the deficit as we look at the July and then the fiscal year to date numbers.

Borrowing (public sector net borrowing excluding public sector banks) in July 2019 was in surplus by £1.3 billion, a £2.2 billion smaller surplus than in July 2018; July 2018 remains the highest July surplus since 2000………….Borrowing in the current financial year-to-date (April 2019 to July 2019) was £16.0 billion, £6.0 billion more than in the same period last year; the financial year-to-date April 2018 to July 2018 remains the lowest borrowing for that period since 2002.

Care is needed here because this is much lower than we saw in the past crisis but none the less after a lot of false dawns the UK government seems to be actually fulfiling its promises to spend more.

Receipts

I did promise to address this as they were heavily affected this July by the QE programme of the Bank of England.

This month interest and dividend recipts were down £1.5 billion compared to July 2018. This fall was largely because of a £2.0 billion reduction in dividend transfer from the Bank of England Asset Purchase Facility Fund (BEAPFF) to HM Treasury.

So if we are looking for the impact of the UK economy on the numbers it showed some growth not a fall.

If we were to exclude these transfers, then central government receipts would decrease by £0.6 billion to £67.3 billion in July 2019 and decrease by £2.6 billion to £65.7 billion in July 2018.

Actually there has been an issue this fiscal year as well.

So far in this financial year-to-date (April to July 2019), £3.5 billion in dividends have transferred from the BEAPFF to HM Treasury, compared with £5.9 billion in the same period last year.

So as you can see without this receipts were positive in July and growth in the fiscal year so far was better than the 2.3% quoted. It is curious that the Bank of England numbers are ebbing and flowing because they have the same £435 billion holdings so I will investigate later.

Comment

We see that the UK government has indeed opened the spending taps. How much of it is Brexit driven is hard to say but at least some of it must be. Can we afford it? With a thirty-year Gilt yield just above 1% ( 1.03%) then we certainly can in terms of repayments. The catch is in terms of the national debt and the amount of capital borrowed but in relative terms that has been falling recently.

Debt (public sector net debt excluding public sector banks) at the end of July 2019 was £1,807.2 billion (or 82.4% of gross domestic product, GDP), an increase of £29.6 billion (or a decrease of 1.3 percentage points of GDP) on July 2018.

Whether any extra spending would be well spent is an entirely different matter. But we find ourselves in a position where this time around it is cheap to borrow.

Meanwhile of course these numbers are for a government that has now been mostly removed…..

 

 

 

The UK should issue a 100 year bond (Gilt)

Sometimes ideas come to fruition at the time but others have a much longer gestation period. My subject of today is an example of the latter as it was back in March 2012 that Chancellor George Osborne included this in the UK Budget.

In light of evidence of strong demand for gilts of long maturities and against the backdrop of historically low long-term interest rates, in 2012–13 the DMO will consult on the case for issuance of gilts with maturities significantly longer than those currently in issue, that is in excess of 50 years, and/or perpetual gilts.

By DMO he meant the Debt Management Office which is the body which manages the UK’s national debt. The plan was for it to do this.

The consultation will build an evidence base to inform the Government’s decision on whether to issue such instruments. It will seek to establish the likely strength and sustainability of demand, the cost-effectiveness and risks of issuance, and the impact on market liquidity and the good functioning of the wider gilt market.

If we look at the plan back then we see it was based on “historically low long-term interest-rates” or bond yields. That was true in March 2012 with longer maturity Gilt yields having fallen by a bit more than 1%. If you compound that over 100 years then you would be quids in so to speak as an issuer.

Investment Week

They held an online debate and Jim Leaviss of M&G told us this.

Few fund managers would publically argue that a yield of supposedly around 3.5% is good value given both inflation and political uncertainty over 100 years.

Such things are a hostage to fortune as it has turned out that any fund manager who had bought such a bond would be giving a lecture tour right now on how clever they had been, as well as deserving a large bonus. We should not be harsh on Jim as who could have predicted the last 7 years.

Currently, we are not bullish on the gilt market: it looks expensive and I am not sure you would want to lock in low yields for such a long time period.

Oh well as Fleetwood Mac would say. He did think that a 100 year Gilt would be bought in spite of that being a bad idea.

However, there has been demand for long-dated gilts given the size of the existing 2060 gilt and the 2062 linker of over £16bn and over £8bn respectively.

If a 2112 is issued, its very existence will cause index-led funds or liability matching pension funds to buy it.

Not everyone in the debate felt that it would work and others thought that the Gilt market was already too expensive. Here is Jeff Keen of JO Hanbro.

Assuming the Bank of England is successful in meeting its 2% inflation target, this implies long term gilt yields should be in the 4%-5% range rather than the currently implied yield for a 100-year gilt of around 3.5%. The difference is a downward price adjustment of around 30%. Beware – gilts are not necessarily a safe haven.

Apologies for embarrassing them.

What happened next?

There was no explicit issue although in 2015 we did covert something into a 100 year bond. From gov.uk.

The Treasury will redeem the outstanding £1.9 billion of debt from 3½% War Loan on Monday 9 March 2015.

The reason for that was the 3.5% coupon which in 2012 had seemed cheap was by then looking rather expensive for the UK taxpayer.

Austria yesterday

You may recall that Austria issued a century or 100 year bond back in 2017 well there is more of it now.

They also revised pricing lower for a tap of Austria’s outstanding debt maturing in 2117 with demand there exceeding 5.3 billion euros. That 1.25 billion euro issue priced at 48 bps over an outstanding Fed 2047 bond, translating to a yield of 1.171%. ( Reuters)

Yes you did read that yield correctly and as pointed out in the comments yesterday there was another sign that it was an issuers party for the Austrian taxpayer.

The country’s debt management agency launched the sale of 3 billion euros of five-year bonds at 23 basis points below the mid-swap rate, translating to a yield of -0.435%. The deposit rate stands at -0.40%.

There was a time when the ECB deposit rate was a barrier for bond yield issuance but as you can see that is now in the past. The bull market for bonds is so strong that it has passed the benchmark and if Germany issued a five-year bond it would blow it away at around -0.6%.

Another sign of how strong the bull market is in bonds is that there was plenty of extra demand for the two issues by the Austrian Treasury. As its overall yield is 2.08% it has improved conditions for the taxpayer there with both issues.

The UK Gilt Market

This has also been in a bull market where yields are both absolutely and historically low. We do not have the levels of much of the Euro area for several reasons. Firstly official interest-rates are lower there with the deposit rate being -0.4% as opposed to the UK Bank Rate of 0.75%. Next we have had ECB President Mario Draghi only recently hint about even lower interest-rates and more QE bond buying. Also with the planned TLTRO money market ( bank subsidy) operation it is in the process of enforcing them.

But we do have very low yields as for example both the two and five-year yields seem to have settled around 0.6%. If we look further out we do have a fifty-year Gilt which yields some 1.38% as I type this. So what is called our yield curve is pretty flat both as a curve and also in comparison with the past.

Comment

This seems clear cut to me as at present yields the UK could issue a 100 year Gilt very cheaply. There are loads of projects which would look extremely viable at these levels. If you are wondering how much? Well even if we issued at the fifty-year yield of around 1.4% that would be 2.1% below 2012. Actually if you look at the way the yield curve shapes we might be able to issue at a yield of 1.3%. Amazingly cheap and less than a tenth of past yields experienced in my career.

The flip-side of the coin is that at such a yield the percentages are heavily weighted against any buyers. So buyers of fixed-income funds might do well to be afraid and perhaps very afraid. It is a bit different for holders who have been in a long running party.

As to size well if you do it why not offer £10 billion and see what happens? I would not be surprised to see it be over subscribed.

Meanwhile every idea has its niches. From PolemicTMM.

UK should issue a 100yr zero coupon 42bio Euro-denominated bond to fund the Brexit bill (if bond mkts continue like this, we may even get -ve rates). EU institutions would end up having to buy it due to EU imposed reserve regs and so effectively end up funding Brexit.

By bio he means billion I think. The quid pro quo for an even lower interest-rate would be an exchange-rate risk.

The Investing Channel

 

Has the UK fixed its public finances?

Last night brought us the Mansion House speeches from the Chancellor of the Exchequer and Governor of the Bank of England. Whilst there was something of a ruckus as Greenpeace arrived my attention was on what the Chancellor would say about the UK public finances.

and we have fixed the public finances………In short, while we have repaired the public finances.

Some clear politics at play but elements of that are true. Then there was a reference to what has been called a “warchest” being available.

Because it doesn’t mean that there would be no extra money to spend.

As I said at the Spring Statement, if we leave the EU in a smooth and orderly way, the fiscal headroom I have built up means an incoming Prime Minister will have scope for additional spending or tax cuts.

“Gentleman Phil” then went on to list his achievements.

As the public finances have improved, I have committed over £150bn of new spending in the last 3 years…

…including an NHS settlement which is the single largest commitment ever made by a peacetime British Government.

Public capital investment is set to reach the highest sustained level in forty years…

…as we build the critical national infrastructure we need to raise our productivity;

I’ve committed £44bn to housing, delivering more new homes last year than in all but one of the last 30 years;

And I’ve cut taxes, with over 30 million people seeing their income tax cut this year;

288,000 people benefitting so far from the abolition of stamp duty for first time buyers;

And British businesses paying the lowest corporation tax rate in the G20.

Apologies for the fact that it is not possible to completely cut politics out of that. But it does give some sort of analysis of the situation. However though the big change I have been pointed out in 2019 does not get a mention.

Borrowing is very cheap

Politicians usually avoid mentioning the falling cost of borrowing because they like to take the credit themselves for the improved public finances. From time to time they may actually be responsible but the trend this year has been across much of the world as we see expectations of more central bank easing. On Tuesday the UK will take advantage of this as we borrow an extra £2.25 billion of this.

1¾% Treasury Gilt 2049

Actually even the 1 3/4% is behind the times because as I type this the UK thirty-year yield is 1.44%. Back in the day I recall it being more than ten times that. Continuing these theme the UK issued an extra £2.75 billion of our ten-year Gilt this Tuesday at a yield of 0.89%. These are practical examples of how lower bond yields feed their way into the public accounts and if we borrow as planned it will have this impact in the next year.

Gilt sales of £117.8 billion (cash) are planned in 2019-20 ( Debt Management Office )

Also there has been a windfall from the way that the rate of inflation has fallen as we move to the latest release.

Interest payments on the government’s outstanding debt decreased by £0.3 billion compared with May 2018, due largely to movements in the Retail Prices Index (RPI) to which index-linked bonds are pegged.

If we return to the broad sweep I described earlier then this from Bloomberg today highlights the ongoing trend.

The world now has $13 trillion of debt with below-zero yields.

Today’s Data

If we look at this in a thematic sense then there was food for thought for the austerity debate from this in May.

Over the same period, there was a notable increase in expenditure on goods and services of £1.9 billion.

So on the face of it the numbers do seem to back up what the Chancellor was saying last night. We do not get any breakdown of this and I have to confess I am wondering if this is a catching-up on expenditure for March 29th which was supposed to be Brexit Day? Only time will tell on that but for now we have spent more.

Switching to the revenue numbers then they were okay in May.

Central government receipts in May 2019 increased by £1.9 billion (or 3.5%) compared with May 2018, to £56.7 billion…..Much of this annual growth in central government receipts in May 2019 came from Income Tax-related revenue, with Income Tax and National Insurance contributions increasing by £0.6 billion and £0.7 billion respectively compared with May 2018.

So if they are any guide the economy continues to move ahead as one measure is tax revenue. But they were not enough to offset the additional expenditure.

Borrowing (public sector net borrowing excluding public sector banks) in May 2019 was £5.1 billion, £1.0 billion more than in May 2018;

Also the additional expenditure in May fed straight into the picture for the year to date.

Borrowing in the current financial year-to-date (April 2019 to May 2019) was £11.9 billion, £1.8 billion more than in the same period last year;

We do not get much extra perspective at this time of year as we have only had two months in the financial year. So we remain with the view that it looks like we are spending more. As to the overall picture it remains true that we are not borrowing very much and ironically in the circumstances would qualify for this part of the Maastricht criteria very comfortably.

Borrowing in the latest full financial year (April 2018 to March 2019) was £24.0 billion, £17.8 billion less than in the same period the previous year; the lowest financial year borrowing for 17 years.

What about the National Debt?

That continues to rise in absolute terms whilst falling in relative terms.

Debt (public sector net debt excluding public sector banks) at the end of May 2019 was £1,806.1 billion (or 82.9% of gross domestic product (GDP)); an increase of £25.0 billion (or a decrease of 1.4 percentage points of GDP) on May 2018.

We would fail the Maastricht criteria here as shown below.

equivalent to 86.7% of gross domestic product (GDP); 26.7 percentage points above the Maastricht reference.

It is also time for my regular reminder that some of the debt is due to yet another subsidy for our banking system.

The Bank of England’s (BoE) contribution to net debt is largely a product of their quantitative easing measures, namely the Bank of England Asset Purchase Facility Fund (APF) and the Term Funding Scheme (TFS). If we were to exclude BoE from our calculation of public sector net debt (excluding public sector banks), it would reduce by £183.9 billion.

Comment

If we look back to when the period of UK austerity started it is important to remember that it was not only a very different world but seemed a different world. The UK thought it had borrowed some 11% of GDP in a single year and was facing a ten-year Gilt yield of the order of 4%. Indeed the Office for Budget Responsibility was expecting the bond vigilante’s to turn up as it forecast that it would now be 5%. The combination of those two factors made the future public finances look dreadful.

Now we are in a completely different situation as we borrow a mere 1.5% of GDP and the ten-year UK Gilt yield is 0.84%. After all back then we were not yet fully aware of the first rule of OBR club ( for newer readers it is always wrong). The saddest part of this is that the political debate has ignored this. So for example when there were suggestions of tax cuts in the Conservative party leadership election we went back to the “can we afford it?” stage when he general we can, often easily. Whether they would be a good idea is an entirely different matter as for example abandoning VAT for a sales tax seemed curious at best.

Returning to the question in my title today then in isolation the answer is yes. The much deeper question comes from what we want the public finances to achieve as we also see examples of areas where cut backs have hurt people and sadly they are often those least able to do something about it.

 

Will fiscal policy save the US economy or torpedo it?

One of the features of the credit crunch era has been the shift in some places about fiscal policy. For example the International Monetary Fund was rather keen on austerity in places like Greece but then had something of a road to Damascus. Although sadly Greece has been left behind as it ploughs ahead aiming for annual fiscal surpluses like it is in a 2012 time warp. Elsewhere there have been calls for a fiscal boost and we do not need to leave Europe to see them. However as I have pointed out before there is quite a distinct possibility that President Donald Trump has read his economics 101 textbooks and applied fiscal policy into an economic slow down. Of course life these days is rarely simple as his trade policy has helped create the slow down and is no doubt a factor in this from China earlier..

Industrial output grew 5.0 percent in May from a year earlier, data from the National Bureau of Statistics showed on Friday, missing analysts’ expectations of 5.5% and well below April’s 5.4%. It was the weakest reading since early 2002. ( Reuters).

Also there has been another signal of economic worries in the way that the German bond future has risen to another all-time high this morning. Putting that in yield terms holding a benchmark ten-year bond loses you 0.26% a year now. Germany may already be regretting issuing some 3 billion Euros worth at -0.24% on Wednesday although of course they cannot lose.

US Fiscal Policy

Let us take a look at this from the perspective of the South China Morning Post.

The US budget deficit widened to US$738.6 billion in the first eight months of the financial year, a US$206 billion increase from a year earlier, despite a revenue boost from President Donald Trump’s tariffs on imported merchandise.

So we can look at this as a fiscal boost on top of an existing deficit. The latter provides its own food for thought as the US economy has been growing sometimes strongly for some years now yet it still had a deficit. In terms of detail if we look at the US Treasury Statement we seem that expenditure has been very slightly over 3 trillion dollars whereas revenue has been 2.28 trillion. If we look at where the revenue comes from it is income taxes ( 1.16 trillion) and social security and retirement at 829 billion and in comparison corporation taxes at 113 billion seem rather thin to me.

The picture in terms of changes is as shown below.

So far in the financial year that began October 1, a revenue increase of 2.3 per cent has not kept pace with a 9.3 per cent rise in spending.

If we look at the May data we see that the broad trend was exacerbated by monthly expenditure being high at 440 billion dollars as opposed to revenue of 232 billion. Marketwatch has broken this down for us.

Most of the jump can be explained by June 1 occurring on a weekend, which forced some federal payments into May. Excluding those calendar adjustments, the deficit still would have increased by 8%, with spending up by 6% and revenue up by 4%.

In terms of a breakdown it is hard not to think of the oil tankers attacked in the Gulf of Oman yesterday as I note the defence numbers, and I have to confess the phrase “military industrial complex” comes to mind.

What will recur are growing payments for Medicare, Social Security and defense. Medicare spending surged 73% — mostly because of the timing shift, though it would have rose 18% otherwise. Social Security benefits rose by 11% and defense spending rose 23%.

So we have some spending going on here and its impact on the deficit is being added to by this from February 8th last year.

The final conference committee agreement of the Tax Cuts and Jobs Act (TCJA) would cost $1.46 trillion under conventional scoring and over $1 trillion on a dynamic basis over ten years,

Thus policy has been loosened at both ends and the forecast of the Congressional Budget Office that the deficit to GDP ratio would be 4.2% this year looks like it will have to be revised upwards..

National Debt

This was announced as being 22.03 trillion dollars as of the end of May, of which 16.2 trillion is held by the public. Most of the gap is held by the US Federal Reserve. Just for comparison total debt first passed 10 trillion dollars in the 2007/08 fiscal year so it has more than doubled in the credit crunch era.

Moving to this as a share of the economy the Congressional Budget Office puts something of a spin on it.

boosting debt held by the public to $28.5 trillion,
or 92 percent of GDP, by the end of the period—up
from 78 percent now.

The IMF report earlier this month was not quite so kind.

Nonetheless, this has come at the cost of a continued increase in the debt-to-GDP ratio (now at 78 percent of GDP for the federal government and 107 percent of GDP for the general government).

Where are the bond vigilantes?

They have gone missing in action. The financial markets version of economics 101 would have the US government being punished for its perceived financial profligacy by higher bond yields on its debt. Except as I type this the ten-year Treasury Note is yielding a mere 2.06% which is hardly punishing. Indeed it has fallen over the past year as it was around 2.9% a year ago and last November went over 3.2%.

So in our brave new world the situation is one of lower bond yields facing a fiscal expansion. There is an element of worries about the economic situation but the main player here I think is that these days we expect the central bank to step in should bond yields rise. So the US Federal Reserve is increasingly expected to cut interest-rates and to undertake more QE style purchases of US government debt. The water here is a little murky because back at the end of last year there seemed to be a battle between the Federal Reserve and the President over future policy which the latter won. So much for the independence of central banks!

The economy

Let me hand you over to the New York Federal Reserve.

The New York Fed Staff Nowcast stands at 1.0% for 2019:Q2 and 1.3% for 2019:Q3. News from this week’s data releases decreased the nowcast for 2019:Q2 by 0.5 percentage point and decreased the nowcast for 2019:Q3 by 0.7 percentage point.

That compares to 2.2% annualised  for a month ago and 3.1% for the first quarter of the year. So the trend is clear.

Comment

As we track through the ledger we see that the US has entered into a new period of fiscal expansionism. The credit entries are that it has been done so ahead of an economic slow down and at current bond yields is historically cheap to finance. The debits come when we look at the fact that the starting position was of ongoing deficits after a decade long period of economic expansion. These days we worry less about national debt levels and more about the cost of financing them, although as time passes and debts rise that is a slippery slope.

The real issue now is how the economy behaves as a sharp slow down would impact the numbers heavily. We have seen the nowcast from the New York Fed showing a slowing for the summer of 2019. For myself I worry also about the money supply data which as I pointed out on the 8th of May looks weak. So this could yet swing either way although this from February 8th last year is ongoing.

The deep question here is can we even get by these days without another shot of stimulus be it monetary,fiscal or both?