How to finance the Hinkley Point C nuclear plant?

The proposed development of Hinkley Point C nuclear electricity generation plant in Somerset, in discussion since 2010 was labelled the biggest white elephant ever by Simon Jenkins in a devastating article in the Guardian this week.

How much electricity does the UK need?

The choice for additional reliable electricity generating capacity is still between continuing to invest in carbon belching coal and gas for electricity, or to invest in carbon-free nuclear. Together they still make up more than 70% of the UK’s electricity generation capacity. Renewables amount to one quarter of the total, made up of the more reliable biomass and hydro on one hand. On the other hand, the remainder of renewable electricity production is intermittent wind and solar power.


Source Office of National Statistics

There is still a need to provide up to 50GW of electricity in peak times (cold winter evenings) to meet demand, although that can drop to 25GW in the summer during the night.  And it could well be that during peak times it is not only dark (no solar power), but that there is no wind and hence no wind power.

At the moment there is no way to store huge amounts of electricity beyond the small pumped hydro stations (about 2 GW for a few hours), so the majority of reliable supply will need to come from coal, gas or nuclear.  In fact, last night solar and wind will only have contributed less than 1%, only about 1/2 a GW of our electricity production just before 8pm last night, when around 35GW of electricity was required in the UK. The wind only became a little bit stronger afterwards, and wind electricity production increased.

So of a total of 5GW installed capacity for solar (at optimal summer sun), and 13GW potential capacity for windpower (at optimal wind-speeds), pretty much none was available last night between 6 pm and 8pm, before the wind picked up slightly.


Contributions of nuclear, coal, gas and wind to total electricity generation 26th/27th Sep 2015

Source: Gridwatch

How to build a new nuclear power station?

Britain has not invested in a new nuclear power station for thirty years. It lost all its expertise in that sector. It is still running plant which was designed ages ago, and they are all coming to the end of their economic live. In those 30 years, the Chinese have built about 30 nuclear plants. The French have 80% of their electricity produced by nuclear energy, the rest is hydro-electric power sourced from the foot-hills of the Alps. They are the experts. If we want to buy nuclear, we have to buy from them.

So it is natural that the new design for Hinkley C should come from a French-Chinese joint venture.  So, no argument there. The argument comes over the price and the financing of the energy.

Instead of paying them for the contract of building the plant on completion, the state-owned French/Chinese builders will run the plant as well  and will be paid over 35 years for the electricity it produces, at a rate agreed at £92.50 per MWh (November 2011 price plus inflation, now over £100 already), which is about twice the market rate for electricity.

At a nominal output of 3.2GW Hinkley C will provide about 6% of electricity if it is run, on average, on 70% capacity, as other nuclear plants are. If that is is the case, and Britain in 2024 has a demand of 340 TWh of electricity per year (same as this year), the cost of buying electricity from Hinley Point C would be just under £2bn per year.

So is Hinkley Point C too expensive?

It first seems that it is. Why should we pay twice the market rate for something which we could have for less? The price briefly touched that high level in 2008, but for most of the last 7 years, we have seen a major fall, and then a very slow increase in wholesale electricity prices, with them mainly hovering around £50/MWh. So I have previously (on other blogs) said the idea of Hinley C is bonkers. But is it?


Wholesale electricity prices since 2008  


The marginal cost of something new

If we buy a new car, rather than keep the old one, that is almost always a choice for the much more expensive option. Even if our old car is broken down, we could always repair it, and often it will be cheaper to do that. But we would like the convenience of something new, which is better equipped, more economical, and more reliable and which will impress the girlfriend or neighbour.

For that we will pay a premium, quite a large one, if we buy a brand new car. It might turn out to be twice as expensive to run per year (including depreciation) than the 10 year old car (which is largely depreciated).

Same for nuclear power. If we want less carbon, and reliable supplies, that is the only option.

Design and finance issues

Clearly there are some issues about the reliability of this particular nuclear plant design, from previous experience in Finland and France where the building of this plant has resulted in a right shambles. But that seems to have been overcome in China. But we have yet to see a plant of this type in operation. In addition, the government will take on a large risk to indemnify the providers of finance, which had to be cleared by the EU, should the project be cancelled. A fee of 2.95% will need to be added by the vendors to the cost of the project, as that is the guarantee fee to the government, which will in turn indemnify the providers of finance, should the project be cancelled. And a return on capital of 11% is allowed by the vendors.

But let us assume that £25bn is a rational price for building the plant, and if we pay about £2bn per year back over 35 years via our electricity bills, that will be about 70bn which we will need to pay for electricity.

A large portion of this will be made up of financing the plant. But probably all of the capital will need to be borrowed in pounds sterling by the French-Chinese company constructing the Hinkley C plant., to protect themselves against exchange rate fluctuations.

Let us assume that the money will be borrowed at 3% interest, which is probably the minimum rate for such a long term project. Even at that low rate, over a 35 year term, the interest will add a substantial percentage to the cost of the new plant.

So if interest 3% was paid on the £25bn loan at commercial terms to a bank, annual repayments would make up £1,163 million each year.

If the UK borrowed, at the current minimum interest rate, currently 0.5%, the annual repayments would be £780 million, a saving of £383 million. Over 35 years the savings would be £13.4bn.

If no interest was paid, however, financed by PQE, the cost would be even less, at £714 million a year. a saving of £449 million per year. Over 35 years, the savings would be 15.7bn.

So each year we could save £449 million a year, almost £0.5billion, if we were to finance Hinkley C through PQE. That is about one quarter of the annual payments for electricity, which we said will amount to £2bn.

Or, let us put it another way. If we used PQE to finance Hinkley C, instead of a loan of 3%, electricity produced from there could be 1/4 cheaper. Not double the current market price, but only 50% more than the current market price.

No matter how this plant is financed, it would generate the same amount of additional demand in the real economy, and possibly inflation, if demand for labour and materials was tight. The way it was financed, whether through a loan or PQE, would not make a difference. Financing through PQE would, however, deflate the potential income for the financial sector by the £449 million of interest per year, a saving to electricity users.  A further 2.95% (close to £750m) of the project cost could be saved, as no indemnity to finance providers would now be payable. This loss of income to the finance sector is a saving for the taxpayer.

To summarise, if we want nuclear power, and decide to build Hinkley C, we should finance it through PQE, as that would allow Hinkley C to charge a 25% cheaper price for the electricty it will generate.

PQE: how to cut the UK’s debt by two-thirds!

Could People’s Quantitative Easing cut government debt by two thirds?

Let us be clear here, the term “People’s Quantitative Easing” has not been fully defined yet. It is a policy still to be determined by the Labour party and its leader, Jeremy Corbyn. But, as defined by Richard Murphy, its usefulness would come in mainly in times of an economic crisis.

So, everybody who has looked in detail at the proposals seems to be in agreement that it would be a good idea at times of high unemployment, in a depression, when there are plenty of resources lying idle in the economy. This is certainly true for “Overt Monetary Financing”, a general term used to describe spending money into the economy through the central bank. Which is colloquially known as “printing money”.

Everybody also is in agreement that the QE undertaken by the Bank of England in the years after 2009 was not a “People’s QE”, but mainly benefited the rich and the banks.  To what extent it benefited the banks especially is unclear, and the Financial Times has called for an audit by the National Audit Office to determine who actually gained from the unprecedented expenditure by the Central Bank, pumping £375bn (about 20% of GDP) into just one asset market mainly controlled by the commercial banks!

That means that PQE (and not more QE) should be the tool of choice in the next downturn. The disagreement would be about how much should PQE there should be, whether other overt financing tools (helicopter money) are possibly more effective and what the role of the central bank should be, which is deemed to have an “independent mandate” to look after inflation.

Now, that is a shame, because PQE, or “overt monetary financing,”  could be equally used to finance every government expenditure, ever. No more borrowing, just PQE!

This is not some loony left-wing idea, but comes from one of the most prominent influential economists of the second half of last century, an avid defender of free market principles and an economic guru to both Ronald Reagan and Margaret Thatcher. Milton Friedman!

In 1948, just after the Second World War, Friedman wrote the following:

Under the proposal, government expenditures would be financed entirely by either tax revenues or the creation of money, that is, the issue of non-interest-bearing securities. Government would not issue interest-bearing securities to the public; the Federal Reserve System would not operate in the open market. This restriction of the sources of government funds seems reasonable for peacetime.

The chief valid ground for paying interest to the public on government debt is to offset the inflationary pressure of abnormally high government expenditures when, for one reason or another, it is not feasible or desirable to levy sufficient taxes to do so. This was the justification for wartime issuance of interest-bearing securities, though, perversely, the rate of interest on these securities was pegged at a low level. It seems inapplicable in peacetime, especially if, as suggested, the volume of government expenditures on goods and services is kept relatively stable. Another reason sometimes given for issuing interest-bearing securities is that in a period of unemployment it is less deflationary to issue securities than to levy taxes. This is true. But it is still less deflationary to issue money

How could the UK have looked after 1951 if it had just issued money by the Central Bank? What if Milton Friedman’s recommendations had been taken and implemented?

Looking back and doing a “what if” analysis is always a bit tricky, but here it should be fairly easy.

If the government borrows, it takes money out of circulation from the real economy. The money available by the private sector to invest and consume must fall. Now if the government does not borrow the money from the private sector, would the private sector spend it? Unlikely, the private sector would keep it in the banking system, and save it there. Again, it is not available for investment in the real economy.

So whether the government spends money by borrowing it first from the private sector, or it just issues (“prints”) money, the same real investment and consumption activities by the government (and the private sector) will happen. That will be the ones the government chooses to undertake. That would have been, in the UK after the war: money to build up the NHS, build the motorways, invest in social housing, and set up a welfare state. More recently free nursery places and tax credits were additional innovations. All Labour policies, we might add.

The amount of inflation is exactly the same as if the government borrowed the money, as the same amount of money is chasing goods and services, whether it was borrowed or just spent into the economy. The main determining factor for inflation is private credit growth rate, which will in times of a boom, exceed increased government spending growth significantly. The rate of growth of private sector credit will determine the amount of money in an economy much more than government spending, and therefore will be the determining factor in asset and consumer price inflation.

That is worth saying again:

No increase in inflation arises if the same amount of increased money is in the real economy. It does not matter if the increase comes from government borrowing or just government spending by the Central Bank. Inflation (in both assets and consumer prices) is mainly determined by private sector money growth.

What about the interest on the government bonds?

Clearly, if the government just issues money rather than borrows it, it saves any interest payments. These interest payments will go to the lenders of the money to the government, the people who had enough money to lend it to the government in the first place. These people are, in the main, just the very rich, who are net lenders to the government. The top 10% of the population, in terms of wealth or income.

Now, the very wealthy which lent their money to the government are, as a group, very likely to lend the interest they receive onto the government again. They did not need the money in the first place, remember, so it is unlike that they need the interest. So it is them who would have lost out on the interest paid to the government had the UK decided not to borrow in 1950.

So, let us just add up the interest which the very wealth would have lost out on. Luckily, the Office of Budget responsibility has detailed the interest the government has paid since 1951. In 1951 it came to £0.5bn for that year. Now, in 2015, it is about 100 times bigger, at almost £50bn.

In total, if you add all the numbers up, for all the years, the UK has paid out the staggering amount of £940bn in interest  to the very rich of its population in the last 65 years. Not because it needed to, but because it chose to.

If it had not done that, we would have government debt in the UK which was £940bn smaller. Not almost £1,500bn, but more like £560bn.

If the UK had followed Milton Friedman’s adviceand though its Central Bank had just spend the money instead borrowed it, the UK debt would have been a bit about one third of the size it is now.

But as it is, almost a trillion pounds has been spent on interest since 1951. Interest accounts for two thirds of the UK debt!

So, same growth, same inflation, same goods and services in the economy. The UK economy would be very similar, if no borrowing had taken place since 1951. If you looked out of the window today, Britain would look perhaps exactly the same, as roughly the same investment decisions would have been made, by the state and the private sector.

The wealthy would still be wealthy, there would be no perceivable difference. But still, the UK would be a more equitable society. The wealthy would have £940 billion less, and the UK debt (which has to be serviced by all of us) would be £940 billion less.

The government debt to GDP ratio would now be something like 30% rather than 80%. The “government debt” would, of course, not be real debt, but just a summary of all the government spending ever. The annual government spending in excess of taxation (the “deficit”) could be half of what it is now, if we did not need to pay interest. All without austerity.

Now, clearly, that just describes the dynamics of the situation over a 65 year period, had we started in 1951 and followed Milton Friedman’s advice.

To get to a situation in the future, where the UK, perhaps in 30 years time, does not have any debt any more, it would have to be slowly replaced by government spending, instead of borrowing.

So how would the government know how much it should spend into the economy? Well, as now, the government will have to decide which roles in the economy it will want to take responsibility for. That would differ, clearly, depending on a Conservative or Labour government. Then it would have to fund these activities.

To pay for these activities would still come mainly from taxation, as now. Perhaps 2%-4% of GDP should be paid for by additional government spending into the economy. More in the beginning to repay outstanding debt and pay interest; less, as government borrowing falls. More in times of recession, less in times of a boom.

However, it should be made clear, that taxation is mainly there to (a) avoid inflation, and (b) redistribute money from the wealthy and fortunate to the less wealthy and less fortunate, according to the mandate received at the last election.

More crucially, unemployment has to be avoided. Should there be unemployment in the economy, the government’s role should be to make work more attractive. It could, for example, reduce the tax on work (National Insurance, income tax) and increase the tax on assets. And become an employer of last resort, should employment fall.

Inflation on goods  and services, but also on assets (housing) would need to be assessed and watched. There should probably be an independent economic commission. It would have a dual mandate, as the Federal Reserve in the US, to ensure unemployment and inflation is low. It would produce a range of recommendations to ensure that these parameters stay on a pre-determined path. That could be 3% unemployment,  3% consumer price inflation, and 3% asset inflation, for example.

Government spending, taxes and interest rates should be the three tools which the government should use, as recommended by the independent economic commission,  to ensure that the inflation targets are met in the long term.

I think it is time we follow Milton Friedman’s advice, with the government just spending money into the economy.

Then, over time, we would try to cut the government debt to one third, focus on unemployment, introduce a more egalitarian society, control asset and consumer price inflation.

And use PQE to finance every bit of government spending!

Is QE good or bad for banks?

Prof. Krugman, in yesterday’s NYT column states that QE has been bad for banks because it led to an erosion of net interest margins. And bankers are now in the forefront to ask for a rise in rates, because they want to increase their profitability.

In detail, he says the following:

So we’ve had a long discussion of the distributional effects of QE and all that, which are ambiguous but also, I now realize, irrelevant. Is QE good or bad for capital, for rentiers, whatever? No matter — it’s bad for bankers, because it leads to a compression of the net interest margin, the spread between deposit rates and lending rates. And that is why there’s so much agitation for rate hikes on the part of finance. Furthermore, while I don’t think institutions like the BIS are corrupt in any direct sense, they probably pick up by osmosis from all the bankers they meet the general prejudice against easy money, leading to increasingly baroque attempts to justify rate hikes despite low inflation.

Now is that true? I cannot see any compression of net margins from the graph which Krugman shows us, which could be attributed solely to QE.  After QE came in after 2008, margins increased, only to fall back later.

Equally, up to 2008, there were interest rate increases, and margins of banks fell notwithstanding. Margins are falling, but probably through competitive pressures, from the mid 90’s onwards. So QE does not seem to have anything to do with it.

So banks might want us to believe that QE is responsible for erosion of margins, but that seems not the case. My view would be that QE has been neutral, as far as interest margins are concerned.

Krugman continues:

Incidentally, this also means that the common claim that QE is a giveaway to bankers is the opposite of the truth; to the extent that journalists with close ties to bankers spread this story, it’s Orwellian. Remember, the Fed isn’t lending money at low interest to banks — banks, with their $2.5 trillion (!) of excess reserves, are lending vast sums at low interest to the Fed.


Here, I really do not know what Krugman means. Yes, banks lend money at low rates to the Fed (and in the UK to the Bank of England), but that is their choice. They could always lend it out at higher rates elsewhere, if they chose to do so. It is a management decision by the banks.

We have indeed writers claiming that QE is not  “Bank’s QE”, as the FT claimed last Friday. I do not think that particular writer has close links to the banking industry. However, as I pointed out in my response, the banks will have benefited from the fact that in the UK the Bank of England bought lots of bonds from the banks which they sold at a premium price, otherwise they would not have sold.  We do not know know at what price they sold to the central bank, or at at which price they could have sold the bonds otherwise, if at all.

The situation with respect to the US programme of QE will have been similar.

Equally, Krugman points out, that $2.5 of excess reserves are in the US banking system at the moment, in the UK the figure is £315bn. On both these balances the central banks pay the banks interest 0.5% in the UK, and 0.25% in the US.

That is a huge transfer of money from the central banks to the commercial banks. $6.25billion for the US, and £1.5bn for the UK per year. All in the name of monetary policy. And the voters are blissfully unaware of this. Because the financial journalists do not make this an issue, and just accept the status quo of the current monetary policies.

So, of course banks benefit from the current monetary policy. And they would directly benefit from an interest rate rise. If interest rates doubled, the money paid to these banks from the government (via the central banks) would also double.

If banks did not benefit, they would attempt to get rid of the reserves, by decreasing deposit rates, so that money leaves the banking system. If banks started charging for their customers for money deposited with them (negative interest rates) then reserves would fall, as money was withdrawn for other, more remnuerative purposes. Banks balance sheets would shrink.

Also, bond liquidity is an issue at present, as set out yesterday in the Sunday Times (gated, but you get the beginning of the story). Now, if it is an issue now, I guess it was an issue back in 2008.

It is now more and more certain, in other words, that the QE programmes in the US and the UK were really just bank rescue programmes. If the central banks had not intervened, the bonds held by the big bond trading desks of the banks would have become impossible to sell, other than at massive losses. Which would of course have meant certain insolvency for the banks. That is my guess.

So the answer to the question “Is QE good or bad for banks?” must be that QE was probably a life saver for the banks, providing them with profits and liquidity at a time of stress, which would otherwise have meant their certain death.  And the current policy of paying interest on reserves, a by-product of the large reserve holding,  is a further way of ensuring their profitability.

The main beneficiaries of QE will have been banks, there can now be no doubt. So really, there should be an independent audit to confirm this (or reject that theory), as demanded by the Financial Times. A similar audit, carried out in the US about the Fed’s QE, would also clarify the position there.

No point selling £375bn of gilts, unless you make profit!

The FT today has two pieces today talking about the effects of the £375bn of existing QE, when the Bank of England between 2009 and 2012 purchased £375bn of gilts (UK government bonds) from the markets.

One, by Giles Wilkes in the FT makes the case for an audit by the National Audit Office of the gilt holding of the Bank of England, and for it to become more open, the other by Frances Coppola rightly says, that the previous QE was also a People’s QE, just not for the kind of people which the new Labour leader Corbyn wants to represent. The 375bn was a QE for the rich.

How do gilt markets work

Neither of the FT articles say that the banks benefited from the QE, although Frances Coppola acknowledges, rightly, that the gilts will have to be sold to market makers of gilts first, who would then pass them onto the government. (If you thought that financial markets are efficient, think again, whereas you can sell anything on ebay, you cannot do so if you have gilts, that has to be passed through an officially licensed market maker).

Now, the market makers also have a stock of gilts on their own books, as they can then trade without first having to buy them. So in a way they ensure the liquidity of the market. But, in return, they will also want a commission for selling it to you. That will be reflected in the fact that they sell for a higher price than they bought the gilts for.

We also know, that the gilt turnover is relatively high, compared to the gilts outstanding. About £15bn were traded daily in 2008-09.  Now, an additional demand of 375bn, even spread over a few years, will certainly have had an influence on the price of these gilts.

In addition, we have to remember, that in times after a crash (which happened 7 years ago this week in September 2008, after the Lehman Brothers collapse) interest rates were likely to fall.

Further, in a financial crisis, markets liquidity usually dries up. That is why we see huge falls in share prices, and other asset prices. Nobody wants to buy. Even bond markets should be affected.

After a crash, interest rates did indeed fall. That is a normal policy response by central banks, and rates dropped from about 5.5% to about 0.5% in the space of a few months. As a gilt trader you know that this is a great opportunity, and if you can get enough gilts early before interest rates drop, you know that you will be able to sell them at a profit, as gilt prices will rise, as interest rates fall.

But the market was still extremely uncertain, and liquidity probably still low. That is where the Bank of England steps in with its first QE programme, announced in January 2009 and started in March 2009.

Now, obviously somebody had the £375bn of gilts before they were sold to the Bank of England, and they will have sold them at the profit.

How will banks have benefited?

So, to claim that the £375bn of QE was a “rich people’s QE” is correct

But to say that the banks did not profit, is incorrect. Being market makers will have made very handsome profits, and will definitely have benefited from the £375 directly.

To what extent we do not know. If they made 10% profit on all the gilts they sold, they will have made £38bn. If they held them from Summer 2008 (high interest rates) and sold them in March 2009 (very low interest rates)  huge profits would have been possible. Perhaps 30% profit.

I would argue, the main beneficiaries of the Bank of England’s Quantitative Easing will have been banks, whose market making divisions will have benefited handsomely from the QE programme. They would only have sold to the Bank of England at a profit.

So not only the rich benefited from QE, as Frances Coppola argued, but mainly the banks, through their bond trading departments, as market makers for gilts.

Who should investigate what that profit to banks  was? Giles Wilkes makes the case for a National Audit Office review, and the profits to the banking sector from the sales should be subject of that review, too.

Also, the Treasury Committee has powers to demand information from the Bank of England about their monetary policy, and the Bank of England governor is questioned by them at regular intervals. They could get that information from the Bank of England, if they wanted to. And if they wanted to hold the Bank of England, and its monetary policy to account.

We would at least know fully who the main beneficiaries of the £375bn QE were, and it would of course confirm that it would have been the banks and the rich.

To re-balance that redistribution of wealth, it seems right that a People’s QE is introduced, spending money on much needed infrastructure for everyone

Why does the Bank of England waste £1.5bn a year?

Yesterday British Labour members elected the progressive Jeremy Corbyn as their new leader with a 59% share of the vote, against the 3 other candidates. He will now be the opposition leader.

So the Conservatives are on the attack, we have seen it already. He will be painted as “a threat to our national security, our economic security and your family’s security”.

So Corbyn should take make sure that whatever is said is thrown back at the Conservatives. The objective is has to be seen to be more competent on security, economics and families. It should be easy.

His first test will come on Wednesday at noon. Each week the British Prime Minister has to justify his policies in a 30 minutes questions and answer session in parliament. Anything can be asked and will, it can be watched live on TV and the exchange provides good entertainment. The opposition, and other parliamentarians can ask searching or sycophantic questions from the prime minister.

The strategy for Corbyn to pursue, hopefully, will be that the government portrays itself as a inclusive government for hard-working families, but that this is in effect one big lie. In reality, the Tory government is a government for the hedge funds which finance it, the banks which it subsidises,  and the City which has an undue influence over the country. It is a government for the 1%.

So what should Jeremy Corbyn ask? It has to throw the Prime Minister off balance and ideally you want to see him defending the indefensible. You can now send your suggestions to the Labour Party, and I have. How about this?

Is the Prime Minister aware that the government currently subsidises the banks to the tune of more than £1.5bn a year?

Is he happy that an allegedly independent Bank of England subsidises banks for no reason whatsoever, and could he suggest a better way to spend £1.5bn a year?

I give him a clue, rather than giving it to the banks, which will spend it on extortionate bonuses, the government could use the money to build 5 new hospitals! EACH YEAR. Why does he waste it on banks?

Cameron will mumble and stumble something about the real threat to inflation will come from Labour, whereas the integrity of the Bank of England will be threatened by the left-wing Corbyn…

The retort should be, that Cameron does not understand anything about Monetary Policy, the bank rate could be set just by edict, and the £1.5bn thus saved be spent on infrastructure improvements for the people, rather than being wasted by the Bank of England on, what will end up, as bankers’ bonuses. Why does Cameron not stop that waste? Is he sure the Bank of England knows what it is doing? Does he know that if Bank of England increases rates, the government will have to  increase subsidies, as in the US?

So the tactics should be clear for the Corbyn front bench. In the end they will have to look more competent on anything to do with money, than the Conservatives.

So what should stick is that the government subsidises banks. It is a government for banks, and not hard-working people. There might be some intricate reason for the management of interest rates to do so (I have not found one) but nevertheless, that management of interest rates is not free. The £1.5bn is a huge cost to us and a huge subsidy to banking.

Now, in any case, it will move the discussion on and casts doubts the competence of the Bank of England. The fact is that it costs the government £1.5bn in subsidies to the banking sector. Can the Tories justify that?

So whether this question will be picked, among many others, remains to be seen.

You might want to stop reading here, as the remainder of this post is really just footnotes substantiating the point made above. If you are interested how this all works, please read on. I have just included everything here as further references. First, excerpts from comments of the longandvariable blog by Tony Yates, the professor of economics who organised a letter criticising the economic policies pursued by Corbyn. Muy discussion in the blog is with Tim Young.

First of all I set out how the Bank of England operated at the time of economic boom, until say 2008, when lending always increased.

Well, Let us go back to first principles. Reserves are money either deposited by banks at the Central Bank, or borrowed from the banks at the central bank.

The distinction is important. If banks deposit money, they receive 0 interest form the Central Bank.

If banks borrow money from the central Bank, they pay currently 0.5% to the Central Bank.

Before we go any further, can we just agree on that. The Central Bank is just like any other bank, it takes in deposits and makes loans. (which, to confuse the Dickens out of everybody, are both called reserves for the central bank) The central Bank pays less interest on deposits than it charges on loans. As all banks do. As otherwise the Central Bank would not be a bank, but some kind of spending department of the government.

The only clients of a central bank are commercial banks. I go to Barclays for my banking, I have a deposit account there it is called deposits. I have a loan there it is called a loan.

Barclays Bank goes to the Central Bank for its banking. Barclays has a deposit account there, it is called reserves. And Barclays has a loan account there , it is also called reserves. (No kidding, that is what they call it, although it really is a deposit account and the other one is a loan account)

So if Barclays has surplus notes (cash) and deposits it with the central bank, the Central Bank takes the excess cash and and credits the deposit account of Barclays with the Central bank which pays no interest. The Central Bank paid no interest on the cash. After Barclays exchanged the cash for a deposit account, the deposit account pays no interest either

As Barclays cannot force anybody at all to take the cash somebody deposited, it cannot create inflation. Same with the money which Barclays has in its deposit account with the central bank. It cannot create inflation either.

So there is no risk to inflation, just because somebody deposited some cash – that is the most ridiculous thing I have ever heard.

Then I set out how this was different when quantitative easing happened in the years since 2009.

I think we agree that what I described above (relationship customer-commercial bank vs. relationship commercial bank-Bank of England) is more or less correct BEFORE 2009. The Bank of England lent money out at a higher rate (the official bank rate) than it paid on its deposits.

That was until 2009. After 2009 everything was different. The UK started Quantitative Easing, which resulted in £375bn of extra money in the banks, which the banks did not know what to do with, as you say.

Now, for some reason, the BoE started indeed paying 0.5% interest on this money. The Bank of England therefore changed from a bank into a spending department of the government. It does not have any interest income from the commercial banks (nobody is borrowing from the BoE as all banks have enough cash and only small demand for loans), but pays a deposit interest rate on the deposits (reserves) of commercial banks at the Bank of England.

The BoE does not spend the money on you or me, but specifically gives 0.5% interest per year to commercial private sector banks. That is the interest it pays on the money deposited with it by commercial banks. It is therefore an industry subsidy to the banks, Which resulted over the 5+ years we have had it at perhaps a £9bn subsidy to the banking industry.

Now, I have never heard anybody mention this anywhere, but the facts are clear. The BoE did not need to pay interest, but it chose to do so and therefore SUBSIDISES the banking sector to the tune of around £1.5bn a year.

The reasons we have to have this interest rate subsidy to banks (we are told by the high priests of this cult called monetary policy) is because to prevent rates from falling further, as you rightly say, repeating the official line. (You say it might prevent inflation, but the whole official point of QE was of course to create a bit of inflation). But that could be much easier achieved a lot cheaper. The BoE could say: Banks have to lend money at a minimum rate of 0.5%, and not below, and that would also put a floor under the rate. A monetary policy by edict, rather than to fiddle around with “monetary operations” in the “interest rate market”. Lyn Eynon makes similar points above, citing other alternatives to straight subsidies.

Nobody, of course, calls “interest payments on commercial banks deposits (reserves) at the BoE” a subsidy to the banking sector, as nobody calls the initial QE a subsidy either. But QE provided profits, (and liquidity) to the financial sector. If we assume a 10% profit of the £375bn to the financial sector, we now have a total cost of this “monetary policy” since 2009 of £37.5bn for QE and £9bn for interest rate subsidies since then, resulting in almost £50bn from the public purse to the financial sector. with a further 1.5bn added each year. Deposits at the bank of England by commercial banks (reserves) are still over £315bn five years after starting QE.

So, in summary, you are defending a regime which subsidises the private sector banking industry to receive a total of£50bn.

In addition another ongoing £1.5bn subsidy a year, when for this £1.5bn we could build at least five new 500 bed hospitals Each year.

Are you mad?

And finally, I make the point that really there is no justification whatsoever in the subsidising of commercial banks the Bank of England.

@Tim Young
“As I mentioned in a reply to Lyn, the BoE has paid interest on reserves since 2006:”

Well, if that is the only thing I got wrong, that is truely shocking. My apologies.

Because that means, that I am right with the conclusion that £1.5bn of taxpayer’s money is being wasted in subsidies to commercial private sector banks, whose management then pays that money to itself in huge salaries and bonuses.

“There is no pleasing prejudiced ignorant lefties. ”

I guess about 99.9% of the population are ignorant. And all of them would be shocked by that fact of £1.5bn waste organised by the bank of England.

They are fobbed off with “Sorry, that is monetary policy, love, if we do not pay 0.5% on reserves, then we will have inflation”. Which, frankly, is incompetent nonsense. Or worse, fraud. The government is paying interest to the commercial private sector banks for money which the government arranged to give to them, through the £375bn QE programme in the first place. In return it gets nothing.

Do we know anybody else, or any other company, which gets money given to it by the government, and then gets interest on top? For doing absolutely nothing? But the private sector commercial banks will.

Now, why do we have a completely inefficient system to set interest rates, when a declaration of “The bank rate is 0.5%” would do the job just as well.

In fact, it would not only be £1.5bn a year cheaper, it would be also more efficient if no interest was paid to banks. The idea was for QE to be used to fund real economic activity, through increased lending. Well, paying 0.5 interest will STOP the banks lending money. Why should they lend, as they have a nice, risk-free little earner? they would be stupid to lend it to start-up companies and other risky investments.

Now, in any other walk of life you would be sacked for gross incompetence, but it seems that in the Bank of England you are richly rewarded.

Is it time to close this not fit for purpose institution such as the Bank of England. They really need a big cull, it seems to me.

We are always looking for productivity improvements, the financial sector is a prime target. We could start at the top, with the Bank of England.

@Tim Young
“The reason why the date matters is that it shows that paying interest on reserves was not some subsidy to banks to bail them out from the financial crisis, as is sometimes alleged.”

Well, if it is true that the BoE already paid interest on deposits we could go back to 2006 and find out whether that was justified, or whether the BoE were equally incompetent then, as it is now

“Why do you think any entity pays a return on its liabilities? Do you think that it is to subsidise the holders of those liabilities?”

You do understand the difference between Tim Young lending me £100, and Tim Young Bank plc lending me £100?

To illustrate:

If you lend me £100 and I pay you back £110 in a year’s time, the £10 will be compensation for you not having the money to spend, while I can, and also to compensate you for the credit risk that I might not pay the money back. But you can only lend me £100 if you actually have the money. Not so with banks.

Now, if Tim Young Bank plc lends me money, it can do so even though all the deposits it has are already lent out. It will just go to the Bank of England and will get the money and that is what is meant by “Loans create deposits” , It is as simple is that. Money created out of thin air.

So previously the TY Bank balance sheet looks like

Assets: £1,000
Liabilities £1,000

after the loan to MU

Assets £1,100
Liabilities £1,100

That is how things worked until, say, 2008. the balance sheets of the banks increasing through higher lending.

In 2009 that stopped. Nobody wanted to borrow, nobody wanted to lend, big depression. The Bank of England created QE, buying gilts from anybody who wanted to sell them.

The £1,000 Assets in detail of TY Bank plc looked before QE like:

Loans outstanding: £600
Notes and Coins £100
Gilts: £300

Now in 2009 TY Bank plc decides out of its own free will to participate in the QE programme. It wants to sell its gilts, for whatever reason, even though they pay 5% interest and seem to be a good safe investment, when to its depositors it only pays 2%. Money for old rope, would be the colloquial expression.

Now, TY Bank plc bank decides to sell the gilts. TY Bank plc gets the market value of the gilts, and uses that money to deposits at the Bank of England.

So the Balance Sheet of TY Bank plc looks like after QE:

Loans outstanding: £600
Notes and Coins £100
Money deposited at the BoE: £300

So, the Bank receives no interest on the notes and coins it holds. Nobody does, even though it is a liability of the BoE.

It receives 0.5% interest on the money deposited at the BoE. Now, this is entirely at the discretion of the BoE. The gilts were sold by TY Bank plc to the BoE and swapped for a deposit account entirely voluntarily, even though the gilts payed a higher interest rate (5%, which is fixed) and the deposit account paid a much lower one (0.5% at the discretion of the BoE).

Now if I went to the TY Bank plc and borrowed £100 from it, say, through my credit card accout with the bank, then TY Bank plc would charge me a whopping 25% interest (or more!), and I would have to pay £125 back in a years time.

The Balance Sheet would look as follows:

Loans outstanding: £600
Notes and Coins £100
Money deposited at the BoE: £200
Credit cards outstanding: £100

So total assets of TY Bank plc would not have increased, they are still £1,000.

But, more importantly, whether the BoE paid 0.5% interest on the “Money deposited at the BoE” or not, me borrowing from TY Bank plc via my credit card would not have been influenced by the 0.5% official bank rate at all. Neither would have any other decision in the UK economy. It is worth saying that again: Whether or not the BoE pays interest on “Money deposited at the BoE” does not make one bit of difference to the progression or health of the UK economy. It is a pure industry subsidy!

The BoE could decide tomorrow to stop subsidising banks, and abolish the 0.5% rate it pays on Money deposited there from banks. It could treat “Money deposited at the BoE” just as it treats other liabilities “Notes and Coins” on which it does not pay any interest either. Nothing would change, other than the profitibility of the UK banks, which would be lowered by £1.5bn a year.

Now, Tim, you not think the public should be told about this scandal, and how would you suggest it is best publicised, that instead of building 5 new hospitals a year, the government decides to give the money to private sector banks!

For nothing in return whatsoever.

Here is the Bank of England official view.

Here is what the Federal Reserve is doing, they are planning to pay more for money held by banks at the Central Bank of the USA, the Federal Reserve. That is how they want to implement the rate rise everybody is talking about.

And here is another blog, giving another view, that there should perhaps be a tax on deposits at the Central Bank by commercial banks (reserves) to encourage spending. So that is exactly the opposite as the government paying interest on reserves. This is from 2009.

Greece – Summary and Index

In the New York Times a couple of days ago Yanis Varoufakis made the point that Greece was crushed, and he will not be standing in the election. It is not even certain that Syriza will win in the 20th September election, and if they do, they will be a lot weaker than before.

The economic programme that Greece will have to implement is the memorandum. Greece will have to recapitalize its banks, and they will need a restructuring of their debts. but at the moment it has agreed to take on more debt. That is part of the 3 year bail-out deal.

None of this will get Greece decisively out of the rot it is in.

The following is what I posted in a reply on the New York Times comments page, and it will be what Greece will have to do next time around. That is if Greece decides that it will not want to follow the programme which it was forced to accept.

We all learned that even the most sensible alternative plan would not have been accepted. The agenda on the other side was to crush Syriza and continue austerity. No good faith on part of the Troika at all.

My advice to Mr Varoufakis for the next time around (not this election, but the one after that), as the problem will not go away:

1) concentrate on things you have control over, your own country
2) declare your central bank independent, but keep the Euro (Montenegro solution) as your national currency, backed by full foreign currency controls
3) declare moratorium on all debt to troika from the beginning
4) Introduce supplementary currency to give basic small income (to ensure universal acceptance) and allow employer of last resort program,
5) get rid of the troika trolls from your country and never let them in again
6) start re-negotiating debt repayments after a 12 months moratorium

Forget about changing the EU in good faith negotiations, although last attempt in first half of the year was worth a try. But we know all know it is impossible, and that means the end of democracy.

In essence I think Syriza did the right thing, they tried to get some concessions, they tried to present alternatives, they tried to get some debt relief, but nothing was accepted.

Should they also have pursued a Plan B? Although there are plenty of Plan Bs proposed on my blog here, it would have been difficult. The reason was of course time pressure.

It will have been difficult enough to agree a Plan A, which Varoufakis is talking about in the New York Times article, to work on details on alternatives was impossible.

And no party can follow a different path to the one proposed to the electors, which is why we now see an election in Greece.

So next time a radical party should present a credible Plan B based on the above advice, and try to get elected, based on that plan B. There are of course critics to the parallel currency approach, and they are summarized in this superb insight from one of the advisors to Varoufakis. They did not think an alternative currency could work, as it would have been seen to be the precursor of Euro exit. Jeffrey Sachs was of the same opinion. I believe the advisers are wrong on some of the technical aspects. (My detailed arguments can be seen here,)

But in detail, for a policy to succeed, it will depend how a party can “sell” the new policy, such as a parallel currency. You will need to say it is a positive policy to support the Euro. And the parallel currency has to be clever, a comparison of various proposals here. But that works best if made clear as part of an election strategy.  However, if if you have your back to the wall as the Greek government had, and are surrounded by powerful troika enemies, an introduction might well fail.

So any radical proposals as set out above will need to be owned and supported by a main-stream Greek party, perhaps Syriza, perhaps someone else, in future.

Until that time, there does not seem to be any point having any more radical thoughts on Greece. The radical action moves to the UK, with People’s Quantitative Easing, for example, if Jeremy Corbyn becomes the new Labour and opposition leader.

Thanks to the people who looked into this blog because they were interested in Greece, from Greece especially (hopefully they found it useful), thanks for the comments, and as soon as new developments happen, Greece will feature again.

For people who are interested, what my proposals in this blog were about so far, as far as Greece is concerned, a little index

  1. My forecast of agreement – the memorandum now a bit stricter than I had forecast and has yet to feature any debt restructuring
  2. Proposal to repay Greek debt, if Europe agrees to buy more goods and services from Greece
  3. Humiliation will not lead to repayment, economic growth will
  4. Grexit and devaluation spells disaster not deliverance.
  5. Four factors which inhibit investment in Greece
  6. Bring in parallel currency, the G-Euro, to counter liquidity squeeze on banks
  7. Twin deficits, budget AND current account, were reason for problem
  8. The case for debt relief
  9. IMF’s case for debt relief, and the case for Greece borrowing from Greek banks
  10. Why was Varoufakis sure that an agreement could come after NO vote against memorandum? (My guess was wrong, though)
  11. How to negotiate conditional debt relief
  12. How a parallel currency, the G-Euro could work in detail in Greece, reducing unemployment, and adding to growth
  13. IMF’s chief economist woeful TINA description of Greece
  14. Three ways to “Grexit”
  15. Grexit, while keeping the Euro, the Montenegro solution Greece’s ultimate ace
  16. 25bn for banks,  nothing for the Greek State (it repays 6bn in interest) are the real numbers behind this 3rd bail-out “Greece needs 86bn” deal
  17. Three German solutions to bank re-structuring
  18. Easy plan to Grexit with new currency 1:1 with Euro
  19. Best post: Analytical comparison of various parallel currency proposals for Greece
  20. Great ideas and no pay: economics of blogging
  21. Discussion of parallel currency in FT by Varoufakis
  22. The use of blogs for development of policy proposals
  23. What if all of £240bn Troika loan to Greece was funded by Greek banks 
  24. This post

The Mosler challenge to 55 economists

In the Financial Times a few days ago, 55 economists criticised the potentially new leader of the UK Labour Party Jeremy Corbyn (results due in a week) for his proposals regarding People’s Quantitative Easing. The idea is that a yet to be set up National Investment Bank sells bonds to the central bank, the Bank of England, and uses these funds to pay for much needed infrastructure investment in the UK.

That is what the economists, led by Professor Tony Yates from Birmingham University had to say:

Peoples’s QE would be a highly damaging threat to fiscal credibility, and unnecessary, since at this time of very low interest rates and tolerable debt/GDP public investment — in many areas much needed — can be financed conventionally.

Everything can always be financed conventionally through more government borrowing, but the Labour party lost the election, it is thought, because more deficits leading to higher debt were seen by the electorate as too risky and hence voted for the Tory Party, which promised more austerity. For the second time in a row, after 2010.

Now,  PQE will actually allow the UK government to finance expenditure for free. The National Investment Bank would have to pay interest on the bonds to the Bank of England, but both are government agencies, and therefore the financing of any investment would be free. This radical idea is part of the appeal of Corbyn, and will contribute to his win as Labour leader, if he actually does win. It also neatly provides a method of not increasing the deficit, or government debt.

Still, the economists believe it would threaten the “fiscal credibility” of the UK to finance things for free. They do not define fiscal credibility, but I would interpret it as the ability to raise taxes and spend money in a credible way. I would think it depends on the size of PQE, compared to the rest of the economy, whether there is a reputational risk, as a tiny £10bn PQE per year programme in a huge £1,800bn  GDP economy as the UK would hugely limit any reputational risk. The risk would in fact be non-existent. But £10bn would enough to finance around 80 hospitals, or more than 50,000 new homes for social housing. So tiny risk, huge reward.

Now the challenge:

Below you find a picture of a US supercar, currently on sale in the UK for just under £100,000. It is a 2010 model of the Mosler MT900S. (Further details here)


I would like to offer it to the 55 economists. There are three financing options:

  1. You can have the car for free. This is PQEE, People’s Quantitative Easing for Economists.
  2. You can pay for the car in instalments. These are £3,000 per year. Forever. So your kids, grandchildren, and great-grandchildren will need to pay. Long after the car will have stopped working. The payments never stop, so over 100 years you or your heirs will have paid £300,000 for the car. But payments continue. Your partner and bank manager might warn you against that option as you have enough debt already.
  3. It will be financed like the last Labour government paid for the hospitals it built through the Private Finance Initiative (PFI). For the next 30 years you will pay 12,000 per year for the car. You will have a maintenance contract for the car, and it means that over 30 years you will pay £360,000. Then the car is yours.

If the economists followed the advice they give the Labour candidate, they would of course reject the offer of a free £100,000 car. The PQEE option would clearly damage their professional reputation They would advocate free money! So that is what they are teaching at university these days, that a potential risk to reputation should always come first, rather than the goods and services which meet the population’s needs at the lowest possible price. It seems.

The economists would prefer the second option, being indebted. That is in fact what happens if a government borrows. It will start paying interest on its debt for ever and ever. Government debt is never repaid (apart from tiny amounts when times are good) and interest will continue to accrue and need to be paid forever. By the heirs of the people who took out the debt.

The third option I have included because another Labour candidate for leadership, Yvette Cooper (husband of former Labour Shadow chancellor Ed Balls) keeps going on about People’s Quantitative Easing being “the private finance initiative on steroids”. I think the PFI financed projects are examples of the great financial scandals of the last 20 years in Britain, where the unscrupulous financial service industry has ripped off unsophisticated clients. In this case Ed Balls, who worked in the UK Treasury at the time of PFI. Yvette Cooper is closely associated with that disaster, which undoubtedly was due to other economists recommending it as a way forward then. If I were her, I would not mention PFI at all, as it just shows that Labour was diddled by the finance sector.

Now, unfortunately the offer of the Mosler car is only hypothetical, should the economists, despite their recommendation what Labour should do, do a U-turn themselves and take stuff for free.

In reality, of course, quite a few, if not all economists, would have chosen the free car,  and dealt with the potential reputational damage later. Or perhaps they would have said that the risk of reputational damage through PQE is quite small, if the PQE amount is quite small. and we should therefore go ahead with a trial version of small PQE.

I would be interested in their response.

Now, if they do not like Mosler’s car, or cannot afford it, they could always read his stuff on economics. I would start with that: “Seven deadly innocent frauds in economic policy“.
That is really free, a free download.