Inflation up to 8.5% for rent! Who owns the land?

The increase of the average rent in Britain over the last year: between 6.3% and 8.5%,  according to an article today in the Guardian.

Rent is now between over £1,301 (+11.6%) a month in London, and £519 (-0.4%)  in the North East. For new lets, the average rent for Greater London is £1,555.

So as prices in goods and services decline (CPI inflation rate: -0.1%) rents go up, in the London borough of Westminster by a record 28%over the last year.

This is obviously great news for buy-to-let landlords, who can now make more than 9% a year on average on their properties. They only have to find the money for a 25% deposit, and then can finance their borrowing at a much lower rate (say, 4%), given the current low interest rates.

A market, which allows these price rises from one year to the next, when general inflation is non-existent, must be inefficient. The market for housing, of course, is superficially kept low, by the government refusing councils permission to build council housing for rent. So people who could normally only afford social housing now have to rent from the private sector. The bill, of course, is paid for by the state.

Also, council planning laws and restricted spaces for house-building (especially in London) make it difficult for supply to keep track with demand. This is an issue of land allocation to housing. Either by owners not making it available for development and hoarding it, or, alternatively, local planning authorities not giving enough planning consents. A classic supply problem.

Funnily enough, though, for a Tory government, which is keen on supply side solutions to, say employment markets, (by introducing a trade union bill, to make it difficult to strike), it does not tackle the housing market supply.  Restricting supply puts value on houses through house (and rent) price inflation, and will make property owning families feel richer, and more likely to vote Tory.

But apart from the politics, it is also an issue of ownership.

Who owns the land, and who keeps hold of it, hoping to make a killing in land price appreciation, before selling it?

The New Statesman back in 2011 had a good summary of who owns the UK. The whole of the article is well worth a look. Here are ten highlights from this article. Just for reference, an acre is just about half a football pitch.

Ten things to know about UK land ownership

  1. About 150 years ago, only 4.5% of the UK population owned some land, now it is 70%.
  2. Around 5%  — 3 million acres out of total of 60 million acres in UK — is urban land where we live, another 3 million acres is where we work
  3. 42 million acres are agricultural land. Whereas the owners of agricultural land paid almost all of the UK’s taxes in 1873, they now receive a subsidy of around £83 per acre  – at least £3.5bn.
  4. Urban dwellers pay £35bn in land related taxes, an average of £1,800 per dwelling, or £18,000 per acre.
  5. Ultimately the Crown owns all the land in the UK, whether it is Freehold, or Leasehold.
  6. 9 out of 10 acres in England are not urban land, so there is plenty of land for development.
  7. At the current rate of urbanization, of 14,400 acres per year, Britain will not be “concreted over” for another 2,000 years.
  8. Behind the scare stories of scared land is a very simple financial fact: an acre of rural land worth £5,000 becomes an acre of development land worth between £500,000 and £1m once planning permission is obtained.
  9. The current Land Registry for England and Wales is at least 35 per cent short of recording all owners of all property after 86 years of trying. It does not record how many acres each owner holds. So who owns the remaining 35% (the bulk of the land) is unknown.
  10. In the UK, the average “farmer” receives between £18,260 and £23,000 every year from the taxpayer for an average farm of 220-plus acres, whether or not he or she grows or herds anything. During the ten years from 2000 to 2009, the top 50 recipients of agricultural subsidy received £168m – an average of over £3.3m per farmer.

So the main points to keep in mind, the Crown owns ultimately all the land, who is the actual freehold or leasehold owner of the land is unknown, and the biggest landowners receive massive subsidies, when the the average urban owner pays around £1,800 in property related taxes. This makes the system highly inequitable. And let us not forget, that many properties, which are registered and commercially held, are actually registered in tax havens.

That, coupled with the massive development gains once land receives planning permission (the value increases 100-fold or 200-fold) makes the UK land sector a prime candidate for a tax overhaul.

It will not happen under the Tories, who are happy to artificially restrict supply to the housing market by refusing to let councils build much needed social housing for rent.

So this should make the land and property market one of the main targets for a reform, and to increase the supply, once a new government comes in. Rents would come down, I am sure.

Africa (and Britain) needs development, but it does not need capital!

I worry about a world in which the rich get to write the rules which the rest of us have to obey

These are the wise words of Angus Deaton, an economist who received a “Nobel” Prize earlier this week. He was awarded his prize for measuring things, mainly how to allocate our money for consumption, how consumption is affected by income, and how we measure poverty

Measuring poverty is, of course, not eliminating poverty, which, if anybody finds the solution, should really have won the Nobel prize.

Ever since classical economics began with Adam Smith and David Ricardo, there have been three main factors of production. Land, labour and capital. Whereas Africa has plenty of the first two, the third, capital is lacking. So, hence the debates about whether to give aid to Africa, This would enable it to build up capital.  Or should we give loans to African countries, through the World bank, for example, to purchase or build the necessary capital, for example, transport infrastructure to bring goods to markets.

If we think that both aid and loans are a bad idea, what else is there? Here is the suggestion of my lecturer at the School of Economiic Science, where I currently study for the Economics with Justice course. Use MOT1.

Now, as all lecturers at the School of Economic Science, my lecturer is a a volunteer. And an architect. He therefore knows something about building. His suggestion is to use MOT1 to build roads. Apparently, if you do not know what MOT1 is, it is an aggregate mix of stones of various sizes, which is the underpinning for roads. Although normally it would be the base layer for tarmac, it can be used as a road by itself, once compacted.

MOT1 is just a collection of stones and rocks of appropriate sizes, it should be available in all countries in Africa. In addition, man-power is available to build the roads. The only problem is the organisation to get the people to build them. So the actual building can be done by hand. hence no capital is needed, the MOT 1 aggregate compacted by hand-held rams, if need be.

The point of our lecturer was this, if Africa wanted to improve its infrastructure, like roads, it could, without the need for outside capital, if it could organize its workforce to build roads.  Yes, it would be quicker by machines, but it would be entirely possible without any capital, if a particular African country wanted to do so.

Better infrastructure should increase GDP growth in Africa by 2% per year, argued the Economist back in February.

So if that is true, and my lecturer is right, that it only needs MOT1 to build roads, maybe my lecturer should have had the Nobel prize for economics?

Clearly, any African country using only MOT1 could only build rudimentary roads, and not railways, or pipelines, or motorways, which Africa could also use. And is currently building.

But, it would be able to build up its own resources to build its infrastructure in time.

Other countries have done it. China was probably just as poor 30 years ago. But China has managed over time to build up infrastructure which is the envy of the world. Britain has difficulty coming to terms with building a new nuclear power station, or high speed railway lines, as the costs seem to be enormous. China, however, a country with only 1/5th of the GDP per person, has built 28 nuclear power stations and close to 10,000 of new high speed railway lines. All built in the last 30 years.
Much of the spending on infrastructure in China is only possible if it has the engineers to build and maintain power stations and high-speed railway lines. Again, that expertise is part of the infrastructure in a country. To gain that expertise, one needs good education systems. None of that needs foreign finance. It is a matter of organising and paying for it internally in the country, whether it is Britain, China, or a country in Africa.

The point is this, foreign development in terms of capital projects will get wasted, if the country does not have the internal structures to use it wisely, a point which the Nobel prize winner Deaton makes. Sometimes it does not need any capital at all to bring more wealth, as my lecturer argues, when proposing that Africa should build a lot of roads itself, by getting organised, and use the MOT1 aggregates.

So is money for the establishment of capital not necessary? The UK could not build power stations or new railway lines without the necessary money. But why does it not do as China has done, and make sure internal cheap finance is available? In China it is state-run banks lending to the state railway companies. We have made some suggestions for the UK before, to borrow at 0.5% per year or finance infrastructure through PQE. As a trading economy, the UK or any African country should make sure, its currency is not under potential pressure from excessive current account deficits. But then it can afford to buy what it needs.

The real constraint, is not capital, as China has demonstrated. The real constraint of development, and increasing wealth is the organisation of resources, mainly manpower to build the infrastructure it needs. Whether that is bags of MOT1 to build roads, or high speed train techonology imported from the West, the money for capital should always be available.

The organisation of resources and manpower is something else. Nations have to  organise their state in such a way, as to be able to pay for capital through taxes, or government finances. And keep their external trade in balance, to have a balanced current account. Then, organised, well educated man-power will always be the main driver of development. The constraints are therefore good government, and good government institutions allowing for education, taxes, and government infrastructure development.

If you read this Economist article, it will talk about the way new infrastructure it is financed in Africa, It will not talk about the fact that good governance is necessary to ensure that infrastructure is maintained and developed. Which is not automatic. Neither in Africa nor in Britain.

The money to buy capital is secondary and should be able to be organised as we want it. It is the rich which have given us the rules, we should remember, and for them it seems capital is paramount. The rich are wrong.

Economics of the Bullingdon boys – wealth funds

Yesterday, Boris Johnson picked up on a topic which was announced by George Osborne the day before at the Conservative Party conference. Local authority pension funds were to be amalgamated into “wealth funds” to allow them to invest in the UK’s infrastructure. That is what the Bullingdon boys are now proposing.

Now, this seems a bit peculiar. As at the moment any infrastructure I know of (roads, railway lines, schools, hospitals) does not make any money. Pension funds, however, invest in things which give them a return. For example, investing in one of the biggest 100 companies on the London Stock Exchange would give them, on average, a 4% dividend payout. In addition to that, many companies buy back their shares and inflate their prices, thereby allowing companies to pay out 60-70% of their profits to shareholders, according to Andy Haldane, the Bank of England’s Chief Economist.

That then gives the pension funds the income it will need to pay pensions, either by selling the assets (shares) it has, or just using the income from dividends.

However, roads, railways, schools and hospitals, the infrastructure which Britain needs, does not produce any income. Neither are we planning to sell the existing infrastructure, which would produce sales receipts to pay pensions. The current railway network in the UK  is subsidised to the tune of £4bn a year, it costs us money, it does not provide a return. So these assets are unsuitable to be included in pension funds.

But new infrastructure will need to be build. The most urgent need is a replacement of our power stations, which will need to be replaced by new nuclear power stations, if we want reliable electricity production and get away from carbon emitting coal and gas power stations. The private sector is not able to provide new nuclear power, such as Hinkley Point C, at the current electricity price. So it will only be build if the state sector guarantees prices (at 2.5 times current electricity prices) and indemnifies the finance providers with government guarantees. The contractors are firms owned by the French and Chinese government. The private sector is almost completely invisible here, other than to provide the finance.

boris johnsonBoris Johnson, the Mayor of London, trying to keep the lights on.


The bill for the new Hinkley Point C power station is currently £25bn. Where would the wealth fund come in? Arguably, the wealth fund could provide all the finance for the power station. And in turn it would look for a 4% return on its investments, as it would get from the other investments it currently holds.

That would mean that the power station would need to pay out £1.0 billion to the investors just in interest (which is 4% of 25bn). However, unlike companies’ shares, the power station is a wasting asset, after about 50 years it will need to be scrapped. So in addition to the 4% interest income the £25bn will have to be paid back, just like a repayment mortgage over 50 years. That would make the annual financing costs about £1.2bn. We have previously estimated that the electricity from Hinkley C would cost the electricity users about £2bn a year. So 60% (£1.2bn of £2.0bn a year) from the sales of the electricity will have to go straight to the pension funds! For financing costs. Electricity users will pay for the public sector pension funds.

So let us be quite clear what happens here. There is virtually no private sector, no market involved. Everything is decided by the government, the builders are government owned, the pension funds are government owned, the price of the electricity is determined by the government, as is the return of the investment for the pension fund. Because unless the return to the pension fund is guaranteed, it has to invest in other assets which have a higher return and more liquidity.

The only private sector involvement would come in from the management fees of the 6 bid pension funds. A concentration of power to the biggest investment funds. (Will Blackrock be involved? Almost certainly, as one of Osborne’s Chief of Staff left the Treasury to join them in the summer!)

Now, would it make sense for the pension funds to invest in Hinkley C? Possibly, if the government could guarantee the £1.2bn per year income for the next 50 years. Because the total of the local authority pensions funds assets at the moment only amount £180bn. So one seventh of the pension investments of all local authority public sector workers would now be invested in Hinkley Point C! Quite risky, without a government guarantee.

Now, what does Boris Johnson think of the Hinkley Point C power station, is it a good investment, and be suitable for inclusion in the wealth fund? Here is what he said a few weeks ago:

We have just done this absolutely crazy deal with the French, EDF Energy, to produce nuclear energy which shows no sign of working and looks like being unbelievably expensive at approximately £93 a kilowatt hour. It is a huge amount of money we are spending on nuclear energy. Hinkley Point B (sic) [nuclear power station] does not seem to coming down the track.

We need to be looking at building many more gas-fired power stations. At the moment, I am afraid, it is taking too long.

So, Boris Johnson presumably thinks this “crazy deal” should not form part of the wealth fund?

Well, fair enough, what else then? The gas-fired power stations he is talking about are being financed by the current electricity generators, and do not need a wealth fund.

I am not going to look at the other major infrastructure investment plan, the HS2 high-speed railway line between London and Birmingham. The estimated cost is at least twice as much as the Hinkley C power station. Whereas all of the UK will benefit from the power station, as we are all electricity users, it will only be a very small portion of users who will benefit from HS2. New passengers will clearly not pay for the cost of the new line, as it would make the cost of a ticket prohibitively expensive. HS2 is therefore another state investment which is run at an economic cost (i.e., loss) to the government, will subsidise rail travel, and not suitable for investment by a wealth fund.

So what will go into these wealth funds? I cannot see any public wealth which would be suitable for inclusion in a pension wealth fund, as it never generates the income or provide the liquidity which a pension fund will need. If Hinkley C goes ahead, it should be financed differently, with the help of very low government finance, or PQE. Thereby making sure that UK electricity users do not provide extortionate interest income to either the financial sector (the current model) or local authority pensioners (if the wealth fund idea was to go ahead).

In summary, the idea of a wealth fund just another stupid idea by the Bullingdon boys, and will go the same way as the pasty tax, and should get reversed. Let us all hope so.

I would think it is high time to change the economic management of this country from the catastrophic Bullingdon Boys to capable managers of the economy. Roll on 2020.

Embedded image permalink

George Osborne, the Chancellor of the Exchequer, relaxing, before becoming chancellor

Credit: @George_Osborne twitter feed

PQE a good idea, but keep it away from Labour!

About three weeks ago I attended the Making Money Work event organised by Positive Money. Three economists were present, Adair Turner (former chairman of the Financial Services Authority), Chris Giles (economics editor of the Financial Times) and Steve Keen (Professor of Economics at Kingston University).


Steve Keen, Chris Giles, Fran Boait (Positive Money) and Adair Turner.

Picture: Positive Money

Now, the benefit of seeing economists all together, it is often very surprising how much they agree with each other. For example, a question from the audience came up, suggesting that inflation rates should reflect the increase in property values. I am sure I saw all economists nodding in agreement at that suggestion, which is a good one.

However, this gets never discussed, including property prices in the measure of inflation; and hence the official inflation rate only reflects consumer prices, leaving property markets to its cycle of boom and subsequent crash. So even though economists agree, it does not become policy.

So, I was equally surprised how much all economists seemed to be in agreement with the main topic of the evening, Overt Monetary Financing.

The main presentation was by Adair Turner on how Britain was stuck with either increasing its already excessive private debts, or use overt monetary financing to get back into a sustainable growth cycle or, more likely, help in a recession. Turner did not see any technical difficulties with overt monetary financing, if done to a very limited amount, say £10bn a year, and the others agreed. However, Chris Giles said he had reservations about Corbyn’s People’s Quantitative Easing, and I am sure he was very critical of PQE in the Financial Times.

Now, here we come to the crux of the matter. I have previously mentioned that Ambrose Evans Pritchard in the Daily Telegraph supports the idea. However, in the same article you will find Jacobins, and Proudhonists mentioned, the implication being that revolutionaries or anarchists (Labour) should not be trusted with PQE. In fact, he suggests that the Conservatives are best placed to use these tools responsibly.

The same with Adair Turner again, who was interviewed by the IPPR about his ideas. a couple of days ago That is what he said.

JG: One proposal for fiat money that’s received a lot of recent attention among UK commentators is new Labour leader Jeremy Corbyn’s ‘People’s QE’. Do you support his proposal?

AT: I have to admit I haven’t looked at it in great detail. But the challenge facing Jeremy Corbyn in proposing any form of monetary finance is clear: whether he can credibly address the hugely important political economy risks.

As I said earlier, the technical case for treating overt money finance as an available tool to stimulate nominal demand – if and when the conditions make such stimulus appropriate – is incontrovertible. But the politicalrisks of its misuse are huge.

So the legitimate concern is that if monetary finance is proposed by people who come from a strongly socialist tradition – a tradition which has tended to reject the idea of any disciplines on public expenditure – there is a danger in practice that it would be used to excess. That is the concern which Corbyn would have to address.

Paradoxically, the governments best placed to use overt money finance without generating legitimate concerns about its misuse, and without therefore generating harmful market reactions, would be those whose overall commitment to a capitalist market economy is unquestioned. This mirrors the interesting reality that some of the most compelling arguments for using overt money finance of fiscal deficits were put forward by economists – such as Milton Friedman – whose commitment to sound money and low inflation were undoubted.

And, here again, the messages is clear: give Overt Monetary Financing to Tories, which have an “unquestioned commitment to a capitalist market economy”. Keep it away from socialists.

Now, these are clearly political points, which have no reflection in reality. As Prime Economics (the think-tank which Ann Pettifor works for, one of the new Magnificent Seven Economists to advice Labour) has pointed out, Labour has shown more financial rectitude than the Conservatives in the last 25 years. Here is Prime Economics Jeremy Smith’s analysis, showing that the deficit under the Tories was much worse over the last 25 years, than it was under Labour:

Source: Prime Economics

So this is only spin, that Labour cannot be trusted.  Based on the Prime Economics’ analysis the Labour government borrows less. If that is the measure of responsibility, Labour should be trusted with PQE, not the Conservatives.

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.