From 7d198e2066f0d5780e88518762b7cb72da139bd8 Mon Sep 17 00:00:00 2001 From: Neil Wilson Date: Sun, 12 Jan 2025 13:07:43 +0000 Subject: [PATCH] Add Debt managment Review post --- content/post/debt-management-review/index.md | 102 +++++++++++++++++++ 1 file changed, 102 insertions(+) create mode 100644 content/post/debt-management-review/index.md diff --git a/content/post/debt-management-review/index.md b/content/post/debt-management-review/index.md new file mode 100644 index 00000000..7949be29 --- /dev/null +++ b/content/post/debt-management-review/index.md @@ -0,0 +1,102 @@ +--- +title: "Time for a Debt Management Review" +date: 2025-01-12T12:38:07Z +summary: "If we're going to have government debt, then it's time to retire Thatcher-era monetarism and adopt a modern, cost-efficient approach to its management." + +--- + +Recent headlines have painted an alarmist picture of the UK's debt +situation, rife with half-truths and outdated comparisons. Even +the [ordinarily rational Andrew Neil][1] has succumbed to monetarist +misconceptions, claiming that + +> Investors will not take on any more British sovereign debt without a +substantial risk premium + +Before drawing flawed parallels between the UK and Germany by comparing +borrowing costs within entirely different currency frameworks. + +Meanwhile, [Faisal Islam at the BBC][2] noted that + +> Government borrowing costs have hit their highest level in 16 years. + +While he offers some context by pointing to the uncertainty of future +U.S. economic policies, his analysis still contributes to the broader +narrative of misplaced panic. + +These commentaries fail to grasp the key issue: the current debt +management framework is a relic of outdated policy, ill-suited for the +realities of the modern financial system. It's time to reconsider and +update our approach. + +## The Origins of the Current Policy + +The UK's current 'full funding' rule dates back to 1985 when it was +introduced to neutralise the public sector's influence on the M4 money +supply.[^9] This framework was solidified by a [1995 review][3] long before +critical developments like Bank of England reserves, interest on those +reserves, and Quantitative Easing (QE) reshaped monetary dynamics. The +rule's foundation—derived from fixed exchange rate thinking and +monetarist orthodoxy—does not reflect the operational reality of the +UK's floating exchange rate regime. + +The floating exchange rate fundamentally alters how government spending interacts with a currency +area. When the government spends, in effect [it gives the private sector the money][5] it uses to buy government bonds. +At an aggregate level, in the UK, the choice boils down to holding a +gilt or a Bank of England deposit. There is no other alternative. This +interdependence makes the lifetime price of a gilt a reflection of +expected Bank of England deposit rates over the same period. + +Yet, the Debt Management Office (DMO) remains shackled by 1990s thinking, +issuing long-term gilts into a market seeking shorter durations. For +instance, [recent ultra-long gilt sales][6] forced the country to lock +in a 5% running yield on £2.25 billion—higher than the current Bank Rate of +4.75%. This mismatch is costly and entirely avoidable. + +## A Call for Policy Modernisation + +The DMO should never sell gilts at yields exceeding the Bank +Rate. Instead, it should align its operations dynamically with +any market preferences for shorter maturities, [as determined +by current redemption yields][8]. At a minimum, the government should +adjust the DMO's remit to ensure gilt issuance is always cost-effective +regardless of market conditions. + +Moreover, the outdated full-funding rule, grounded in discredited +monetarist beliefs about the M4 money supply, should be scrapped. By +default, HM Treasury should leave deficits on the Ways and Means account +at the Bank of England, paying the Bank Rate. This approach eliminates +redundant cash management processes, saving costs and streamlining +operations. + +The DMO's role should shift to reducing this default cost +by issuing gilts and Treasury Bills on tap, priced in line +with OBR yield curve projections. It should only issue securities if +doing so would be cheaper than the projected floating path alternative, +ensuring interest payments on any deficit increase remained within budget. + +## Conclusion + +The UK's debt management framework is stuck in the past, constrained +by Thatcher-era monetarist principles that never applied in the first +place. Just as the government recently updated its debt definition from +Public Sector Net Debt to Public Sector Net Financial Liabilities, it +must now overhaul debt management practices to reflect modern monetary +realities. By embracing a more flexible, cost-efficient approach, we +can discard outdated constraints and better support the nation's renewal. + +A debt management review is well overdue. Let's make 2025 the year we +move beyond 1990s thinking and embrace a framework that fits today's +economic challenges. + +[^9]: "When the 'full fund' policy was introduced in 1985, it was designed to ensure the financial transactions of the public sector had no direct effect on the M4 money supply". [Debt-Management Review, July 1995](https://web.archive.org/web/20220308123738/https://www.dmo.gov.uk/media/2083/report95.pdf) + +{{}} + +[1]: https://www.dailymail.co.uk/debate/article-14267671/ANDREW-NEIL-economy-Budget-Taxes-cuts-financial-Labour.html +[2]: https://www.bbc.co.uk/news/articles/cx2pg75yn88o +[3]: https://web.archive.org/web/20220308123738/https://www.dmo.gov.uk/media/2083/report95.pdf +[5]: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4890683 +[6]: https://www.dmo.gov.uk/media/d34ffquc/070125conventional.pdf +[8]: https://www.dividenddata.co.uk/uk-gilts-prices-yields.py +