Jul 20th 2010, 9:42 by Buttonwood
IMAGINE that you are a govermnment with a huge fiscal deficit. You are worried that you might get punished by the markets as Greece has been. You decide to embark on an unpopular round of tax rises and spending cuts. Your next step is to abandon a fund-raising product because it is...too popular!
That is what the British government has just done. It has stopped the sale of index-linked national savings certificates. These paid the rate of inflation plus 1% for five years, with returns being tax-free. According to National Savings, the product was abandoned because it had exceeded the government's fund-raising target.
Exceeded the target! This is a government that has to raise £160 billion ($240 billion) this year, Rejoice, as Mrs Thatcher might say. Money raised from retail investors is money you do not have to raise from foreign investors, hedge funds and the like.
Ah, well. The worry is that money is being diverted from the banks. But a bit of healthy competition for the banks is no bad thing. Savers know they treat their customers abysmally. They lure them in with an attractive headline rate, only to drop the yield without notice, leaving savers on 0.10% or similar. Savers have to keep closing and re-opening accounts. It is a tax on the elderly or anyone else too busy to spend their life monitoring the web for announcements of new savings accounts.
But even the stated reasoning is dubious. The banks need deposits so they can lend to industry, or so the argument goes. But if the money to fund the deficit doesn't come from retail investors, it must come from pension funds and insurance companies which will buy government bonds. That will reduce the amount such institutions have to invest in industry via corporate bonds and equities. The "crowding out" argument makes the case for cutting the deficit, not abandoning a popular savings product.
So let us come to the real reason why this product has been dropped. It was attractive because the inflation rate has been high; the headline inflation rate has been 5% so those who bought the certificates have been getting 6% tax-free. (Buttonwood should declare an interest; I am such a saver. But the change does not affect the value of my existing portfolio, only stops me from buying more.)
If you believe the government and the Bank of England, however, the inflation rate is set to come down. Over the long run, a government should leap at the chance to fund itself at 1% real; that ought to be less than Britain's GDP growth rate.
A cynic would look at the decision and say "Aha! The government either believes that inflation will stay high, or is pursuing a deliberate policy of inflating away its debt. It would rather issue bonds at a nominal 3% fixed than pay 1% real." Britain has more scope than most governments to pursue an inflation approach, because the average maturity of its debt is almost 14 years.
Is this overly cynical? I don't think so. After all, the Bank of England recently bought £200bn of gilts, funding more than one year's deficit. This is debt monetisation as practised by Rudolf von Havenstein, head of the Reichsbank during the Weimar republic. Inflation is already above target and has been for several months but the Bank of England has kept rates at 0.5%.
Of course, such an idea will be laughed out of court. The Bank's move was "quantitative easing" designed to stabilise the financial system, not a way of funding a spendthrift government. But as they say in Yorkshire "they'll tell you owt", i.e those in power will give you any old excuse. After a while, you have to stop listening to what they say and start watching what they do. And the latter should make investors very suspicious.
UPDATE: Totle is right, owt is anything, nowt is nothing. As for certificates being generous, a 1% real return is not generous historically. Savers should get some real after-tax return or why would they save? The certificates look so good in relative terms because the government/Bank of England are punishing savers with low rates, high inflation and high taxes.
Comes from The Economist
That is what the British government has just done. It has stopped the sale of index-linked national savings certificates. These paid the rate of inflation plus 1% for five years, with returns being tax-free. According to National Savings, the product was abandoned because it had exceeded the government's fund-raising target.
Exceeded the target! This is a government that has to raise £160 billion ($240 billion) this year, Rejoice, as Mrs Thatcher might say. Money raised from retail investors is money you do not have to raise from foreign investors, hedge funds and the like.
Ah, well. The worry is that money is being diverted from the banks. But a bit of healthy competition for the banks is no bad thing. Savers know they treat their customers abysmally. They lure them in with an attractive headline rate, only to drop the yield without notice, leaving savers on 0.10% or similar. Savers have to keep closing and re-opening accounts. It is a tax on the elderly or anyone else too busy to spend their life monitoring the web for announcements of new savings accounts.
But even the stated reasoning is dubious. The banks need deposits so they can lend to industry, or so the argument goes. But if the money to fund the deficit doesn't come from retail investors, it must come from pension funds and insurance companies which will buy government bonds. That will reduce the amount such institutions have to invest in industry via corporate bonds and equities. The "crowding out" argument makes the case for cutting the deficit, not abandoning a popular savings product.
So let us come to the real reason why this product has been dropped. It was attractive because the inflation rate has been high; the headline inflation rate has been 5% so those who bought the certificates have been getting 6% tax-free. (Buttonwood should declare an interest; I am such a saver. But the change does not affect the value of my existing portfolio, only stops me from buying more.)
If you believe the government and the Bank of England, however, the inflation rate is set to come down. Over the long run, a government should leap at the chance to fund itself at 1% real; that ought to be less than Britain's GDP growth rate.
A cynic would look at the decision and say "Aha! The government either believes that inflation will stay high, or is pursuing a deliberate policy of inflating away its debt. It would rather issue bonds at a nominal 3% fixed than pay 1% real." Britain has more scope than most governments to pursue an inflation approach, because the average maturity of its debt is almost 14 years.
Is this overly cynical? I don't think so. After all, the Bank of England recently bought £200bn of gilts, funding more than one year's deficit. This is debt monetisation as practised by Rudolf von Havenstein, head of the Reichsbank during the Weimar republic. Inflation is already above target and has been for several months but the Bank of England has kept rates at 0.5%.
Of course, such an idea will be laughed out of court. The Bank's move was "quantitative easing" designed to stabilise the financial system, not a way of funding a spendthrift government. But as they say in Yorkshire "they'll tell you owt", i.e those in power will give you any old excuse. After a while, you have to stop listening to what they say and start watching what they do. And the latter should make investors very suspicious.
UPDATE: Totle is right, owt is anything, nowt is nothing. As for certificates being generous, a 1% real return is not generous historically. Savers should get some real after-tax return or why would they save? The certificates look so good in relative terms because the government/Bank of England are punishing savers with low rates, high inflation and high taxes.
Comes from The Economist
