The Impact of the UK Repaying Its National Debt

I often find myself wishing I had a pound for every time I’ve encountered an asset holder, often someone commenting on a retirement fund or residential property, who defends a misguided policy by insisting it would “benefit their pension.” If only that were true, I would likely have enough funds to rescue the entire system.

It cannot be repeated often enough (please, share this with your friends as much as you can): All pensions depend on future prosperity. Undermining the present — such as:

* Deteriorating infrastructure in transportation, energy, or clean water supply
* Neglecting health and social care services
* Diminishing the quality of education
* Allowing unemployment to persist, particularly among youth

… lowers the baseline for current prosperity, which subsequently reduces what we can draw upon in the future. These are not hypothetical problems that may arise; they are occurring right now and represent areas where government intervention is warranted.

I am not merely an observer. I possess significant investments in both financial assets and residential real estate. These investments are deemed by those managing my fund to be the most viable for long-term returns — I have little to no influence over their investment strategies. I fully anticipate that these assets will face declines, impacting the returns I have been promised for my retirement. This is not a comforting prospect, especially given my limited ability to mitigate my risk. However, the alternative to the current path taken by governments and central banks — writing off unsustainable asset valuations — as noted by Murphy, could lead to a second Great Depression.

By Richard Murphy, Emeritus Professor of Accounting Practice at Sheffield University Management School and a director of Tax Research LLP. Originally published at Funding the Future

Recently, there were intense and sometimes angry reactions on LinkedIn to my comments in a recent video, indicating that concerns over the UK’s national debt level are misconceived, as the UK can never go bankrupt. The UK government can always produce the sterling currency required to settle its national debt whenever it chooses.

These responses made me realize that the commentators clearly did not grasp the ramifications of the debt repayment they advocate or what such repayment might entail.

The Objections

To clarify, let me outline the primary objections. The loudest voices suggest that:

• The UK cannot repay its national debt as I propose.
• If it did, the country would become inundated with cash, leading to hyperinflation.
• They firmly believe this debt and the associated interest threaten our national wellbeing, although they struggle to articulate why. They want it reduced, but the method they favor is unclear.

Now, let’s explore the available options for alleviating government debt. There are essentially two.

The Mechanisms

First, the government could repay the debt as I have suggested. This mechanism closely resembles quantitative easing, so we know it is effective. The government creates new currency or reserves at the Bank of England and utilizes these funds to buy back existing government debt at market value.

In accounting terms, as illustrated in the UK government’s Whole of Government Accounts, this effectively cancels the debt. What replaces it are the central bank reserve account balances established to facilitate this repurchase, held by UK banks and other financial institutions that previously owned the debt and now hold deposits with the Bank of England. Technically, the debt remains, but its nature shifts from long-term bonds to short-term deposits.

Secondly, the government could repay its debt by consistently running fiscal surpluses. This would mean the government would tax more than it spends, accounting for both current and capital expenditures, using the surplus for what is referred to as debt repayment, which is actually compensation for deposits held with the government.

While one could explore variations on these approaches, these truly encompass the available options.

Appraisal: Repaying the Debt

The first option is entirely feasible. This results in a mere asset swap. Government bonds are exchanged for balances at the Bank of England, held by banks and other financial institutions.

This is the undeniable result of this strategy. If the debt is repaid using newly created sterling, recipients will need to deposit the funds they receive since payments will be made electronically by the government through the Bank of England’s central bank reserve account facility. The only secure place for banks or financial institutions to deposit these funds is back with the Bank of England, the sole entity capable of guaranteeing repayment.

Essentially, this ‘repayment’ merely alters the government’s debt profile from being long-term and fixed-interest to very short-term and highly liquid (though technically non-repayable for the financial sector as a whole). With this scenario, the interest on these funds would likely drop, similarly to Japan’s approach, where central bank reserve account balances would not accrue interest, significantly reducing government debt interest payments and meeting the concerns of those worried about government debt levels.

However, there are significant drawbacks:

• Banks would lack the bonds necessary for operating the overnight repo market in London, undermining the credibility of the UK banking system and heightening risk for private-sector firms.
• Pension funds would not possess the assets essential for securing the long-term income they promise to savers upon retirement.
• Life insurance companies would be unable to find investments necessary to meet their liability funding needs.
• Foreign governments and others outside the UK wishing to save in sterling would lack mechanisms to hold sterling as a reserve asset, jeopardizing the terms of UK trade.

Thus, while UK debt could be repaid in this manner with lower interest costs, the financial services sector in the UK would effectively collapse, rendering it incapable of delivering current services and significantly increasing financial risk in the private sector.

Is this something anyone would actually want to pursue? Certainly not. However, this thought exercise highlights just how much the UK government currently subsidizes this sector. The payment of interest on this debt acts as a subsidy to the financial services industry, which is a compelling reason to tax it more heavily.

Running Government Surpluses

Now, examining the second alternative for debt reduction, running consistent government surpluses would be necessary. This approach could be more catastrophic than repaying the debt.

Such a strategy would demand that the government extract more money from the economy through taxation than it injects through spending annually, essentially functioning as a continual brake on economic activity. Income, growth, investment, and the overall size of the UK economy would decline each year under this policy.

This outcome is inevitable under such a policy regime. Additionally, the implications of reduced UK debt, previously highlighted, would still apply, albeit over a longer timeframe, leading to the same long-term consequences.

Therefore, attempting to repay the so-called government debt would be a fundamentally destructive endeavor regarding the UK economy, financial sector, income levels, and financial security. There is no other conceivable conclusion regarding any such proposal, leading to crucial questions about why anyone would advocate it as an economic policy:

• What are they hoping to achieve?
• Why are they pursuing this goal?
• What makes them believe the potential outcomes are desirable?
• Have they carefully considered their proposals?

These questions remain unanswered, as it is challenging to fathom why anyone would champion something as harmful as reducing the UK national debt. Still, some individuals appear eager to pursue this path, and their true motivations would be worth exploring.