Is the Bank of England financing the Treasury?

Many observers view the coincidence of quantitative easing (QE) and the recent decline of bond yields to very low levels as evidence that the Bank of England has played a significant role in pushing yields down, allowing the Treasury to borrow at lower rates. The reasoning behind this conclusion relies on the laws of supply and demand, and the inverse relationship between the price of a bond and its yield: by conducting large scale purchases of bonds, demand for those bonds increases and causes a rise in their price (decrease in their yield) and reduces the cost at which the Treasury can borrow. There are even fears that should the Bank ever sell its bond holdings, the process would happen in reverse, pushing yields up, and forcing the government into a difficult fiscal position—a bond bubble.

These views are entirely plausible—I held them myself in the not too distant past. Nevertheless, I had to reconsider this position after coming across a presentation given by David Beckworth, assistant Professor of Economics at Western Kentucky University. I’ve recreated one of the charts from the presentation below but with different countries. It shows the yields on the debt of several of the world’s largest economies, with the UK & US having undertaken QE, Germany could be considered to have a small amount through OMT, and Australia has had none; a neat experiment. 

Clearly there’s a strong correlation between the yields of these countries. Now, if UK QE drives UK yields down (and prices up) then why do the Australian, US, and German yields follow the UK so closely? The Bank isn’t buying their bonds. Why do the US and UK yields follow an almost identical path when their QE was conducted at completely different times? An overwhelming amount evidence supports the notion that QE reduces short term yields, but on this grander scale, one can hardly assert that the overall decline in UK yields over the last 5/6 years can be attributed largely to domestic monetary policy. Surely this is a global phenomenon.

Maybe it’s the Fed?

Perhaps a more disturbing conclusion can be drawn. What if the original reasoning was correct, but instead of the UK and the Bank of England, it’s the Fed and the world economy. After all, the US dollar is the world’s reserve currency, and it’s by no means unreasonable to suggest that the selected bonds are near perfect substitutes so that demand for one is demand for all. If such is the case, the Fed has a frightening amount of power over the world economy.

Again, the logic is sound. But the Fed only holds around 17% of total US treasury securities, roughly the same share it held in 2007. As Beckworth said to his American audience: “85% (his numbers differ marginally from mine) of the largest dollar run up in US debt history was funded by you, me, our financial intermediaries, and foreigners.” So it’s unlikely that Fed QE is responsible for the global yield decline.

Liquidity Shortage, high Asian Savings rates, or neither?

If not QE, what is behind the global decline in yields? In my opinion, it’s due to the fact many central bankers are apparently unfamiliar with the lessons outlined in Bagehot’s 19th century classic Lombard Street. By failing to provide ample liquidity in the early stages of the crisis, when they had the opportunity to nip it in the bud, a routine cleanup developed into a full blown crisis. Investors, in a panic to increase their liquidity, rushed to the next best safe liquid asset—government bonds. Thus in a way they are keeping yields down, but only indirectly by not following the lessons outlined by Bagehot, which has stunted growth and created a liquidity shortage.

Another question remains with regard to what extend the decline since 2007 is a continuation of the trend of the last 30 years. Over this period there’s been a continued decline in yields. It could be high Asian savings rates leading to vast amounts of cash searching for interest baring assets. Furthermore, the Western world has (up until now) seen improved management of fiscal and monetary policy compared to the tumultuous 60s and 70s. Either way, it’s clear from the evidence presented here that QE is not likely to be causing any bond bubble, nor should it be seen as monetising government debt.

Help to What? Moving forward from conference season

Help to Buy was conceived and born into a dysfunctional legal and political environment, including: (1) a draconian, outdated planning regime which still retains features of its social-democratic origins in the 1940s; and (2) Housing Benefit, a rent subsidy amounting to a staggering £24bn a year, nearly half of which is directed to the private sector, behaving exactly as expected: perversely benefiting private landlords to the detriment of virtually everyone else, including private renters and—in the wake of the implementation of the benefit cap—welfare beneficiaries as well.

With that context in mind, the Adam Smith Institute argued early last month that the Help to Buy programs, also subsidies, are likely to have a difficult adolescence and produce similar effects, disproportionately hurting the poor and the young while improving the position of existing landowners. We are by no means alone in this view; many believe the scheme will make housing less affordable in the long term by driving up prices, increasing inequality, increasing household debt in an environment where interest rates are very likely to rise, and increasing the overall risk of losses for participants in the sector (including new homebuyers, whose liability to repay high-LTV mortgages could become very onerous, very quickly if interest rates move upwards).

The Government's move last week to empower the Bank of England to harness Help to Buy if the housing market overheats is a welcome admission that the Government shares at least some of the concerns of its critics. It is, however, a pity, and a loss for progress, that the Conservatives are unable to admit this in public, as most recently seen with Radio 4's interview of David Cameron on Tuesday.

In that interview, Sarah Montague peppered the Prime Minister with a list of the scheme's non-partisan opponents, including the ASI, and the reasons for our opposition. The Prime Minister blithely replied that “you need to get out more and listen to ordinary people who want to buy a home,” and that his government's objective was to liberate young Britons who, “trapped in rental accommodation, [are] paying high rent to somebody else”.

On the subject of housing, Cabinet-level officials have repeated similarly populist rhetoric with increasing frequency over the past 30 days. While this might resonate with younger voters, it does nothing to address the fundamental imbalances that underpin the high price of housing, and misleads the public as to the character of the crisis. As the Spectator's Fraser Nelson pointed out, the Anglo-Saxon fetish for homebuying is not a value universally shared; if this were the case, he playfully suggested, we should perhaps send humanitarian aid to the long-suffering peoples of “Austria, Denmark, the Netherlands, Korea and Sweden as well as France and Germany,” where short-term leasehold tenure is more widespread.

Even if the question of tenure were a normative one (and it isn't), in practical terms, the distinction is almost entirely sentimental in the medium-term. For the purchaser who takes maximal advantage of the equity loan component of Help to Buy, for over half a decade he or she may expect to trade his or her landlord for a bank and, after 5 years of interest-free lending, the Treasury—while not paying down very much principal, at least on a typical long-run amortisation schedule. There is also, of course the matter of capital appreciation; but even this, in a climate of high and rising prices, carries the potential to be a double-edged sword for banks and borrowers alike.

The real substance of the housing question is not one of tenure, nor one of "aspirations" (especially when the political realisation of these aspirations is inefficient at best, and reckless at worst). The country would benefit most from a renewed focus on affordability in the long term, a measure on which the British housing market – social and private, rented and purchased—continues to remain under significant stress.

In this respect there is very little difference between purchased or rented accommodation. In May, for the first time in 18 months rents rose across every region in the country; records were broken in London, where the average monthly individual rent now exceeds £1,100. Only yesterday, Boris Johnson—referring to a “massive affordability gap” in the London rental markets—called for additional government-subsidised support, “allowing companies to make tax-free loans for rental deposits, as they can for childcare.”

We might call such a program “Help to Rent.” Armed with the knowledge that the government already spends £10 billion a year subsidising tenants in the private rental markets—a new Help to Buy Equity Loan scheme every 17 weeks, or Help to Buy Mortgage Guarantee every year—the Mayor’s proposal, too, is unwise, for all the usual reasons.

If the crises in social rented, private rented, and private purchased accommodation are to ease, aggressive supply-side solutions are necessary to increase the availability of housing, which will gradually bring down its price and increase the availability of finance (as lower price-to-earnings ratios will make banks less reticent to lend). One option to achieve this, while appeasing more parochial voices who seek to retain the national character of urban and rural environs, might be placing greater emphasis on private property rights in planning laws governing built-up areas, a form of liberalisation which would allow developers to option out, and then raze, inefficient stock in places with few architecturally or socially redeeming characteristics (such as Fulham and Battersea) and replace it with buildings of considerably greater ambition.

Subsidising demand will not and cannot, given present legal and political restrictions on development, achieve this outcome. Further injections of government cash will only make life more difficult for future market entrants who are forced to pay for these subsidies while competing against them. As the Conservative Party Conference draws to a close, young Conservatives—and indeed first-time buyers of any political persuasion—should resist and oppose calls by senior Tory figures for additional state intervention in the housing market. If affordable housing is the goal, it's time to call for rather less.

Isn't this absolutely wonderful about payday loans?

Although the loans are marketed as a quick, flexible way to get cash for items like home improvements and holidays, almost four out of five people who turned to Christians Against Poverty (Cap) with problem debts, including payday loans, said they had used them for food. Half said they had paid gas and electricity bills with them, while a third had borrowed to meet rent or mortgage costs.

Payday loans are indeed an expensive way of getting small amounts of money very quickly. But they're also the only way of getting small amounts of money quickly. It's that second which is the point that has to be kept in mind.

Think through the alternative possible sources of money. You're out of cash for whatever reason and you've got to feed yourself and the family tonight. You're out of luck with friends and family and who else is there? The government of course: you could try applying for some benefit or other. Perhaps you wouldn't have starved to death in the six weeks it will take them to process a claim. The banks won't even think of lending someone £50 to tide them over. And even if they would it costs more to arrange an overdraft with a bank that it does to try Wonga.

So, we now find that we've got entirely private sector and profit seeking companies setting up to meet a real social need. For there really are people who need to be able to feed the kids on money borrowed for a few days or a week or two. And we find that those who do indeed borrow money from these companies do so to feed the kids, not to blow it on a holiday.

Isn't this excellent? Social need met by unplanned and uncoordinated market action? Or have I misunderstood the point that Christians Against Poverty are trying to make somehow?

The problem with rent controls

There's a growing number of calls for rent controls here in the UK. This really isn't all that sensible an idea for as has been pointed out before:

Swedish economist and socialist Assar Lindbeck commented years ago that, “In many cases rent control appears to be the most efficient technique presently known to destroy a city—except for bombing.”

As Mark Perry goes on to point out this has implications for that most recent disaster in Mumbai, when an apartment block collapsed in the night, killing scores:

Mumbai’s buildings department is known for its corruption, and bribing inspectors and other government officials is considered part of the normal cost of doing business. One result is that many buildings are visibly crumbling. Another problem is rent-control rules that allow tenants to live in apartments for a few dollars a month and even pass those rights on to their descendants, giving landlords little incentive to invest in building maintenance. The city requires extensive approvals for even minor repairs, a process so cumbersome that repairs are often either delayed or done illegally and without consultation from engineers.

Rent controls are exactly like any other form of price control. If you set the price above the market price, as we've been doing with farming for decades, then we'll get a glut. If we set the price below that market price (as has always been true of rent controls, always, everywhere) then we'll get a shortage. And that shortage will come about in two ways. Less new building than otherwise will take place and extant building will not be maintained leading to appalling tragedies like this one.

There is of course the vague possibility that the government might stumble across a rent price which doesn't cause either shortage and decay, nor a surplus, but at that point said rent controlled price would be exactly the same as the market price so why bother?

The real question we should be asking those who advocate rent control is, well, so why is it that you want to reduce the quantity and quality of housing in the UK?

On why Africa is poor

The economist has an interesting article linking to this paper trying to work out why it is that Africa is so poor. If you're deeply interested in why so muich of Africa is so depressingly poor then you might well read both pieces.

The general answer is institutions of course. But then the general answer to long term growth is indeed institutions so that's really no great surprise. Africa has no great shortage of the usual things that everyone says is necessary for growth. There's land, water, people, minerals, natural resources, what's missing is the structure that allows these to be melded together into the creation of ever greater value. There's some fairly dry comments in the paper on this:

The first-generation literature argued that a major source of growth failures was the intervention of African rulers in their countries’ economies for largely political purposes. Indeed, one of the main purposes of the many structural adjustment reform programmes implemented in the 1980s and 1990s was to limit the capacity of African rulers and ruling parties to interfere in their economies in order to capture rents with which to reward supporters.

They also note that at least something seems to have been working since the late 90s for the economic growth rates of the continent have risen very strongly. I would blame that neoliberalism, globalisation and the Washington Consensus for that myself.

But behind all of this, and the worrying about whether it will last, I find something immensely cheering. For they make very clear and plain that the current levels of poverty in Africa are nothing unusual in historical terms. The $750 GDP per capita levels of some of the poorer countries are roughly the same as those of the North Sea (ie, Holland and GB) in the late middle ages. The $2,500 or so of South Africa is near the same as those North Sea economies before the industrial revolution really got going around 1800. Something that I find hugely, wonderfully cheering.

For what it shows us is that we didn't become rich by stealing what they had: we were just as poor then as they are now. It means that wealth is something that is built, not taken. And further, that it having been done once is extremely good evidence that it can be done again.

We also have good evidence that it doesn't have to take 300 years. China in 1978 had GDP per capita around and about the same as England in 1600. 35 years later China's GDP is about what GB's was in 1950. It is possible to do this, for places to run through the industrial revolution at warp speed and make, by any rational historical or current world standard, people rich in just one generation.

We can even make a pretty good stab at defining what will do it too: those decent insitutions conducive to grwoth seems to be necessary. One set of which is described in that Washington Consensus. Add in the pixie dust of globalisation and neoliberalism and we do seem to be getting there.

Why cannot the British left understand markets?

Forgive me but this is going to be a bit of a rant on one of my bugbear themes: why is it that the British left simply cannot understand markets? Here we've got Martin Kettle describing one of David Sainsbury's ideas:

As a result, says Sainsbury, in opposition Labour now needs to embrace a new form of political economy – the progressive capitalism of his title – in order to govern better and better understand the future. That means embracing capitalism in two particular ways – the recognition that most assets are privately owned and the understanding that goods and income are best distributed through markets.

Neither of those two things are in fact capitalism. Capitalism does indeed describe a method by which assets (and more particularly, productive ones) are owned but it means that they are owned by hte capitalist, not simply privately. The opposite to private ownership is State ownership. It's entirely possible to have privately owned assets but which are not owned by capitalists as the various flavours of mutual ownership show us. John Lewis and Mondragon by the workers in those companies, the Co Op or building societies by the customers ofr them and so on. Private ownership of assets is not necessarily capitalism.

As to markets, this is where I start to get rather angry with the left. For markets combine nicely with capitalism, this is true, but then markets combine nicely with absolutely method of asset ownership. They are, variously, the calculating engine we must use for nothing else at all can tell us as much about the economy as the prices in markets. They're good, as noted, at the distribution of goods and incomes. But this is nothing at all to do with capitalism per se. Which is, as above, a description of who owns the assets, not how we perform the function of exchange of production.

But why should I get angry at the left for not understanding this point? Because in their hatred of capitalism, desire perhaps for some form of socialism or social democracy, they manage to throw the market baby out with the capitalist bathwater. And of the two the markets are vastly more important for our standard of living.

There is a reason why we here at the ASI generally describe ourselves as a "free market" think tank, not a capitalist one. It's because we think those markets are more important than who owns the assets. And I for one really do wish that the left in Britain could understand that that market system is essential in any form of complex economy, yes, even the more equal one they say they want to create. So, please, could they get with the program and stop railing against markets, whatever it is they want to shout about the capitalists?

There's a because missing in The Guardian's analysis of tax evasion

When different regions are compared, Europe comes out the worst in terms of the size of its black market and the total amount of tax it loses as a result. As a region though, Europe also has the highest tax rates in the world. Out of 36 countries looked at, Europeans averaged a tax rate that was 39% of their GDP, compared to a world average of 28%. The lowest rates were found among 39 African countries which had taxes that represented around 17% of their GDP.

Sigh.

That "also" needs to be replaced with a "because".

The more tax you try to squeeze out of people then the more people are going to try dodging the tax you're squeezing out of them. The higher the tax rates then the more tax evasion there will be.

There's more we can say about these figures too: here they're talking about tax evasion, not tax avoidance. Evasion is the illegal stuff and it's almost entirely the activity of individuals: large companies simply do not involve themselves in illegal shenannigans. This is about the VATless builder's non-invoice, absolutely nothing at all to do with offshore or the multinationals. Or perhaps the dole claimer working a few hours cash in hand: the sort of thing that is never going to be wiped out by any system of economic management or taxation at all. The question thus becomes well, how much of this do we want to try and wipe out?

And there we come up against the other side of the problem. Our aim isn't in fact to extract the maximal amount of tax from the economy. It is, rather, to allow, encourage even, the maximum utility of the populace. We want everyone to be as happy as they can be without bursting with joy at the sheer pleasure of it all. Which means that we've got to measure the utility of reducing tax evasion against the disutility of the methods we use to do so. For example, we could be extreme and state that paying someone may only happen when an armed agent of the State is in the room. If the correct tax is not applied at that moment then the agent will shoot everyone. Yes, absurd and extreme: but it makes the point about disutility of certain methods of reducing tax evasion. Less extreme or absurd, we could ban cash altogether and everything must be done by electronic card. The trail there being auditable and the taxman would certainly catch many more than they do now. But there's a certain disutility to that too.

In the end we come to a reasonable conclusion: that there's an acceptable level of tax evasion considering the foul things we might have to do to reduce that level. Other values, such as liberty and freedom, come into play against that desire for revenue. Whether we're at the right level now is another matter of course: but that is where we must start the debate. What will attempting to collect more revenue do to other values we hold dear?

Oh, and one more very important thing. Assume we accept these estimates of tax evasion: this does not mean that we would ever be able to collect it all. For simply by bringing all into the tax net some of that economic activity would not happen at all. Economics does happen at the margin and so it would be the marginal transactions that did not happen. Which means that we can state without fear of contradiction that reducing tax evasion might make the State richer, up to a point at least, but it will absolutely certainly make everyone in aggregate poorer. For simply to tax currently untaxed economic activity is to reduce the amount of said economic activity.

It's because of socialism you fools

This is a classic headline from The Guardian:

Venezuela food shortages: 'No one can explain why a rich country has no food'

Absolutely anyojne can tell you why a potentially rich country like Venezuela has no food: it's the socialism you fools!

Of course, given that the Guardianistas are all currently weeping with joy over the Miliboy's propsals to bring back socialism and price controls we'd perhaps not expect them to note this particular point but that just means that we'll have to do it for them.

For Oliveros, an additional cause for the shortage of basic food staples is the decrease in agricultural production resulting from seized companies and land expropriations. "More than 3m hectares were expropriated during 2004-2010. That and overvalued exchange rate destroyed agriculture. It's cheaper to import than it is to produce. That's a perverse model that kills off any productivity," he says.

Well quite, stealing the land from people who are farming it so that it then doesn't get farmed isn't going to increase food production. But there's a much more basic point that we should make as well. Governments fixing prices can have one of two effects. If prices are set too high then we get the vast wine lakes and butter mountains of the old EEC. And if prices are fixed below market rates then we get shortages. Of course it's impossible for government to get the price just right for it lacks the information to be able to do so: and even if it had it there's no point in fixing prices at what would be the market rate anyway.

And we can go a stage deeper too. Perhaps it's true that some people in Britain find electricity too expensive, perhaps some people in Venezuela are too poor to be able to afford a decent diet. If those are situations that you want to try and remedy then the solution is to give those people more money to purchase those things on the market. What you don't do is go and screw up a functioning market through price contols or any other regulatory nightmares so that no one has access to those desirable things.

A point that rather puts the kibosh on "predistribution" really.

It's not entirely obvious that the power firms are ripping consumers off

My reaction to Ed Miliband's proposal to introduce price caps on energy was not, I'm sorry to say, something that was printable in a respectable place like this. So I'll spare you that and look instead at the basic contention that is being made.

Clearly, Miliboy must believe that the energy firms are ripping off consumers if he thinks that their prices need to be capped. If they were indeed ripping off consumers then we would see it in their profits. They would be making excess returns, profits well above their cost of capital and well above the rest of the market as well.

From the FT:

Last time I looked the cost of capital to a publicly traded firm was in the 8 to 10% range. They're making around and about that return on the capital they're employing meaning that there's just no room there for  excess profits. And if there are no excess profits then they cannot be unfairly ripping off the consumer.

So the whole idea falls over for lack of evidence that there is in fact the problem originally identified.

The end of loneliness

There's a video doing the rounds by Shimi Cohen, called the "Innovation of Loneliness". The thesis is that modern, internet-based social networking results in more loneliness. Impersonal communication displaces the intimacy of conversation. This, combined with the ability to tailor those communications to promote our self-image, results in us claiming "to have many friends while actually being lonely", while technology's promise of constant interconnectedness, causes us to constantly share our experiences in a desperate bid to not feel alone.

Not all of the claims stack up. For a start, sharing is not the only function of a social networking platform, the main one being, of course, to network. Connections are powerful resources that can fulfil a wide variety of ends - not just the selfish-sounding pursuits of "career, wealth, self-image, and consumerism" that Cohen emphasises, but also the intimate pursuits of friendship and romance. You might upload a selfie to Facebook or post on Twitter about your brand new shoes, but you might also use either of those social networks to arrange a drink with friends or, if you're lucky, even a date. Even then, some modern platforms like Skype facilitate the intimate conversations that Cohen fears we are losing. Rather than eroding social and familial connections, modern communication technology allows us to keep in touch with friends and loved ones when they are half-across the globe: there is now simply no excuse to never write home.

The truth is, we're usually well aware of which are our close or intimate friendships, and which are our wider connections. The benefit of having those connections though, is that they have the potential to turn into closer relationships, on a scale that is just totally unprecedented in human history.

Many of Cohen's claims are perhaps simply facts of human nature, rather than the fault of advancing communication technology. Was the age of letter-writing that preceded email much better when it came to wasting our time and energy "pursuing the optimal order of words in our next message"? Given the lengthy delay between replies and the added time and cost of writing and posting, letters were undoubtedly more stressful and time-consuming.

The internet for many people has freed them from the millennia-old tyranny of village gossip. It allows us to forge connections that then more intimate relationships with people who we actually like and agree with, wherever they may be, almost totally freeing us from geographical constraints. It even allows us to choose to whom we cater our self-image. Some of us may well spend hours agonising over our profiles, but it's a small price to pay to also spend far less time agonising about how Bert from next door, who never liked you, could seize upon any quirks and differences from the rest of the village, and make you a social pariah. You can now choose your own 'village' without actually having to move house, and it's no accident that social liberal attitudes are most prevalent among the most interconnected generation the world has ever seen.

Humans have always been lonely at times. The internet can make that fact more obvious, as we gain a remarkably open window into the everyday experiences of more and more people around us - but it is also the technological advance that has done more than anything else in human history to put an end to loneliness.