Why the Government Bonds Owned by the Bank of England Are Not a Debt Burden, Even When They’re Repaid

Yves here. While I wish I had some Easter programming, a mini tutorial will do. It would have been helpful for Richard Murphy to have also deployed the usual bookkeeping T accounts, since some find those visuals to clarify the money flows, but I trust this explanation of (fiat issuer) government bonds held by central banks works on a stand-alone basis.

By Richard Murphy, a chartered accountant and a political economist. He has been described by the Guardian newspaper as an “anti-poverty campaigner and tax expert”. He is Professor of Practice in International Political Economy at City University, London and Director of Tax Research UK. He is a non-executive director of Cambridge Econometrics. He is a member of the Progressive Economy Forum. Originally published at Tax Research UK

I received this email very recently, and share it with the author’s permission:

Hi Richard,

Hope you’re well. After reading some of your articles and watching one of your videos, I’m left with a question that I hoped you could answer.

The Bank of England holds lots of government debt. What happens when the bonds they hold mature? Doesn’t the treasury need to pay the bank?

From what I understand, any interest earned on the bonds makes its way back to the treasury but what about the payment for the bond when it matures? Isn’t that used to fund more purchases of bonds?

If the above is correct, isn’t it right to say the debt remains a burden until the Bank of England forgive the treasury for the debt they hold and do not claim payments when the bonds mature?

I hope you don’t mind me disturbing you over the bank holiday weekend and there’s obviously no rush to reply.

All the best,

Etc.

Since this seems to be a recurring question I thought it worth replying on the blog.

First, it is true that interest is still paid on these bonds. This is deliberate. It is intended to perpetuate the deficit narrative. The claim is that the country is over-burdened by debt and that as a result the country cannot afford things like education.

What the government never makes clear in its own accounting is that this money comes straight back to it from the Bank of England, which it owns. The cost is not real as a result. Good accounting would require that the income and expense be offset against each other and that only the net cost of interest be shown. But that would not play into the hands of the debt fetishists so that does not happen.

Let’s deal with the second issue then, of debt repayment when a bond comes to the end of its life, and most especially with regard to those bonds notionally held by the Bank of England. Note I say notionally, because actually they are entirely beneficially owned by the Treasury, but we can ignore that in what follows.

To make things easier let’s assume the bond is for a total of £10 billion and let’s assume the entire bond issue is held by the Bank. That does not happen in practice, but making the assumption just let’s me ignore third party repayment in what follows, and does not alter the key explanation.

It’s important to recall that the Treasury has no money as such. That is hardly surprising. The only tangible representations of money that we have are notes and coin, and these are not used to repay bonds. So, in other words all the Treasury does have are electronic bank balances, which are held with the Bank of England, the government’s wholly owned bank.

In that case, when redemption is due to the Bank of England the Treasury asks the Bank to pay the Bank’s subsidiary that owns the bonds £10 billion. And given that the Bank has to make any payment the Treasury asks it to do under the terms of the 1866 Exchequer and Audit Departments Act (last revised in 2000) that is exactly what the Treasury will do.

So now what has happened is that the Treasury no longer owes the Bank of England subsidiary in respect of a bond. It instead owes the Bank itself the same sum, but on its bank account. In other words, all that happened is that there has been an asset swap by the Bank and a liability swap by the Treasury.

The Bank’s subsidiary did have a bond. Now the Bank itself has £10 billion owing to it on a bank account. The Treasury did owe the Bank’s subsidiary for a bond. Now it owes the Bank on an overdraft. So, in effect, repayment means that nothing has changed. The Treasury stills owes its own bank exactly the same amount of money as it did before repayment was made. And the Bank is also no better off. Nor is it owed by anyone different to whom it was owed money before this swap took place.

But, as we know, the Treasury won’t now run an overdraft with the Bank of England even though it is allowed to, and did so regularly until 2008. That means that in practice it will now issue a new bond for £10bn so that it can clear the overdraft. And since under current QE arrangements the Bank of England is effectively matching new bond issues by the Treasury with pound for pound new bond purchases this means that the Bank will, in effect (it’s indirect, but the substance is what I am suggesting) buy that new bond issue. In the case of QE bond redemptions this has, incidentally, been true since 2009, so nothing has changed in 2020, just to avoid the suggestion that there is something unusual about this current arrangement.

The result is that the Bank will now pay the Treasury £10bn, whether directly or via the money markets, to buy that bond. In effect, the Bank will clear the Treasury’s overdraft and say that it now owns a bond again in its place. The Treasury is entirely happy with this arrangement, however it is organised, because that is precisely what it intended should happen.

What this means is that we have now had a reverse asset and liability swap that puts both parties back in the position they were in when they both started. The Bank of England subsidiary now owns a bond again, the Treasury owes for it, and there is no overdraft. It is as if nothing happened.

So the question is, might this be onerous? My answer is straightforward. It is only onerous if doing the little bit of double entry book-keeping within the government’s accounts that this requires is onerous, because that is all that really happens.

Throughout these transactions there is no real change to the economic substance of the relationship between the parties. The Treasury always appears to owe the Bank of England £10 billion at all times, but since the government controls them both this is anyway meaningless debt because in reality no third party is involved. There is no burden then.

So, how was that burden of debt that once existed to third parties removed? The answer is, of course, through quantitative easing (QE). QE creates new money. That new money cleared the governments debt when QE took place, replacing it with what is called ‘base money’. Unless you can figure out a way that base money can be repaid without the government deciding to cancel it, and no one has yet, that debt has been cancelled in that case by QE. The obligation to pay has gone.

So, there is no burden left after QE is my summary, and the notional maturing, repayment and reissue of debt between the Bank of England and Treasury is just economic game playing of no consequence at all in the real economy.

I hope that helps.

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16 comments

  1. v

    What I find odd is that if the government is the legal owner of the Bank of England why then is the BoE stationed in the City of London (district) which – as Nicholas Shaxson explains in depth in his book Treasure Islands – exists outside many of the laws and democratic controls which govern the rest of the United Kingdom.

    Reply
    1. Grebo

      When it was founded in 1694 the Bank of England was privately owned. It was not nationalised until 1946. Since it is owned by the government it must do whatever the government says, so there is no point in moving it.

      Reply
  2. Chris Herbert

    I kind of get this, but I don’t understand why it is operationally done this way. Is it just ideological ‘hand waving’ to pretend there is a debt burden that, in reality, does not exist? No wonder the public has no clue.

    Reply
    1. DTK

      Is US QE different from UK QE? My understanding is that US QE is the Fed reversing a T-Bill; going from a currency drain to a currency add, which creates no new money. Thank You

      Reply
      1. Adam1

        It boils down to how one defines money and how loose one throws the term money around. If you consider ALL government liabilities as a form of “money”, then QE never adds new money to the system. However if you define money as only one specific type of government liability, like only base money as mentioned by the author, then when QE is performed you can create new money.

        This is why you’ll see many MMT’er have a preference for discussing financial assets (liabilities held by the counter party; in the government debt perspective, the non-government’s holding of government bonds). “Money” is to readily thrown around and has different meanings to different people it can become very confusing very quickly.

        Reply
    2. John Zelnicker

      @Chris Herbert
      April 3, 2021 at 12:02 pm
      ——-

      Yes, it is basically hand-waving. If there is a debt burden, according to neo-classical(?) economics, then the government doesn’t have sufficient monetary resources to provide for the welfare of its citizens.

      It was Milton Friedman who said something to the effect that it’s worthwhile to deceive people about the truth of fiat issuance because like religious mythology, it helps to keep them from being too demanding.

      Reply
      1. eg

        Samuelson said much the same thing: that the myth is useful to get politicians to unwittingly constrain themselves unnecessarily, to the benefit of them that has and to the detriment of them that hasn’t. It’s a grift.

        Reply
  3. lcn

    The debt burden is a vestigial narrative of the gold standard regime. Now that we are in the fiat system, the narrative is perpetuated because we don’t want people to start demanding nice things from their government; things like, I don’t know, maybe universal housing or universal healthcare and universal education.

    If people have guaranteed housing, healthcare and education, most will be dis-incentivized to work. These nice things are deemed unaffordable by the government so that they will continue going out everyday and report to work (be productive) in exchange for wages that will secure their food, clothing, shelter, and health.

    Until we can devise a system and get rid of this enforced slavery, the pretense of debt (oftentimes qualified with the word ‘unsustainable’) will continue.

    Reply
    1. Karl Greenall

      I tried to find the evidence for your assertion that “If people have guaranteed healthcare, housing and education, most will be dis-incentvized to work”.
      Like you, I could not succeed in doing so.
      Thanks for reminding us of this fact.

      Reply
  4. Don Scott

    It’s a long time since I worked in accounting, but this all looks like the shuffling of the same deck with the QE being the magic wand that makes the debt disappear. Yesterday I watched a very good talk at Harvard by Singaporean ambassador and international relations expert Kishore Mahbubani. Despite it being 5 years old, it is still highly relevant. https://www.youtube.com/watch?v=bVkLqC3p0Og
    It’s focus is how will the USA contend with a China that will soon overtake it in terms of economic size. Near the beginning, he notes that during the 2007 Financial Crisis, the USA approached China to get their assurances that they would continue to buy American Treasury notes – a counterbalance to the massive trade deficit the USA had with China – we’ll keep buying your goods if you’ll keep buying our T-Bills.
    Dr Mahbubani then notes that China felt broadsided when the USA started QE – which I take it the Chinese took as something that would diminish the value of the almighty US dollar over time, thus reducing the value of the T-bills – which China had bought by the $ Trillions. This has led China down a road to trying to create a new trading currency, which I think is the new digital currency they are beginning to introduce to sidestep the dollar’s status as a reserve currency – after all, there has never been a time when the reserve currency did not belong to the worlds largest economy – at least for the last 200 years or so – perhaps longer. There are a number of Mahbubani lectures on U-tube and I suspect you Naked Capitalist readers will find them of interest and cause some degree of retrospective thinking to many.

    Reply
    1. Foy

      If China wants to run a trade a surplus, it has to do something with all those trillions of USD it now owns from running a trade surplus. The only viable option for them which is of sufficient size and risk free is US Treasuries. Thats why they bought the Treasuries in the first place. They can’t just leave the whole surplus they generate in a US bank account(s), what happens if that bank(s) goes bust? Bank accounts are uninsured or only insured up to a small amount. And China is limited in what they can spend it on in the US by US laws. They have no where else to go if they insist on running a trade surplus.

      I don’t think China is quite prepared to reduce its trade surplus with other countries just yet.

      Reply
  5. Kurt Sperry

    Can the PRC have a global reserve currency (of any sort, even one with magic blockchain sparkles) and keep their massively mercantilist economic model? I don’t see how they’d ever create sufficient liquidity.

    And well done thinking big coming from accounting. Easily, the people I’ve met who are most hellbent on not understanding MMT have been accountants.

    Reply
    1. Procopius

      I am not an economist, but I don’t think they can. If they become the issuer of the world’s reserve currency they will be in the position the U.S. is in now. Other nations must have dollars, not only to buy things from the U.S., but also to buy things from other countries. If the reserve currency becomes the renminbi, rather than the dollar, then every other nation in the world will manipulate their currency until they have a trade surplus with China, and China will have the strong currency. The U.S. can then weaken the dollar against the renminbi/yuan and rebuild our manufacturing capabilities.

      Reply
  6. Sound of the Suburbs

    Every effort has gone into hiding how the monetary system works, and everything about debt, money and banks is obfuscated to the nth degree.
    Even the most basic things you take for granted aren’t true.
    Banks don’t take deposits or lend money, and this is quite clear in the law. It is important for the legal system to know, but they don’t really want anyone else knowing.
    You are not making a deposit; you are lending the bank your money to do with as they please. This is why they can do bail-ins; it isn’t your money once you have put it in the bank.
    They are not lending you money; they are purchasing the loan agreement off you with money they create out of nothing.
    https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf

    Richard Werner explains in 15 mins.
    https://www.youtube.com/watch?v=EC0G7pY4wRE&t=3s
    This is RT, but this is the most concise explanation available on YouTube.
    Professor Werner, DPhil (Oxon) has been Professor of International Banking at the University of Southampton for a decade.
    Richard Werner was in Japan when things went wrong in the 1980s and has been looking at this for a long time, so he has had a big head start compared to everyone else.

    Individuals, and groups, identify specific problems and look at these in great detail.
    To get the full picture we need to put the work of Richard Werner, Steve Keen, Richard Koo and MMT together.
    Richard Werner, Steve Keen – Private debt and money creation from banks
    MMT – Public debt
    Richard Koo – the big picture of how private and public debt creates the money supply

    The zero sum nature of the monetary system is not understood by policymakers.

    https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
    Money and debt come into existence together and disappear together like matter and anti-matter.
    Bank loans create money and debt repayments to banks destroy money.
    Bank loans create 97% of the money supply
    The money supply ≈ public debt + private debt
    Money and debt are like opposite sides of the same coin.

    They talk about paying off the Government debt.
    This means the private sector will have to take on that debt to maintain the money supply.
    You don’t want the money supply to shrink as that causes debt deflation (think Great Depression).

    This is the US (46.30 mins.)
    https://www.youtube.com/watch?v=ba8XdDqZ-Jg
    The private sector going negative is the problem as you can see in the chart. This is when the financial crises occur.
    When the Government deficit covered the trade deficit they were fine, but then they tried to balance the budget
    As the Government goes positive, into Bill Clinton’s surplus, the private sector is going negative causing a financial crisis.
    The current account deficit/surplus, public deficit/surplus and private deficit/surplus are all tied together and sum to zero.

    What were those old rules of thumb they developed over the years by trial and error?
    Balanced government budgets AND balanced trade (current account)
    You can’t have one without the other, as the Americans have demonstrated so well.

    Germany finds it easy to balance the budget because they run big current account (trade) surplus.
    They don’t understand why what works for them, won’t work for other countries in the Euro-zone that run current account (trade) deficits.

    Richard Koo used to work in the Federal Reserve Bank of New York and is only too familiar with the flow of funds in the economy.
    Central banks use the flow of funds to see what is going on in the economy, it sums to zero.
    It’s essentially the same as the chart of the US above (46.30 mins.), but divides the private sector into household and corporate sectors to give more information on what is happening in the economy in monetary terms.

    This is Japan when they had a financial crisis in the early 1990s, the Government was running a surplus.
    Richard Koo shows the graph central bankers use, and it’s the flow of funds within the economy, which sums to zero (32-34 mins.).
    https://www.youtube.com/watch?v=8YTyJzmiHGk
    Richard Koo’s graph of the flow of funds shows the Japanese Government ran a surplus as the financial crisis hit.
    The terms sum to zero so, as one is going positive, another is going negative.
    The Government was going positive, as the corporate sector was going negative into a financial crisis.

    Central bankers, like Richard Koo, do actually know a lot of what MMT theory says.
    It comes from the zero sum nature of the monetary system.

    Reply
  7. Jason

    What legal obligations does the government have to pay up the overdraft it owes to the BOE?

    I know there are no practical consequences since Treasury can issue bonds that people will snap up because they know BOE will buy them up afterwards. So I am just asking about legal obligations.

    Reply

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