Central banks are now printing money to repay themselves

3D chrome Dollar symbolIn a recent report titled Debt and (not much) deleveraging the McKinsey Global Institute found that between 2007 and the second quarter of 2014, the total global debt had grown by $57 trillion. The total global debt as of the second quarter of 2014 stood at $199 trillion or 286% of the global GDP.
Government debt constituted a significant portion of this. The total government debt all around the world had stood at $33 trillion as of 2007. It has since jumped to $58 trillion, a jump of $25 trillion, at the rate of 9.3% per year.
What is interesting is that a lot of this government debt is owed to central banks. “Today, the central banks of the United States, the United Kingdom, and Japan hold 16, 24, and 22 percent, respectively, of government bonds outstanding in their countries,” the McKinsey report points out. Governments borrow money by selling bonds.
In the aftermath of the financial crisis that broke out in September 2008, central banks in developed countries started printing money. The idea was to flood the financial system with a lot of money and drive down interest rates. At lower interest rates more people were expected to borrow and spend. This would benefit businesses and in turn the overall economy.
In order to pump the printed money into the financial system the central banks bought both government as well as private sector bonds. And that is how they have ended up with massive holdings of government bonds on their balance sheets.
The central banks of the United States as well as the United Kingdom have stopped printing money and buying bonds. Nevertheless, central banks of a few other countries continue to print money and buy government bonds.
The Bank of Japan is mandated to buy 80 trillion yen worth of government bonds every year against 50 trillion yen. Starting in January 2015, the European Central Bank has also decided to buy up to €720 billion of government bonds in a year. So, in that sense central banks continue to accumulate bonds at a rapid rate.
A central bank gets paid interest by the government on the government bonds that it has in its kitty. This interest that a central bank gets paid is a part of the profit that it makes. The profit is remitted back to the government. Hence, what this means is that the government is basically paying interest to itself on its debt.
“In a sense, this debt is merely an accounting entry, representing a claim by one part of the government on another. Moreover, all interest payments on this debt typically are remitted to the national treasury, so the government is effectively paying itself,” the McKinsey report points out.
If the money that governments owe to their central banks is not taken into account, things start to look a little different. The government debt to GDP ratio in the United States falls from 89% to 67%. In the United Kingdom the number similarly falls from 92% to 63%. In case of Japan, the drop is huge—from 234% to 94%.
What these numbers also tell us is that central banks are printing money to repay themselves. How did this astonishing situation arise? Take the case of Bank of Japan. The Japanese central bank prints money and buys government bonds directly from the government. This helps the government finance its increased expenditure. A part of this expenditure is also repaying the bonds which are maturing. A part of the maturing bonds are held by Bank of Japan. Money is fungible, and hence that means that the Bank of Japan is printing money to repay itself.
This is a weird situation. As John Truman Wolfe writes in Crisis by Design, The Untold Story of the Global Financial Coup, a book published in mid-2010: “How bizarre is it that instead of simply printing the money themselves, governments ‘chose’ to borrow it from their respective central bank. The United States is currently $16 trillion in debt—and the debt is growing at the rate of $49,000 a second! Last year’s interest on the debt here was $454,000,000,000—Why borrow money from the Fed ([which] simply creates it out of thin air by making a book entry and clicking a mouse) when the government could simply print its own without borrowing it and paying interest on it.”
It is now being said that this situation can be set right given that the debt owed to central banks is ultimately an accounting entry. As the McKinsey report points out: “Whether central banks could cancel their government debt holdings is unclear… Another option that has been suggested is to replace the government debt on the central bank’s balance sheet with a zero-coupon perpetual bond.”
A perpetual bond would mean that the government will have to never repay the bond, at the same time it won’t have to pay any interest on it given the zero coupon. While this sounds fancy, this would still mean a default by the government. Governments defaulting on their debt has happened regularly in the past. “Today’s rich European nations, including England and France, defaulted repeatedly from the 14th to the 18th centuries (France did it eight times). Latin American economies defaulted repeatedly in the 20th century, and Argentina has done it once in the 21st. The most recent sovereign debt restructuring was in 2012 in Greece,” the McKinsey report points out.
And any default or a semblance of a default won’t go down well with financial markets all over the world. “Any such move could create backlash in the markets and, in some countries, by policy makers.”
A financial market backlash would mean that bond yields will go up, which in turn will push up interest rates. This is something that the governments of the Western economies can ill-afford at this point of time. Any move up in interest rates will have a negative impact on the economies, which are floundering at this point of time.
Given this, even though it is just an accounting entry, getting out of central bank debt won’t be so easy for western governments.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on Apr 13, 2015

Here is why the government should not forget about the fiscal deficit

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010When it comes to ideas to revive an economy which is not doing well, economists are essentially two trick ponies,They will first suggest that the central bank should cut interest rates. At lower interest rates people will borrow and spend more, businesses will benefit and the economy will grow faster as a result. QED.
And if that is not happening they will suggest that the government should increase public expenditure. As the government spends more money, that money will land up as income in the hands of people who will in turn and spend that money. The money that they spend will land up as income in the hands of other people, who will also spend that money. And so the multiplier effect will work, first leading to spending, and in turn creating economic growth.
The second trick seems to be dominating the debate currently in India. The mainstream view now seems to be getting around to the idea that the government should forget about the fiscal deficit, during the next financial year and spend more money, in the hope of creating more economic growth. Fiscal deficit is the difference between what a government earns and what it spends. The difference is made up for through borrowing.
The finance minister
Arun Jaitley had said in his budget speech in July 2014: “My Road map for fiscal consolidation is a fiscal deficit of 3.6 per cent for 2015-16 and 3 per cent for 2016-17.” It’s now being suggested that the finance minister should abandon these targets for the time being.
The logic offered is very straightforward. The
combined fiscal deficit of the central government and the state governments has fallen dramatically over the last few years. In 2009-2010, the number was at 9.33% of the gross domestic product(GDP) of India.
By 2013-2014 this had fallen to 6.78% of the GDP. During this financial year(i.e. 2014-2015) it is expected to fall to 6.03% of the GDP. Along with this the total liabilities of the central government have also gone down over the years from 48.8% of the GDP in 2009-2010 to 46.3% in 2013-2014. This number is expected to fall further to 45.7% of the GDP in 2014-2015, as per the government debt status paper released by the ministry of finance in December 2014.
So, what this seems to suggest is that the finances of the Indian government(s) are well placed at this point of time and given that, the central government can easily spend more. But is that really the case? Rajiv Shastri makes a very interesting point in a column
he wrote for the Business Standard in December 2013:In reality, quantifying deficit and accumulated debt only as a percentage of GDP has the potential to misguide. In isolation it distorts both, the true scale of fiscal profligacy and the government’s debt-servicing ability.”
What Shastri is effectively saying here is that the government does not have access to the entire GDP to repay its debt. It repays its debt only out of the money that it makes every year through taxes and other sources of revenue.
How is the central government doing on that front? In 2007-2008, revenue receipts stood at 10.87% of the GDP. By 2013-2014, they had fallen to 9.06% of the GDP. As far as tax collections are concerned, they have fallen from 8.81% of the GDP to 7.36% of the GDP. This year tax collections are expected to be at 7.59% of the GDP. This number is unlikely to be achieved given that the shortfall in tax collections is expected to be around Rs 1,05,084 crore or around 0.84% of the GDP.
The non-tax revenues of the government have also fallen from 2.05% of the GDP to 1.70% of the GDP between 2007-2008 and 2013-2014. During this financial year the number is expected to be at 1.65% of the GDP. Interestingly, the interest that the government pays on its accumulated debt was at 3.43% of the GDP in 2007-2008. It has jumped to 3.79% of the GDP in 2013-2014.
An increase in interest payments means lesser money gets spent on other important things. As economists Taimur Baig and Kaushik Das of Deutsche Bank Research point out in a recent research note: “
India’s central government spends nearly a quarter of its total spending on servicing the large debt burden…Bringing this down would create valuable space for other far more important expenditures.”
What these numbers clearly tell us is that the ability of the government to service the debt that it has accumulated has been coming down over the years, which is clearly not a good sign. Also, when compared to other emerging market countries, India has one of the highest government debt levels in the world, as can be seen from the following table.

Further, it is also worth remembering that a lot of other emerging market countries have already tried increased public spending in the aftermath of the financial crisis (as I said at the very beginning, economists have basically got only two ideas) and the results haven’t been great.
As Ruchir Sharma of Morgan Stanley points out in a column in today’s edition(Feb 16, 2015) of The Times of India: “Many big emerging nations including China, Russia and Brazil just tried a full-throttle experiment in stimulus spending, and it failed. The average growth rate for emerging economies excluding China has fallen to 2.5% today, from more than 7% at the height of the spending campaign in 2010. That is the lowest growth rate in four decades, outside of a global recession.”
Any government looking at increasing its spending in order to boost growth should keep this in mind. Also, at the end of the day what matters is not the quantity of spending but the quality of spending.
As Baig and Das point out: “
Recent budgets have routinely allocated close to 5% of GDP in capital spending, a non-trivial amount by any measure. But these generous allocations have not materialized in a discernible pick up in the investment cycle…If the authorities aim at high quality, high multiplier projects worth 4-5% of GDP as opposed to simply ramping up the rate of spending, they will handily achieve the goal of providing a boost to the economy, in our view.”
Also, increasing public spending by the government takes away attention from economic reforms. Both can rarely be executed together. As Sharma points out: “A stimulus mindset is the opposite of a tough reform mindset, and governments can rarely do both as the contrasting experience of the 1990s showed. By the end of that decade, most emerging nations had no money to burn, no lenders they could turn to.”
Given these factors, increasing public spending by the government may not be the best way to go about reviving economic growth.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The article originally appeared on www.firstpost.com on Feb 16, 2015