PERPETUAL BUDGETARY BLUE

On the eve of the Budget, the UK government announced it would consider issuing very long term bonds known as ‘perpetuals’ (50 to 100 years duration), in order to take advantage of historically low rates of interest . This would seem to be a rational response from a government who is pursuing a conventional (and conservative) economic policy path based on public austerity to promote private affluence. This could be described as the blue solution, both for its political connotations but also psychological and symbolic ones.

Blue is the colour of melancholy but also happiness through the latter’s association with clear skies. It is also related to personality types who are rational, analytical and clear-minded but underpinned by a gender differentiation (blue for a boy and pink for a girl).  In Hinduism, blue represents the fifth chakra the purification point of the body located in the throat.

So personality, psychology and symbolism combine to form the objective basis of the current economic policy, whose blue hue can purify the economy of its irrational (and presumably red bits). So should economic policy in the leading economies of the world be perpetually blue? This  returns us to budgetary stance and the logic of fiscal rectitude to promote economic recovery.

The question of whether to issue perpetual government bonds reminds us of the relationship between interest rates and the price of these bonds. For example, a government issues consols (bonds with no redemption date) at a price of £100 each, offering an annual coupon (fixed amount of interest paid each year) of £5. Thus, if interest rates are set at 5%, then the value of the consols, traded  in  the secondary market (bought and sold by traders after their primary issue by government) would be £100. If interest rates are lowered to 21/2% then the value of the bonds traded increases to £200, as the £5 coupon payment now represents a 21/2% return on this investment, and vice versa.

The yield on investing  £100 consols is determined by the changes in the price and the fixed coupon payment. This is known as the current yield. If the current traded price is £95 then:

Current Yield   =   Face value   x Coupon rate100 x   5% =  5.26%                                                                                                Current price                95

There are other  types of yield that apply to what is called the term structure of interest rates, with a range of returns and years to maturity although the calculation is a little more complex.  This is the crucial point in the public discussions of debt of what you pay and what you get back in investment. The problem is that the masters and mistresses of the finance universe and in their Second Estate (politicians) and Fourth Estate (journalists) minions’ febrile reporting, they focus on the total size of nominal  public debt and not its temporal distribution and real value at different points in time.  In other words,  no distinction is made between different yields and maturities This is illustrated  below in the 30 year nominal yield curve  for euro-denominated debt issued in  the European Union:

This issue was put into sharp relief by the proposal to create perpetual bonds in the context of funding infrastructure investment, another of the eve of Budget interventions by the British Prime Minister who suggested that the UK’s roads could be built and improved by selling them to pension funds and sovereign wealth funds. The paradox of his Chancellor announcing that issuing ‘perps’ would appeal to the former, whilst the latter’s buying of public assets would push up yields on them seems to have escaped him. Moreover, if the issuing of perps reduces the cost of public investment why turn to more expensive private investment? Furthermore, the returns to  this investment are likely to be repatriated overseas rather than re-cycled within the UK.  Perhaps it was a ‘blue’ moment, but which part of the psychological and symbolic distribution of this hue we are uncertain of.

This brings us back to the UK budget, which can be said to have delivered some inter-generational re-distribution from all pensioners to wealthier younger people. However, questions of inter-generational equity in relation to the housing market were not touched upon. The increase in stamp duty (a tax levied on the purchase of domestic housing) for houses whose value is above £2m was used to defray opposition  to the reduction in the top rate of income tax from 50 pence in the pound to  45 pence.  With nearly half of black young men being unemployed, reduction in pension rights;  trebling of tuition fees for higher education; and access to further education being financially restricted, the young are being offered the alternative of the rock and the hard place. A modest proposal would be to start with the housing market.

This proposal rests on establishing a national investment bank that would be the organising agency for infrastructure projects. Funding would come from issuing bonds associated with income flows from projects, with the national investment bank able to borrow from the UK government at its perpetual rates.  In respect of the housing market, the re-introduction of a capital gains tax on the increase in site value at sale would be introduced with its revenue streams hypothecated for the building of social housing, particularly in regions where housing is in short supply.

This investment bank could also issue mortgages to first-time buyers or through intermediary lenders at rates commensurate with government borrowing ones. The effect would be to balance both owner-occupier and rental (both social and private) markets whose prices have been distorted by the fall out from the financial crisis. There has been a revival in the ideas of Henry George, the   19th century American politician and political economist who thought that the only form of taxation should be a ‘single tax’ on land.  There are precedents for the modest proposal: the Caisse des Depots et Consignations in France and the pre-crisis roles of the Federal National  Mortgage Corporation (Fannie Mae) in the US. In the former case, there are subsidiaries known as societés d’economie mixtes that have private shareholding: an example that a British national investment bank could follow if desired.

With the forecast  trend rate of annual growth for the world economy between 2013 and 2018  being 4.2%,; 2.5% for the US; 2.1% for EU; and, 2.2% for the UK, the blue period looks likely to remain a constant feature of our socio-economic spectrum .  But, if the modest proposal  above isn’t addressed in some form then the continuing inter-generational inequity will mean the younger generation will be seeking higher wages to compensate for their increased costs of providing education, housing and pensions for themselves. And who would blame them for looking for red-hued alternatives as the economy’s blue chakra does not rid them of the impurities that they have had to imbibe in the last decade?

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One Response to PERPETUAL BUDGETARY BLUE

  1. Greg Bull says:

    Some good points here. Clearly banks did well out of falling interest rates in recent years…..the value of their long term bonds etc (and therefore assets) just kept going up.
    Nice if you want to go on a lending spree etc etc. Doesnt this sound familiar ?
    Another good point on land taxation…..land values in the UK were running at absolutely
    ridiculous levels even as we moved into recession. Some government obsession here
    with getting planners to try and negotiate with builders for social housing on each development. Better to just tax it in the first place. Policy has done little to new affordable housing for the young. We had better answers in the 1940’s and 50’s.
    Also good ideas about funding infrastructure. Net lending still negative to businesses in the UK by banks (see The Economist).

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