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Julian D. A. Wiseman
★ Publication history: this version only at www.jdawiseman.com/papers/finmkts/UK_GBP_default_de_facto_impossible.html. Re previous versions see box. Usual disclaimer and copyright terms apply.
The first version of this document was written in late 2011, shortly before joining Société Générale. It was published under the SocGen name on 04 October 2011. Readers, public and private, sent some helpful comments, so a second version was published on 09 November 2011.
The © of the first version was mine, but the improvements in the second version belong to SocGen. SocGen has kindly allowed this third version to be based on the second version, though obviously responsibility for it lies with the author and not with that former employer.
I believe this to be an important thesis, worthy of much close attention from the rating agencies.
Usual disclaimer and copyright terms apply.
The first version of this essay was greatly improved by the legal assistance of Jacob Gifford Head, Barrister. This assistance is gratefully acknowleged.
★ Abstract: UK sovereign debt almost entirely in £, and its internal decision-making machinery could command the printing of £ in a crisis. Inflation possible, sure; devaluation of the curreny possible, sure; but default is de facto impossible.
★ Contents: • Gilts may be issued: no ceiling; • Compelling the Bank of England to buy gilts (◊ Maastricht rules, ◊ The Bank of England Acts, ◊ Each House of Parliament); • Modes of failure (◊ Summary: the BoE can be commanded to pay); • Civil emergency; • Willingness to pay; • Other powers; • During an election campaign; • Scotland; • Non-£ default?; • Ratings; • Elsewhere; • Conclusion; • Footnotes; • Afterwords.
We start at the Information Memorandum: Issue, Stripping And Reconstitution Of British Government Stock, published by the UK Debt Management Office on 24 March 2016.†1
2. Stocks are issued pursuant to the provisions of section 12 of the National Loans Act 1968.
3. The principal of and interest on Stock and sums payable in respect of strips will be a charge on the National Loans Fund, with recourse to the Consolidated Fund of the United Kingdom of Great Britain and Northern Ireland.
This is the basic prospectus information, saying who is the issuer. And the DMO has the vires (or power) to issue gilts on behalf of the Treasury, because:
In institutional terms, the DMO is legally and constitutionally part of HM Treasury (HMT) and, as an executive agency, it operates at arm's length from Ministers. The Chancellor of the Exchequer determines the policy and financial framework within which the DMO operates, and delegates to the Chief Executive operational decisions on debt and cash management, and day-to-day management of the office.
The legal authority to borrow stems from the National Loans Act 1968, which gives great discretion to Her Majesty’s Treasury (HMT)†2. In particular:
12(1) … any money required … may be raised in such manner and on such terms and conditions as the Treasury think fit, and money so raised shall be paid into the National Loans Fund. …
12(2) For the purpose of raising money under this section the Treasury may create and issue such securities, at such rates of interest and subject to such conditions as to repayment, redemption and other matters (including provision for a sinking fund) as they think fit.
12(3) … the power to raise money under this section extends to raising money either within or outside the United Kingdom and either in sterling or in any other currency or medium of exchange, whether national or international.
So the law allows HMT to raise money, without legal limit, at any maturity from short to perpetual, in £, in other currencies, in SDR, and in precious metal, provided only that “the Treasury think fit”†3. Arguably it would even allow oil-denominated or oil-linked borrowing. There is no issuance ceiling, no debt ceiling, nor any other restriction that could cause a sudden stop.
So HMT may issue, but what if investors don’t want to buy? More relevantly, what if investors don’t want to buy at a price at which HMT wants to sell? Can the Bank of England (BoE) be compelled to do so? Yes, by various means.
Until the UK actually leaves the EU, it has not left, which might be thought to introduce some international awkwardness. So the Treaty on The Functioning of The European Union (as the 1992 Maastricht treaty was renamed) continues to apply in the UK. From page 101 Article 123 of that treaty (“ex Article 101 TEC”):
1. Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.
2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions.
This seems to prohibit the central bank purchasing government debt at auction. Seems to, but actually doesn’t.
Let us compare to the US. US Federal law is not only supreme, if necessary, it is enforced. For example, in 1957 Arkansas Governor Orval Faubus used his state’s National Guard to resist the implementation of the Supreme Court ruling in Brown v. Board of Education. So the central government, in the person of President Dwight D. Eisenhower, sent the Army, in the form of the 101st Airborne Division, to enforce Federal law. In very real practice, Federal law was enforceably supreme.
EU enforcement is far weaker. If a national politician insists on a course of action contrary to EU treaties, rules or judgements, well, that is how it is. A summit might be called. There might be a statement hinting at criticism of the recalcitrant. But there are no troops. There is no action. And indeed, even the statement might not happen: the sovereign states of which the EU is comprised have been even lighter on countries acting in accordance with a genuine and important national interest.
In other words, the treaty functions as a guideline broadly defining good behaviour. It is not enforceable. But the UK has a reputation for being bound by its word, and particularly in matters of national debt, might wish to maintain this reputation. Not a problem. Rearranging the phrases for legibility, “national central banks” are “prohibited” from “the purchase directly from” “central governments” “of debt instruments”. The purchase “directly”, eh? So the BoE bidding at auction is prohibited. But the BoE may still instruct a gilt-edged market maker (‘GEMM’) to bid on its behalf.
Indeed, this isn’t so far from practice during the BoE’s Quantitive Easing, when: the DMO sold; the GEMMs bid and bought; and shortly after the BoE bought from the GEMMs. If needed, the temporal gap could be shrunk.
So the EU rules prevent nothing even while they theoretically apply.
But does UK law allow the BoE to be so instructed? From the Bank of England Act 1946 (HTML, PDF), as amended by s.10 of the Bank of England Act 1998:
4(1) The Treasury may from time to time give such directions to the Bank as, after consultation with the Governor of the Bank, they think necessary in the public interest, except in relation to monetary policy.
This power is very general, and subjective. That is, if challenged, HMT would need to show that the direction was not “in relation to monetary policy”, and that it thought its order was in the public interest. But there is no requirement that it objectively be in the public interest—the thought suffices.
For monetary-policy matters the Bank of England Act 1998 specifies the “Treasury’s reserve powers”:
19(1) The Treasury, after consultation with the Governor of the Bank, may by order give the Bank directions with respect to monetary policy if they are satisfied that the directions are required in the public interest and by extreme economic circumstances. …
19(3) A statutory instrument containing an order under this section shall be laid before Parliament after being made.
19(4) Unless an order under this section is approved by resolution of each House of Parliament before the end of the period of 28 days beginning with the day on which it is made, it shall cease to have effect at the end of that period.
19(5) In reckoning the period of 28 days for the purposes of subsection (4), no account shall be taken of any time during which Parliament is dissolved or prorogued or during which either House is adjourned for more than 4 days.
19(6) An order under this section which does not cease to have effect before the end of the period of 3 months beginning with the day on which it is made shall cease to have effect at the end of that period.
Strangely, it seems that neither Act specifies what is and what is not monetary policy.
If requiring the BoE to purchase gilts is not an act of monetary policy, then HMT could use s.4 of the 1946 Act to direct the BoE to buy gilts at such-and-such a price.
But if requiring the BoE to purchase gilts is an act of monetary policy, then HMT can still “by order give the Bank directions”, but under s.19 of the 1998 Act. Without the consent of Parliament these directions cannot remain in effect for more than a month or so.
It is arguable whether, in 1998, the purchase of gilts would have been construed as monetary policy. But events since then have expanded the practice of monetary policy: multiple central banks’ equivalents of the Monetary Policy Committee have bought debt, public and private, by various means. Whether or not it was, it has definitely become a tool of monetary policy.
Thus a direction compelling the BoE to bid for gilts could not be made under s.4 of the 1946 Act; it would have to be made under s.19 of the 1998 Act, which requires that such a direction be “approved by resolution of each House of Parliament”.
This is one of the standard types of statutory instruments†4, specifying the ‘affirmative procedure’. According to the relevant Parliamentary Factsheet (HTML, PDF), “Approximately ten per cent of instruments subject to Parliamentary procedure are subject to the affirmative procedure”. Rejection is not unprecedented, but is rare: there are about 3½k SIs per year, yet “the last occasion that the House of Commons annulled an SI was in 1979 and the House of Lords voted to annul the Greater London Authority Elections Rules 2000 in February 2000.”
So how can a government get the required approval?
The UK is not the USA. By design, the USA has a divided government. And if one part should be determined to destroy the other, there might be collateral damage. In contrast, a former Lord Chancellor described the UK’s system of government as an “elective dictatorship”.
There is an election. Members of Parliament (‘MP’, ‘MPs’) are elected, for example, at the 2015 election, for the constituency of Maidenhead in Berkshire, Theresa Mary May. The MPs of the House of Commons choose from amongst their number a Prime Minister (‘PM’). The PM is from the House of Commons, remains in the House of Commons, and is answerable to the House of Commons. If the government, headed by the Prime Minister, cannot win a no-confidence vote in the House of Commons, the government falls and there is another election. Fixed-term Parliaments Act 2011, s.2(3)(a) and s.2(4): Parliament is dissolved and there is a fresh election if “the House of Commons passes a motion” “That this House has no confidence in Her Majesty’s Government.”. So the PM can always command a majority in the House of Commons, because if the PM can’t, the PM ceases to be PM.
Formally the Queen appoints the Prime Minister, but as explained by the website of the British Monarchy:
In appointing a Prime Minister, the Sovereign is guided by constitutional conventions. The main requirement is to find someone who can command the confidence of the House of Commons. This is normally secured by appointing the leader of the party with an overall majority of seats in the Commons, but there could still be exceptional circumstances when The Queen might need to exercise discretion to ensure that her Government is carried on.
In contrast, the PM might not be able to command the confidence of the House of Lords, yet the approval of “each House of Parliament” is needed. With respect to primary legislation, the House of Commons can over-ride the House of Lords (the 1911 and 1949 Parliament Acts), but, as explained by the Companion to the Standing Orders of the House of Lords:
10.02 The Parliament Acts do not apply to delegated legislation. So delegated legislation rejected by the Lords cannot have effect even if the Commons have approved it. … The House of Lords has only occasionally rejected delegated legislation.
Even the Salisbury Doctrine provides only a little help, as it is customarily applicable only to a Government Bill mentioned in an election manifesto. Nonetheless it does make the unelected Lords unwilling to over-rule the Commons.
And even if not that, the government’s box of tricks would not be empty.
HMT could direct the BoE “to bid at least such-and-such a price for at least such-and-such a quantity at the gilt auction next week”. Such an order could then be allowed to lapse, 28 days later, long after it ceased to be relevant.
Indeed the order could be repeated ahead of every subsequent gilt auction. As an example of similar precedent, the Terrorism Act 2000 allowed the designation of an area, for 28 days, in which police could search without any need for reasonable suspicion. That authorisation for the whole of Greater London was given for multiple periods, each starting at the end of the previous, without upsetting the courts. (See ¶18 of Gillan v. Commissioner of Police for the Metropolis, though the government eventually lost on other grounds.)
Alternatively, the government could pass a very short Act, expanding s.19 of the BoE Act 1998 to give the government authority to compel the BoE to purchase gilts as and when and in whatever form directed by the Treasury. Being primary legislation, the aforementioned Parliament Acts could be used to over-rule a refusal of the Lords to pass this small Act. The Lords, mindful of this possibility, would have reason to be helpful.†5
There is precedent for small amending Acts, for example, the Police (Detention and Bail) Act 2011, rushed through within a week to reverse a judicial interpretation of the Police and Criminal Evidence Act 1984. Parliament can even make the changes retrospective, as it did by s.1(3). It is worth reading as an example of the power of Parliamentary Sovereignty.
1(1) In section 47 of the Police and Criminal Evidence Act 1984 (bail after arrest), in subsection (6), at the end insert “and any time during which he was on bail shall not be so included”.
1(2) In section 34 of that Act (limitations on police detention), in subsection (7), at the end insert— [ … ]
1(3) The amendments made by subsections (1) and (2) are deemed always to have had effect.
So by one means or another, even without the support of Parliament, a UK government can compel some large gilt purchases by the Bank of England. With that support it could rewrite the legislation as it deemed necessary.
A British government has a lot of power over legislation, and over UK entities such as the Bank of England. For that reason, it is difficult to construct modes of failure. Described are one non-failure, and one implausible possible failure.
Even so, the worst that can happen is to complicate a direction to the BoE, made under “extreme economic circumstances”, compelling gilt purchases. In other words, the worst that can happen is to hinder the government doing something that it has never needed to do.
Assume that a direction has been given under s.19 of the BoE Act 1998. The government then tables the required statutory instrument, and, for whatever reason, the Commons or the Lords quickly defeat the resolution of approval.†6 However, this would be but a minor inconvenience, as explained by Conventions of the UK Parliament:
218. The Clerk of the Parliaments explains what happens if [a statutory instrument] is defeated. If it is affirmative, it may be re-laid, though it must be at least slightly different. … If the Lords rejected it again (which has never happened), the Government could in the last resort embody it in a Bill.
Alternatively, assume a minority government. That is, assume the government is formed of a party or parties that do not command a majority of the House of Commons. Of itself, this is not frequent, and minority governments are typically short-lived. Even in 2010–2015 the government, albeit a coalition of two parties, had a majority. Of course, this would typically be followed by a new election, so also assume that there have been several elections in quick succession, each of which has produced a minority government, and that another election is unlikely to change this—the Commons have no confidence in the government, but won’t pass an act saying that.
Still, the business of government would carry on: wars fought; criminals arrested; NHS patients cured; tax demands made and paid; spending spent; coupons and principals paid; and more gilts issued by the usual means. Nothing need go wrong for the DMO. A country could live like this for decades, and comfortably. Belgium often does. But if hurried statutory instruments should be needed, and the combined non-government parties were determined on mischief, then the government could have difficulty compelling the BoE to buy gilts.
Of course, the reason that a 1946 s.4 direction cannot be given is that central-bank buying of gilts is part of monetary policy. So the Treasury could still endeavour to persuade the MPC that the best monetary policy would include the BoE bidding for gilts at auction. MPC meetings are always attended by a non-voting “Treasury representative”, who could make the case. The MPC might well hear such arguments sympathetically. Indeed, the BoE and the MPC might well prefer being asked to being directed.
Thus the government has emergency means of accessing unlimited £ funds. In extraordinary circumstances compelling central-bank buying of gilts might be awkward. Constructing circumstances in which it is impossible requires some implausible facts, central-bank folly, as well as extraordinary stretching of constitutional norms.
During a temporary civil emergency (such as flood, terrorism, fire, power outage) a bank holiday could be proclaimed. From the Banking and Financial Dealings Act 1971:
1(3) Her Majesty may from time to time by proclamation appoint a special day to be, either throughout the United Kingdom or in any place or locality in the United Kingdom, a bank holiday under this Act.
The Information Memorandum explicitly refers to this Act:
7. If the due date for any amount of principal or interest in respect of Stock or any amount payable in respect of a strip is not a business day then payment may not be made until the next succeeding business day and in such cases the holder of the Stock or strip will not be entitled to any further interest or other payment in respect of such delay. For these purposes, "business day" means any day which is not a Saturday or Sunday, Good Friday, Christmas Day, nor a day which is a bank holiday in England and Wales under the Banking and Financial Dealings Act 1971.
The 1971 Act also applies to other debtors:
2(3) An obligation on a person to do a thing on a day on which he is prevented from doing it by an order under this section, or is unable to do it by reason of any such order, shall be deemed to be complied with if he does it so soon as practicable thereafter.
Using bank holidays primarily as a means of delaying payment, without genuine reason, would be frowned upon by the rating agencies. And it wouldn’t be done, partly the previously discussed powers suffice. But if there were a civil emergency causing temporary operational problems, payment could be lawfully delayed without default.
Non-default entails both an ability to pay and a willingness to pay. The above has argued that there is ability with spare. What about willingness?
For over three centuries the UK (preceded by England & Wales) has been a good payer.†7 There were outstanding eight ‘perpetual gilts’, which had no set final maturity but were callable by the Treasury. In 2015 all were called. Of these, the oldest was 2½% Annuities, which had paid every quarterly coupon since issue in 1853, the proceeds having presumably been spent on the Crimean War.†8
Starting with that record of payment, what is the government’s optimal strategy? Such a long-standing reputation is surely worth a lot of defending. Further, it seems that the belief of UK politicians, of whatever political colour, is the same: that reputation is worth a lot of defending.
The Information Memorandum also says:
6. Government Statement
122. As explained in the statement issued by Her Majesty’s Treasury on 29 May 1985, in the interest of the orderly conduct of fiscal policy, neither Her Majesty's Government nor its servants or agents undertake to disclose tax changes decided on but not yet announced, even where they may specifically affect the terms on which, or the conditions under which, Stock is issued or sold by or on behalf of the Government. No responsibility can therefore be accepted for any omission to make such disclosure and any such omission shall neither render any transaction liable to be set aside nor give rise to any claim for compensation. A copy of the statement may be viewed on the DMO's website at: [a link in Dec 2017 changed to www.dmo.gov.uk/media/14588/1985hmttaxstatement.pdf]
There’s a better copy at www.jdawiseman.com/papers/finmkts/19850529_hmt.html, with some notes.
123. Subject as set out below, the English courts shall have exclusive jurisdiction to settle any dispute which may arise in connection with Stock or any application for Stock. However, in relation to any application for Stock, the DMO reserves the right, to the extent allowed by law, to bring proceedings in any other court or concurrent proceedings in any number of jurisdictions. This clause is for the benefit of the DMO.
8. Governing Law
124. This Memorandum and any Notices making amendments to this Memorandum together with any prospectus or other offering document issued under its provisions, and any non- contractual obligations or matter arising therefrom or in connection therewith, are governed by and shall be construed in accordance with the laws of England.
125. The right is reserved to amend or supplement this Memorandum by further notices given from time to time. Any notice given under this paragraph will be published by the DMO in such manner as the DMO considers appropriate.
The 1985 statement and these four paragraphs give HMT, acting via the DMO, considerable power over various matters relating to the debt of the United Kingdom. To the best of the author’s knowledge these powers have never been used mischievously, but they exist.
The UK government operates under slightly different rules during an election campaign. These rules evolve from one election to the next, particularly as the technology of media evolves, but the principles vary less. From General Election Guidance 2015:
1. General Elections have a number of implications for the work of Departments and civil servants. These arise from the special character of Government business during an Election campaign, and from the need to maintain, and be seen to maintain, the impartiality of the Civil Service, and to avoid any criticism of an inappropriate use of official resources. This guidance takes effect at the Dissolution of Parliament on 30th March 2015. The Prime Minister will write separately to Ministers advising them of the need to adhere to this guidance and to uphold the impartiality of the Civil Service.
3. During the Election period, the Government retains its responsibility to govern, and Ministers remain in charge of their Departments. Essential business must be carried on. However, it is customary for Ministers to observe discretion in initiating any new action of a continuing or long-term character. Decisions on matters of policy on which a new Government might be expected to want the opportunity to take a different view from the present Government should be postponed until after the Election, provided that such postponement would not be detrimental to the national interest or wasteful of public money.
Preventing default most definitely counts as “Essential business” which “must be carried on”. So the previous reasoning would not be different with Parliament dissolved and an election underway, nor during any post-election coalition negotiations.
As already quoted, s.19(5) of the Bank of England Act 1998: “no account shall be taken of any time during which Parliament is dissolved”, which gives additional flexibility during campaigning.
The United Kingdom consists, unsurprisingly, of more than one Kingdom: that of England, and that of Scotland. The UK is England, Scotland, Wales, and Northern Ireland. Scotland has about 8.4% of the UK’s population (≈5.2 million out of ≈62.2 million total), and about 8% of UK GDP. Scotland does however have a lot of the empty space, being 32% of the land area. The Scottish National Party wants Scotland to be independent, and indeed there was a 2014 Scottish independence referendum which resulted in a decision to stay in the UK.
If Scotland were to leave, the UK’s debt and international assets, including the permanent seat on the UN Security Council, would stay with England and Wales and Northern Ireland. The loss of 8% of GDP would raise UK’s indebtedness ratio by a factor of about 1÷0.92, equivalent to increasing it from ≈89.2% of GDP to ≈97%. Such a change would be unwelcome, but would not alter any of the previous legal arguments. (Observe in the already-quoted ¶124 of the Information Memorandum that it “shall be construed in accordance with the laws of England”.†9)
But those who lost that referendum want a second go (but if they had won and Scotland were now independent, they wouldn’t now say that $50 oil is a significant change in circumstances requiring a re-vote). But if a second referendum reversed the verdict of the first, what would happen to the UK’s debt? HMT, 13 January 2014:
The Treasury has today set out detail on government debt in the event of Scottish independence. The technical note makes clear that the continuing UK Government would in all circumstances honour the contractual terms of the debt issued by the UK Government. An independent Scottish state would become responsible for a fair and proportionate share of the UK’s current liabilities.
From that ‘technical note’:
1.1 In the event of Scottish independence from the United Kingdom (UK), the continuing UK Government would in all circumstances honour the contractual terms of the debt issued by the UK Government. An independent Scottish state would become responsible for a fair and proportionate share of the UK’s current liabilities, but a share of the outstanding stock of debt instruments that have been issued by the UK would not be transferred to Scotland. For example, there would be no change in counterparty for holders of UK gilts. Instead, an independent Scotland would need to raise funds in order to reimburse the continuing UK for this share.
That was a political action of a state that is really willing to pay its debts.
A non-£ default by the UK is, of course, not impossible, but nonetheless is very unlikely.
Not impossible? Though the UK parliament has ultimate authority over the Bank of England, it doesn’t over the US Federal Reserve, European Central Bank, or the Bank of Japan. So the UK cannot compel unlimited access to $ or € or ¥.
Very unlikely? Nonetheless, the author believes a non-£ default by the UK is very unlikely, and that that one of the primary reasons for this has been heralded too little: Since late 1992, the value of the £ against foreign currency has been free-floating. Not even a managed float: floating very free.
For the government and for a bank, owning £ assets funded in foreign money is risky. And since 1992†10, that risk has been very obvious. The variability of £/$, £/DEM, £/€, £/¥, £/CHF, etc, have been starkly visible, not ignorably theoretical. This is why the assets and liabilities of large entities, public and private, have been approximately FX matched. And if a private entity should collapse onto the government’s balance sheet, that combined balance sheet would remain approximately matched.
Observe what happened in practice. From July to November 2008, £/$ fell from above 2.00 to under 1.50, yet the stresses in the banks were not ascribed to this fall. Why? Because £/$ had long been a known unknown, so market participants were approximately hedged.
Indeed, it is easy to find examples of previous defaults by countries with currencies that were pegged, or nearly so. Such a story can start with a currency peg, foreign interest rates being lower. Local entities borrow in foreign currency, seemingly risklessly. Then the peg breaks; foreign liabilities become much larger when measured in local currency; much default follows. Much rarer have been defaults by countries with almost all the government debt in free-floating domestic currency. The UK has almost all of its government debt in the currency over which it is sovereign; most of the government debt is long-term and fixed-rate; and that currency is perhaps the freest-floating of all currencies.
This essay explains the de facto impossibility of UK £ default. This essay does not model the decision process of a rating agency, nor does it replicate nor predict the future opinion of any rating agency.
Indeed, a rating agency might have a different opinion. Even though that different opinion would be wrong, it would still be the opinion of the rating agency.
This thesis is about the UK, but obviously has lessons for other countries.
Germany, France, Italy, Greece, and the other members of the eurozone do not have the sovereign ability to print the numéraire in which their debt is denominated. That alone gives them all—yes, including Germany—a materially higher risk of default than has the UK. Obviously some have income exceeding expenditure (Wilkins Micawber: “result happiness”); others don’t (“result misery”).
The USA in theory has these sovereign powers, but its internal decision-making process means that it can’t necessarily use them. Sometimes the Executive wants to act as if the UK’s National Loans Act 1968 applied there, while the Legislative—in demanding a silly price to raise the debt ceiling—seems hell-bent on economic suicide. Perhaps if enough members of Congress could see themselves as a future President then a USA version of NLA68 could pass.
Denmark: the DKK is the only member of version II of the Exchange Rate Mechanism. The Danmarks Nationalbank keeps €/DKK within ±2¼% of EUR 1 = DKK 7.46. Currently DKK policy interest rates are below those of the EUR, so one might expect that Danish players currently prefer to borrow in DKK. But over the lifetime of a long bond that might change, in which case Danish players would prefer to borrow in EUR. And if the peg were then to break, those euro liabilities could land in the lap of the Danish government. So this thesis about de facto impossibility does not apply to Denmark—even though, for other reasons, Denmark is currently an excellent credit.
Japan: perhaps somebody expert could say whether Japan’s distribution of decision-making powers more closely resembles that of the UK or that of the USA.
Emerging-market countries often have large dollar borrowings, or state-owned enterprises with same, or a currency that doesn’t float freely. In theory an EM could have a deep local-currency debt market, a floating currency and hedging vehicles for it, and an effective government capable of taking honest competent decisions. But that doesn’t seem very “emerging”.
Her Majesty’s Treasury have all the authority they need to issue debt, within or outside the UK, without limit as to quantity, in such manner as they think best.
The Treasury have the power to compel the Bank of England to purchase gilts. If Parliament were to disrupt this, the matter would be settled by an election.
Debt markets look ahead, and because such emergency means of funding can be seen, that should reduce the need for them to be used. Nonetheless, they exist.
So the UK will pay its £ debts: sovereign default in £ is de facto impossible.
But that does not say anything about the purchasing power of the pounds in which the UK will pay. Also, it does not say anything about the relative merits of alternative investments, such as compounded short-term deposits. These matters are not riskless, but are not default.
There are other countries that are very unlikely to default. But a sovereign default in £ by the United Kingdom is de facto impossible.
— Julian D. A. Wiseman
London, July 2016
(Many of the footnotes in the earlier versions of this essay were just links; as this is published in HTML those links have become active links in the text.)
†1 There have been several versions of the Memorandum: 24 Mar 2016; 23 Nov 2015; 22 Aug 2013; 15 Aug 2011; 22 May 2009; 20 Aug 2007; and 21 Dec 2004. They are not identical, but the differences have not been material—at least, not yet. Some of these changes have been accompanied by a ‘Notice of Amendment’, that of 24 June 2011, but only that one, saying: “For the avoidance of doubt, the above amendment shall apply to all Stocks currently in issue, whether issued under the Information Memorandum, under previous versions of the Information Memorandum, or otherwise.”
†2 Her Majesty’s Treasury is legally plural as there are there are at least six Lords of the Treasury who serve concurrently, jointly serving as a commission for the Lord High Treasurer. The First Lord of the Treasury is the Prime Minister; the Second Lord of the Treasury is the Chancellor of the Exchequer; the Junior Lords typically being other MPs. Hence “the Treasury may … as they think fit”.
†3 This phrasing was not new, first appearing in the National Loans Act 1939, s.1 (which was repealed by the 1968 Act): “Any money required … may be raised in such manner as the Treasury think fit. … For the purpose of raising money under this section, the Treasury may create and issue such securities as they think fit.” (HTML, PDF).
This 1939 Act was introduced to the House of Commons on 7 December 1939 by Sir John Simon, the then Chancellor of the Exchequer, who eloquently justified the need for these broad powers—even today, much of that speech rings true (start column 94), and the author commends it to US policy makers. That speech made reference to various WW1 financing acts— alas not on www.legislation.gov.uk as they were wholly repealed before that website’s base date of February 1991—which imposed a £ limit to the borrowing. Perhaps those limits might have been an inspiration, or partial inspiration, for the US debt ceiling in the Second Liberty Loan Act of October 1917.
†4 Many Acts have similar requirements, even if not identically worded. For example, in the Banking Act 2009 in s.2(5) and in s.75(7)-(8); and in the modifications to other Acts done by the Financial Services Act 2012 in s.4(1)(9N) and in s.6(1)(3H).
†5 The Parliament Acts are rather slow, but an alternative has precedent. In order to pass the 1911 Parliament Act the Prime Minister, H. H. Asquith, threatened to appoint new Lords until the government had a majority of the Lords. That could be done, or at least re-threatened.
†6 One might think that this problem could be avoided by delaying the laying of the Statutory Instrument before Parliament until after the auction. However, s.4(1) of the Statutory Instruments Act 1946 requires that the SI “shall be so laid before the instrument comes into operation”, the allowed exceptions probably being insufficient for this purpose.
†7 Charles II, king from the restoration in 1660 until his death in 1685, was a notoriously unreliable debtor. In the words of a contemporary, “A merry monarch, scandalous and poor.” Other comment of the time concurred, but too bawdily for reproduction here. So the Bank of England was founded in 1694 to borrow money on behalf of the government, with a greater perception of creditworthiness. Since then the E&W/UK government has been a good payer.
†8 The author owns, in bearer form, £100 nominal of 2¾% Annuities (first issued 1884). I haven’t been assiduous about collecting the quarterly coupons (“£0·68” each as payments truncate fractions of a penny), nor have I redeemed the principal. Should I?
†9 Standard legal wording has shifted over time from “the law(s) of England” to “the law(s) of England and Wales”. In legislation from 1189 to about 1950 it was always the former; from then to about 1980 it became about half of each; since when “… and Wales” has predominated. So the DMO’s usage of just England is a little dated but not unusual. Yet this old-fashioned wording was introduced in the 2007 version of the Information Memorandum (the 2004 version not specifiying a governing law).
†10 GBP ignominiously left the Exchange Rate Mechanism on 16 September 1992, though, arguably but irrelevantly, the FX risk was obvious before then. The exchange-rate policy has been a very clean float since 25 February 1993, the UK intervening only in concert with others to affect the value of a non-£ currency, and even that only twice and in small size. On 22 September 2000 the BoE “purchased €85 million against sterling” (announcement). And on 18 March 2011, “The Bank sold ¥12bn for £93m. This was the first coordinated G7 intervention since 2000” (statement, and more on ¶47 on p9 of EEA accounts July 2011).
• Also at jdawiseman.com is a list of ≥1946 conventional gilts, and a complete list of non-conventionals: linkers; ‘perpetuals’, floaters, and variable-rate gilts.
• The General election 2017: guidance for civil servants is equivalent to the 2015 guidance linked in the section entitled During an election campaign. These things evolve, but only slightly: “English as tuppence, changing yet changeless as canal water”.
• In December 2017 the DMO’s website was re-arranged, and links have been updated.
• March 2020, Management of the Official Reserves, p5, contains a summary of the rarity of FX interventions:
The government has not intervened in the sterling exchange rate for domestic policy reasons since 1992. The UK has participated in two G7 co-ordinated interventions in the foreign exchange market since then, in 2000 (for the euro) and 2011 (for the yen).
• January 2021, an interesting comment was made by Sir Robert Stheeman, as published on 11 Aug 2020 by the Official Monetary and Financial Institutions Forum in an article entitled UK DMO chief on crisis borrowing:
I am not making a political point. Being sovereign in one’s own currency has significant advantages, and perhaps not in the way some people would automatically assume. It is not a question of having the ability to print money – no sensible country would want to misuse that sovereignty to debase its currency or to pursue deliberately an unnecessarily inflationary policy. The advantages of being a ‘true sovereign’ such as the UK are more subtle. They are about the government issuer being the undisputed issuer of the bond market benchmark and the central bank having the ability to operate monetary policy independently in the interests of that sovereign country’s economy. It is about flexibility and credibility within the institutional framework. It is, therefore, the ability to respond rapidly in a crisis, it’s about the co-operation between the institutions, the key institutions within the jurisdiction.
I agree. Nonetheless, the ultimate cause of this “co-operation between the institutions” comes from one side having, in a crisis, clear parliamentary authority over the other. Even though the rules make that difficult to abuse.
• January 2021, a rotted link was moved from the ECB to eur-lex.europa.eu.
— In due course, more might appear here. —
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