There is a view that we don't have to worry about the record debt the government has accumulated since coronavirus laid waste to our way of life and our economy. And in two senses I would half agree – though the other half of me is wracked with anxiety.
First, this is not a uniquely British problem; it is a problem of all developed economies.
However, you should not underestimate the geopolitical significance of the explosion of debt in the rich West, because it represents by implication the fastest transfer of wealth and power to China and Asia in our lifetimes.
Second, there is the important counterfactual – namely what would have happened if the government had not borrowed and spent all that cash. Which does not bear thinking about.
All that said, it will be a huge moment on Wednesday when the Office for Budget Responsibility confirms that the UK is on course to borrow around £400 billion this year, equivalent to around 20 per cent of national income, and that the national debt will rise to well over 100 per cent of that same national income. Outside of world wars, this is a uniquely large and fast rise in public sector debt.
The supposed catastrophe of the banking crisis caused a deficit that was seen as an existential threat by the then-governor of the Bank of England – though it was half the size of the current deficit. But, you will doubtless say, interest rates are so low it really doesn't matter if the government is borrowing on this scale: the money is effectively free. The PM and Chancellor would be fools, surely, to look this gift horse in the mouth and they should continue the spending splurge for as many years as it takes to level up, re-wild, re-tool, re-skill and do all that's necessary to make the UK green and pleasant again. In other words, the last governor was just wrong.
Well, former governor Mervyn King may well have exaggerated the risks faced by the UK at that juncture a decade ago. But as it happens he and his colleagues also created a structure for financing the government's emergency borrowing needs that brings very significant risks – what those who work in the City would call the risk of ‘gearing’.
Here is why – and it is quite complicated, so please bear with me. When the government borrows, it sells bonds known as gilts to investors. And these gilts carry an interest rate that is currently very low and is typically fixed for 10 or 20 or even 50 years. Now the average maturity of these bonds is more than 15 years, according to the government's Debt Management Office. So in theory the government can forecast with some certainty its interest rate outlays for many years to come.
Except that because of quantitative easing – that Mervyn King innovation which made it temporarily cheaper for the government to borrow – the Treasury is now much more exposed to temporary short-term fluctuations in interest rates. And that is a serious and troubling risk when the government's borrowing needs are so huge.
Here is how the potentially devastating ratchet works. To remind you, the Bank of England started to engage in quantitative easing – the purchase of government debt, gilts by the Bank – after the 2008 crash, as a new lever to cut the cost of capital. But when the Bank of England buys gilts, it has to finance this purchase by creating reserves. In practice it is buying the gilts by borrowing from commercial banks at Bank Rate, the benchmark interest rate for the whole economy.
And because the Bank of England is a public-sector institution, it is in effect the Treasury that is on the hook for all the reserves created by the Bank of England to finance quantitative easing.
At this point, you have doubtless lost the will to live. So I will go straight to the punchline. The Bank of England owns £875bn of government bonds or gilts though its quantitative easing programme (actually it might not yet be quite £875bn, but it will be soon). And the Bank of England is paying Bank Rate to finance that stock of bonds. Which means that the Treasury is paying Bank Rate to borrow that £875bn.
So every time the Bank of England cuts interest rates by 0.1 per cent, that saves the government almost a billion pounds. And every rise of 0.1 per cent costs the government almost a billion pounds.
Times that by ten for every 1 per cent rise in interest rates. The point is that interest rates will have to increase at some point. Maybe not tomorrow. But it will happen.
Coronavirus has eliminated capacity from the economy. Even a modest rise in activity could lead to inflationary pressures, which in turn could persuade the Bank that it's time to increase the Bank Rate. When that happens, the dangerous gearing to which I referred earlier would kick in. Because when interest rates rise, there will be a treble whammy for the government.
First, and as I mentioned, it will have to pay more interest in effect on the gilts it has already sold that are owned by the Bank of England.
Second, it will have to pay more interest on the borrowing it will be carrying out through issuing new gilts (because interest rates are rising) – which for the next few years will be at least £300bn every single year, probably considerably more, as it has to refinance both existing debt and borrow more.
Third, if interest rates are rising, the Bank of England will not be engaging in quantitative easing, so there will be less market demand for gilts and that means the government will be forced to pay even more to borrow from the market.
Even if the era of high interest rates is over for the foreseeable future, a 1 per cent rise in interest rates in the course of this Parliament is not inconceivable.
And it is not hard to come up with a scenario in which a 1 per cent rise in the Bank Rate adds £20bn or more to the government's borrowing costs every single year. The coronavirus debt is not free. We just don't know quite how expensive it will turn out to be.