13 October 2008

Removing Depositor Guarantees Would Mean Cheaper National Debt

In a previous posting, I gave reasons why removing the guarantee on deposits in banks would go a long way to resolving the problems that have caused the current banking crisis.

There is a pleasant side effect that removing depositor guarantees would also create, which is that it would make servicing the national debt cheaper. I'll explain why:

At present, the UK government carries debts of in excess of £500billion. In the ideal world, the government wouldn't carry that debt; it amounts to over £8,000 per person in the UK and it is an irresponsible way to operate a government as it allows the cost of todays spending to be passed on to future generations. Unfortunately, we aren't in the ideal world and that level of debt won't go away overnight, so while we have it, we need to find a way to fund it as cheaply as possible.

Around £84billion of that debt is funded by people investing with National Savings & Investments (according to their annual report), through products such as premium bonds. NS&I should have a strategic advantage over private sector banks, as somebody investing in NS&I is lending money to the government and therefore has a government guarantee of repayment. Unfortunately, the government throws this advantage away by guaranteeing some investments in private sector banks too, even though the government isn't the borrower.

If the government removed the guarantee on private sector bank deposits, the advantage would materialise. People would see the risk in banks and demand higher interest rates from them. On the other hand, NS&I would be able to use its government guarantee as a major selling point and reduce its interest rates, knowing that it would be the only port of call for investors looking for safety.

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