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Pressure on Debt Management Office as gilt issues hit record levels

Don’t confuse the Debt Management Office (DMO) with a personal advisory service for the cash-strapped. The distinction is one of the first made on the DMO’s website, where it clarifies for those in need of financial guidance that the department is in fact “responsible for the Government’s debt”.

Relatively unknown as it may be, the DMO performs perhaps the most valuable task in the country. It raises the money the Government plans to spend but hasn’t been able to secure in taxes: what is known as the Central Government Net Cash Requirement (CGNCR). In other words, the DMO taps global investors – from pension funds to China’s central bank – to pay for Britain’s public services. And it is about to get very busy.

Economists reckon the national debt is on course to soar over the next five years by £500bn to a record £1 trillion. It is the DMO’s job to raise that extra debt in the markets by issuing Government bonds, called gilts.

Unfortunately, it has not got off to a particularly good start. Wednesday’s auction of £1.75bn of 2049 gilts drew so few bids it was left uncovered for the fist time in seven years, sparking fears about the Government’s ability to raise such an enormous quantity of debt.

To be fair, no one is blaming the DMO, which is in essence little more than an operations office for the Treasury’s funding needs. The Treasury sets the CGNCR every year and decides, following advice from the DMO, how much should be issued in short, medium and long-term gilts. All the DMO does is decide the date of the auction and run the bid process.

Until 1998, the DMO was part of the Bank of England but the Government decided to hive the office off when the Bank was given independence over interest rates. According to Robert Stheeman, head of the DMO, the decision was taken because “if you bundled up debt management and monetary policy there is the potential for the most extraordinary conflict of interest”. If the Bank had a lot of debt to raise it could, conceivably, slash rates to reduce the interest burden.

Even so, a growing number of economists reckon the DMO should be given back to the Bank. Charles Goodhart, London School of Economics professor, told the Treasury Select Committee he would “sack the DMO” while New Star chief economist Simon Ward argues the two are natural bedfellows as “you can influence monetary policy through debt management”.

The advent of “quantitative easing” – economic reflation by increasing the money supply – has made the separation look distinctly odd. Gilt issues are sucking cash out of the economy as pension funds choose to buy safer Government debt rather than invest in companies. To counter this, the Bank is buying from the same investors over the next three months £75bn of those DMO-issued gilts.

Hedge funds have already worked to out how to arbitrage the process and are making juicy profits directly from the taxpayer.

According to Tim Congdon of Lombard Street Research, the whole process “is quite idiotic, frankly”. He believes that the Bank, if it ran the DMO, would simply issue fewer gilts in the first place and “quantitiative easing” would be achieved by buying bank debt.

Moreover, the extra gilt issues are putting increasing strain on the DMO. It is expected to issue a record £146.6bn this year compared with £58.4m last year, and another £110bn in 2010. Staff numbers have already risen from 86 in October to 108, but Mr Stheeman says it’s still “not enough”.

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