Does NS&I have a hidden agenda?

by Neil Faulkner on 27 July 2010  |  12 comments
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Neil Faulkner believes NS&I has a secret reason for withdrawing index-linked savings certificates.

National Savings and Investments (NS&I) has suddenly stopped selling tax-free savings certificates. Existing customers can continue to roll into new certificates as their old ones expire, and don't have to stick with the same type of certificate, or certificates of the same length.

There are two kinds of certificate. One pays a fixed-interest rate and the other is linked to inflation, promising to pay slightly more than inflation as measured by the Retail Prices Index for the duration, which can be up to five years.

If you want to guarantee that your savings will beat inflation and earn you a little money in real terms, that certificate was our only choice.

The official reason for their removal

The certificates give the government some extra cash. We loan the government our savings through a range of NS&I products - certificates, ISAs, savings accounts and premium bonds. The government pays us interest (or prize money) in return. However, NS&I can't compete too hard for our savings, as the banks won't allow it.

NS&I explains it has an annual target range for deposits into its savings products. Hence, it pulled its certificates without warning because demand got dangerously close to the upper range.

Another plausible reason

That's the official reason, but there's a plausible alternative. Neither banks nor the government want people tying up their savings in government products that promise to beat inflation when many economists are predicting high inflation down the road.

The facts supporting this theory are:

• Instead of removing the certificates, NS&I could have made the terms worse, e.g. paying interest of inflation minus 0.5%.
• Indeed, NS&I merely reduced the rates of some of its non-certificate products. It could have stopped new purchases of premium bonds, savings accounts and cash ISAs, but didn't. The cash ISA in particular still pays an attractive rate.
• Index-linked certificates have been available for decades.
• NS&I tells me savings certificates have attracted just an extra £6.7bn since 2005, taking it to the latest tally of £24bn, which is very little compared to more than £888bn in banks, NS&I, mutual lenders and deposit takers altogether.

No hard evidence

Whilst that second theory is more likely to be true than me winning the lottery next week, there's no hard evidence. Unless you're a conspiracy-theory maniac, you'll recognise that this is just a possibility, and not necessarily the greatest possibility.

Anything can seem suspicious. The fact that the government sets the NS&I savings targets can seem suspicious, but so can David Cameron's announcement, as I write, of a National Citizens Service, encouraging 16-year-olds to do community service. Suspicious minds might think it's a pre-cursor to military National Service. We can put a sceptical slant on anything.

Confirming a hypothesis

Last summer I wrote that we could expect changes to the inflation-linked certificates:

“...that deal could be amended at any time, especially with spiralling inflation...”

That wasn't an idle thought. In the past, governments have suspended the convertibility of paper money to gold and even forced citizens to sell their gold to the government. What's more, governments don't wait for inflation to rise before intervening. They're in the best position to know about inflation first, and take action in advance.

My (pre-credit crisis) economics textbook implies it's a central bank's duty to talk down inflation, smoothing it out over a longer period. The ECB, the Federal Reserve and the Bank of England have certainly been doing that, when I've got my suspicious hat on.

All I had last summer was a hypothesis that the removal of these certificates was a sure sign of high inflation to come. That could be wrong, but yet here we are, with the certificates being withdrawn after 35 years' service.

Recent question on this topic

• gaiamaterre asks:

  i have £25 000. Where can i place it so i can have as much interest as possible. This will be my retirement money;

  • 
    MikeGG1 answered "Have you retired or is this your future retirement fund?  If that is the case then how soon..."
  • 
    gaiamaterre answered "thank you Mike for your help. I will retire in between 9 to 14 years . I should have a 10..."
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My apology

The reason I'm apologising is because I didn't ram this view home hard enough. Despite writing notes for more rousing articles on it, I got no further than that one line in summer 2009. I believe the fault can be explained best by the brilliant economist who was J. K. Galbraith. He said that journalists who speak out publicly against financial euphoria:

“…will be the exception to a very broad and binding rule. They will be required to resist two compelling forces: one, the powerful personal interest that develops in the euphoric belief, and the other, the pressure of public and seemingly superior financial opinion that is brought to bear on behalf of such belief.”

In this case it was not euphoria but deflation hysteria I should have fought harder. The talk last year was largely of deflation risks. (There's still some talk of it now, to an extent. A good number of economists - even some predicting high inflation to come - see a short-term risk of deflation.) I should have pointed out over the past year more forcefully that the best way to avoid inflation is to act long before the expectation of inflation takes hold.

Only once, in Rising prices: the greatest threat to your finances in January this year, did I recommend the certificates, but not as strongly as I should have.

What now?

Our best protection against inflation is gone, but the good news is you wouldn't have wanted to put all your savings in these certificates: your money is tied up for too long and if high inflation never came you might have lost quite badly.

Consider keeping some money flexible in easy-access cash ISAs and savings accounts, and follow the best rates. If you have plenty of savings that you don't need for a while, you could spread out your money and risk further. Look into your options, which may include paying off debts, using cheap, very long-term investments such as a few index trackers or ETFs from a mix of developed and emerging markets, and even, if you so wish, a bit of gold or Zopa.

Compare easy-access savings accounts and cash ISAs.

More: Investing favours the brave | How to successfully diversify your portfolio