Posts tagged ‘debt’

End Of An Era

“Mr Speaker, I am abolishing the Autumn Statement.”

2016 has already delivered much in the way of political upheaval. But no one was expecting this! Granted, there was much laughter as the new Chancellor told MPs that, having done away with the traditional spring Budget and Autumn Statement, he would be moving to an autumn Budget and a Spring Statement. (He had to clarify that this really was a significant change because the Spring Statement wouldn’t actually say much.)

Thus concluded the only truly dependable projection from HM Treasury. What did the rest of this, the last ever Autumn Statement, have to tell us?

Reports of the event were dominated by the forecast effects of Brexit. Of course, nobody knows what these will actually be. The Office for Budget Responsibility plumped for lower growth, higher inflation and more borrowing than before. Its guesses are worth no more than the Bank of England’s – though they were, interestingly, very different. The Bank, in its Inflation Report out earlier this month, had GDP for 2018 and 2019 coming in at +1.5% and +1.6%. The OBR thinks the answer will be +1.7% and +2.1%. Counter-intuitively the OBR is also forecasting lower CPI inflation (2.5% and 2.1% as against 2.7% and 2.5% over on Threadneedle Street). It is likely mere coincidence that higher growth and lower inflation will have combined to produce a less alarming debt forecast. In any event, the inconsistency serves to demonstrate nicely the speculative nature of all these kinds of exercise.

Regular readers will know how important the level of gilt yields is too. They have fallen since the Budget and this has delivered a projected bonanza of £24bn over the course of the next five years. That is the impact of a fall in gilt yields of all of 0.3%. (So long as they don’t go up again, the nation’s finances are safe. Well, safeish.)

The Chancellor briefly alluded to longevity and suggested that the next Parliament consider doing something about it. This is a good idea: the state pension bill is forecast to reach £101.9bn in fiscal 2020-21, up from £91.5bn this year. And that represents a compound annual increase of only 2.7%. More aggressive inflation, or a higher rate of earnings growth would push the cost higher.

We have no idea what growth and inflation will be over the next few years. Nor does the Treasury have much, if any, control over interest rates. There are, however, material numbers over which it does have some say. And in this febrile political environment, with Brexit on the horizon (or possibly not), public debt already forecast to reach 90% of GDP soon and no medium-term prospect of balancing the books, what is the expected net impact of the Chancellor’s policy decisions? Why, to widen the budget deficit by £4bn next year, £6bn in 2018-19 and £8bn the year after that! And those numbers are predicated on the basis of 43 discrete policy changes covering everything from tax reliefs available to museums to the exemptions regime for social sector rent downrating. Taxes up, borrowing up and the tax code as complex as ever. The ghost of Gordon Brown still hovers over the building whose magnificent remodelling he instigated all those years ago.

But – as many have felt, at times, this year – enough of politics. Despite the mainly Brexit-related fuss it caused the Autumn Statement contained nothing to suggest that the management of the country’s economy is to undergo change. The UK’s national debt remains problematic, and the Treasury seemingly content to be at the mercy of future events. That, from a pure investment perspective, is the key message from the last Autumn Statement in history.

25/11/2016 at 5:10 pm

Concerning Government Debt

With August almost upon us the summer lull is well underway. The FTSE 100 index has drifted along in a 100 point range over the past three weeks; volatility has also fallen away in the US and European stock markets; sterling seems to have found a stable level in the wake of its Brexit-driven devaluation; and yields on the major bond markets, including the gilt market, have found their lows for now. The oil price has fallen back again – the near Brent crude contract has been testing $42 per barrel today, down from over $50 at the start of the month – but aside from that there has been little to report.

There is a chance that could change next week. After the US close today, the European Banking Authority will publish the results of its latest “stress test” for the EU’s largest banks. There has been a lot of focus on the problems in the Italian banking sector: bad loans in Italy have been estimated to amount to 360bn, or about 22% of the country’s GDP. Indeed, when the EBA ran its last test in 2014 the worst-placed institution was found to be Banca Monte dei Paschi di Siena, and an emergency capital raise was required as a result.

This time round statements to the media suggest there are unlikely to be any nasty surprises. European banks have already underperformed the market this year, first of all during the Febrary panic and then in the aftermath of the UK referendum, so a lot of pessimism has been priced in to the sector. And at the stock specific level, the weaker institutions have already suffered severely: BMPS shares have fallen by more than 80% over the past 12 months. Deutsche Bank, another focus for concern, has seen its share price fall by almost 60% over the same period. In fact there may even be value in ending some of the uncertainty in this area. We shall see.

What we know already, however, is that national banking systems rely ultimately on state support in times of crisis. Should there be systemic failure in Italy, or elsewhere, it would fall to national governments to control the damage via bailouts, managed insolvencies with “bad bank” spinoffs and so on. Those governments rely in turn on their sovereign balance sheets. That is better news for some countries than for others: Greece, on the one hand, is in no position to bail out Athenian lenders, while Germany, on the other, could stand credibly behind its banking system if required to do so. So what do those balance sheets look like, compared to the recent past? Which of the world’s largest economies should be able to withstand further shocks to their financial systems, and which of them are probably too deeply indebted to manage it?

Budget Deficit / Surplus % of GDP: pre-crisis, mid-crisis and post-crisis

2006 2009 2015
UK -2.6 -10.3 -4.2
US -1.5 -10.1 -4.2
Japan -1.3 -8.8 -6.7
Eurozone -1.5 -6.3 -2.1
Germany -1.7 -3.2 +0.7
France -2.3 -7.2 -3.5
Italy -3.6 -5.3 -2.6
Greece -5.9 -15.2 -7.2
Brazil -3.6 -3.2 -10.4
India -4.1 -6.0 -4.1
China -0.8 -2.2 -3.4
Russia +7.4 -6.0 -2.9


Gross Government Debt % of GDP: pre-crisis, mid-crisis and post-crisis

2006 2009 2015
UK 42.4 65.7 89.2
US 62.0 85.0 105.2
Japan 177.6 192.9 227.9
Eurozone 67.3 78.3 90.7
Germany 66.3 72.4 71.1
France 64.4 79.0 96.2
Italy 102.6 112.5 132.7
Greece 103.6 126.7 176.9
Brazil 55.5 59.2 66.5
India 60.0 57.3 51.7
China 32.0 36.9 43.9
Russia 7.7 8.3 13.5


This data is sourced from various government agencies and central banks. While there is a certain amount of methodological variety at play the key points are fairly obvious.

Looking at the data on national debt burdens first, it is plain that most developed nations are appallingly badly placed to weather a fiscal storm arising from another financial crisis, or indeed from any other source. The exceptions are (predictably) Germany, and (to a lesser extent) the UK. The one bright spot comes from the bond markets: with interest rates so low in all these nations the burden of servicing their debts is relatively undemanding. In fact Chancellor Hammond may well find he has some limited scope for fiscal loosening come the Autumn Statement if rates stay at their current levels.

Staying in the developed world and turning to the budget deficit data, the eurozone as a whole looks pretty healthy, as does the US. At the national level, however, there are of course some terrible problems. With its shrunken GDP and hefty deficits the burden of Greek debt is now higher than it was prior to the restructuring of 2012. In Italy the budget deficit is actually quite modest now, but that hasn’t helped reduce the country’s debt burden because of its low growth: the Italian economy is 8.5% smaller in real terms than it was in early 2008. This has fed the bad loan problem in the country’s banking system while eroding what ability it has had to manage any serious shock.

Away from Europe, Japan’s balance sheet has exhibited eye-watering deterioration. The postponed sales tax increase there is due next April. This may drive growth down again but it is unlikely to improve the country’s fiscal metrics much. It is true that Japan’s net government debt position is not quite so bad (128% of GDP on the IMF’s estimate for 2015; China’s net sovereign debt position is also greatly reduced at 17%). But with debt at these levels, population decline and (this year) a strong yen the prospects for this quondam global powerhouse remain sclerotic at best.

Brazil, which was downgraded to junk over the period from last September to February by the Big Three rating companies, has suffered economic strife in recent years. Compare its fortunes to those of India, where growth has seen the debt burden shrink even as moderate fiscal deficits have persisted. To end on a positive note it is remarkable how well Russia has managed to cope with the collapse in oil. The days of 7% budget surpluses might be long gone but there is little debt to speak of – and not much of a deficit either.

The numbers here will in many cases take years to improve. In Japan’s case it is not clear how they might be improved at all. Many countries simply cannot afford a national emergency, and will find their fiscal planning easily destabilized by movements in interest rates. Depending on the outcome of the EBA’s analysis tonight there may be one or two European countries very grateful for the backstop represented by the ECB’s ability to intervene in bond markets this weekend.

29/07/2016 at 4:17 pm

Mountain Or Molehill?

As market bears know all too well, one of the world’s crushing problems at present is China, and everything connected thereto. At the height of the panic which made for such an enjoyable start to 2016, one specific pointer towards China’s imminent and terminal doom was identified as her debt “binge”. Only this Wednesday, this very same binge headlined a blog post from The Economist magazine which warned:

“DEBT in China is piling up fast. Private debt, at 200% of GDP, is only slightly lower than it was in Japan at the onset of its lost decades . . . and well above the level in America on the eve of the financial crisis of 2007-08 . . . The value of non-performing loans in China rose from 1.2% of GDP in December 2014 to 1.9% a year later. . . .”

Specifics such as these betoken credibility. Yet they also invite questions. What does “private debt” mean? Which matters more: the 1.9%, or the 200%? What are the equivalent numbers for the other economies mentioned?

Let us start with the components of “debt” in China. First of all the only one which the bears seem not to want to mention: sovereign debt. This is estimated at 43% of GDP by the IMF on a gross basis for 2015. At the same time, however, China has huge sovereign reserves – about $3.2trn at the moment, again on IMF numbers, which is about 31% of 2015 GDP. With the country targeting a fiscal deficit of 3% this year and reserves trending downwards since 2014 it is true that the country’s sovereign debt position is deteriorating on a net as well as a gross basis but it should be obvious that it is nobody’s idea of a crisis. (UK sovereign debt was 88% of GDP on the same, gross basis in 2014, the eurozone’s over 90%, the USA’s over 100% and Japan’s approaching 250%.)

The “private debt” figure mentioned in the quote comprises a corporate (non bank) debt ratio of 165% and household ratio of 40%. That sounds a lot scarier than 43%. But it is not far off similar figures in other places. Only yesterday the Federal Reserve published America’s balance sheet for last year showing non-bank corporate and household debt of 74% and 82% respectively, making “private debt” of 156% altogether. Lump in sovereign and financial sector debts too and the total comes out at a cool $63.4trn, or 364% of US GDP. (The equivalent figure for China is 247%.)

The UK’s balance sheet comes out even worse than this on a broad basis due to the massively distorting impact from the financial sector. According to our own balance sheet, our total financial liabilities for 2014 came out at a nice, round £30trn, or about sixteen and a half times our GDP that year. Use net figures for the financial sector, however, and this plunges down to a much less startling 487% of output, of which a mere 349% is that “private debt”.

These sorts of numbers are esoteric territory, and not usually visited by relevant parties such as ratings companies. There are reasons for this. Vast swathes of the figures are prone to uncertainty and conceptual artificiality, for instance. We can look at government budgets, and bond yields, and arrive at a view on the sustainability of a country’s debt position. But what is the household sector surplus, or deficit?

Let us draw a line under these “private” or “total” debt to GDP arguments now and move on to non-performing loans. The banking system NPL ratio did rise from 1.5% to 1.6% in 2014 and will have risen further last year. The government is working on new measures to convert NPLs into equity stakes in struggling companies and one can read this bearishly. Whatever the final announcement and accompanying figures on this front, however, we do know that the required reserve ratio for major banks stands at 17% despite recent monetary loosening, up from 7.5% a decade ago. We must, as always, wait and see. The time bomb expected from Chinese trust investments two years ago failed to detonate, but bond defaults have been making headlines. Perhaps this time the country’s banking system, strongly capitalised as it is, will blow up in the face of an NPL crisis the government is already taking measures to manage.

The Chinese economy, like all economies, has its problems. And like the problems of other countries, some of these are local in nature. But in talking up a catastrophic debt burden where none really exists the bear case overreaches itself. There is enough out there to worry us in the real world – we do not have to look for phantoms.

11/03/2016 at 4:22 pm

Devils In The Detail

So another Autumn Statement has been and gone. As is now traditional the Chancellor tried to lift the mood by repeating some of the more substantial announcements made in his previous set-piece appearances. But there were changes too. Most significant among these was the U-turn on tax credit reform, which would have hit the incomes of low earners hard (for those who have not yet seen the headlines the BBC’s “key points” summary is as good a place to look as any). It was widely and accurately reported that this had become affordable due to improvements in the OBR’s forecasts for the British economy, delivering £27bn of extra pie in the fiscal sky between now and the end of the current parliament.

As usual, there was a gap between spin and reality on the matter. In his speech to the Commons, Mr Osborne attributed his windfall as follows:

“This improvement in the nation’s finances is due to two things. First, the OBR expects tax receipts to be stronger. A sign that our economy is healthier than thought. Second, debt interest payments are expected to be lower – reflecting the further fall in the rates we pay to our creditors.”

Higher tax receipts can indeed signify economic growth. The OBR’s growth forecasts, however, haven’t changed much. In a rather lower-profile address given by Robert Chote, OBR Chairman, he gave the following additional information on this topic:

“[T]he underlying fiscal position looks somewhat stronger over the medium term than it did in July, before you take into account the Autumn Statement measures. This in part reflects the recent strength of income tax and corporation tax. But it also reflects better modelling of National Insurance Contributions and a correction to the modelling of VAT deductions.”


In fact, looking at the data presented at Mr Chote’s press conference, the impact of these modelling changes tots up to +£12.6bn over the five fiscal years to 2019-20.

Now let’s look at the rates demanded by those creditors. Here is how the forecasts for the UK’s central government gross debt interest have changed since the summer:

Summer Budget Autumn Statement
Fiscal Year £bn £bn
2015-16 46.7 46.5
2016-17 51.1 51.0
2017-18 55.9 54.2
2018-19 57.2 55.7
2019-20 58.5 57.3
TOTAL 269.4 264.7


£4.7bn out of such large totals is not a huge amount (less than 2% in fact), but in policy terms it is material, equivalent to the entire cost between now and 2020 of increasing the personal allowance to £11,000, the single biggest giveaway of the last Budget.

Underlying the relatively modest reduction in the projected cost of debt interest is a similarly modest reduction in projected gilt yields. The OBR data for these is scrambled between different documents for the Budget and Autumn Statement, which possibly explains why no media source appears to have covered it. But the point is that the average market interest rate assumption for the next five years has fallen all of 0.4% since July, from 2.7% to 2.3%. It is on such details that material elements of this country’s fiscal policy now have to be based.

Of course movements in gilt yields have not always been modest. And what ought to concern us is the extent to which they will impact the exchequer should they begin to rise again over coming quarters. Two short years ago – before cheap oil abolished inflation – the ten year gilt yield stood a full 1% higher at 2.8% as against 1.8% today. The Autumn Statement of 2013 put average interest rates for 2015-2019 at 3.8%. What would a forecast change of +100bp do the £4.7bn bonanza secured by a change of -40bp? A proportionate adjustment would wipe out £12bn at a stroke – exactly the amount of the extra spending on defence announced by the Prime Minister on Monday (to be spread over the next ten years.)

Look further back and the message is equally clear. The first half of 2011 was not exactly the cheeriest of times: Greece was collapsing, emergency monetary measures were in full swing and panic was pushing gold to record highs. Still the ten year gilt yielded more than 3.8% for much of the time. And in the years before the credit crunch began to bite the average was about 4.5%.

Neither is the cost of debt linked entirely to interest rates: there is inflation to consider as well. Of the UK’s £1.5trn nominal value of outstanding debt, over £300bn nominal is index-linked to RPI. Since July the OBR’s RPI inflation assumption has been cut by 0.2%; the average for the next five years is down to 2.4% from 3.1% a year ago. And talking of inflation, the CPI measure – which now governs increases to pensions and other benefits – has also seen forecast falls since the summer. The OBR’s average for the next five years is 0.5% lower now than it was last year, 1.3% versus 1.8%.

But then again, who really is talking of inflation? Not the Chancellor. Neither the word nor the concept made a single appearance in his speech on Wednesday. Still, Mr Chote had something to say:

“[W]e still expect inflation to kick up over the coming year as favourable base effects drop out. We expect it to rise slightly more quickly than in July thanks to greater pressure from unit labour costs.”

Something to think about there, possibly.

In summary the Autumn Statement carried an element of political drama but the macroeconomic substance remained hidden away – when it was not being positively spun, that is. Mr Osborne seems to have a rare knack for making political capital from fiscal policy, rather like his predecessor Mr Brown. But the evolution of the country’s debt position and the official forecasts on which policy is based have relatively little to do with him and much more to do with interest rates (and inflation).

27/11/2015 at 4:59 pm

The Joy Of Negotiating

While they may not yet be making headlines across the broader media as in days gone by, the ongoing negotiations between Greece and her creditors are the subject of the most widely-read article on Bloomberg today. Entitled German-Led Bloc Willing To Let Greece Leave Euro, the piece has the following money quote from Edward Scicluna, finance minister of Malta:

Germany, the Netherlands and others will be hard and they will insist that Greece repays back the solidarity shown by the member states by respecting the conditions … They’ve now reached a point where they will tell Greece ‘if you really want to leave, leave.’

It is now nearly five years since the downgrade of Greek debt caused worldwide panic over the condition of Europe’s sovereign balance sheets, and for much of that time there have been some who have advocated euro withdrawal and default as the solution to the country’s problems. Somewhere near the zenith of this view’s popularity readers may remember that it was Titanically flawed:

First of all, the currency … There would be rapid depreciation – indeed, the possibility that [it] could cease to be transferable internationally. (The Icelandic krone threatened this at the nadir of the recent crisis with the result that the supply of imported food was jeopardized.) Even if the drachma were tradeable, immediate, rapid inflation would occur. At the same time, bank deposits and other assets would have to be re-denominated, decimating the wealth of the nation overnight. These twin effects would demolish household and business consumption and consign the country to a further period of sharp economic contraction.

All well and good, say the defaultists. But at least Greece would be free of her debt!

Yes, and no. Greece is still running a budget deficit and in the catastrophe scenario this would get worse. So unless the Greeks wanted total state shutdown, they would still have to borrow money. Who would be the lenders? The EU; the IMF: exactly the same people who are lending to them at the moment. The conditions imposed by those lenders – who would still have effective control of the country’s economy until their loans were repaid – would be at least as punitive as the conditions they’re imposing now. In other words, there would be at least as much austerity to contend with, and possibly more.

One key feature of the economic landscape has changed since then, however: Greece has been running a primary budget surplus since the middle of 2013. This means that, ignoring debt interest, the government is raising more in tax than it spends. The last available data from the Bank of Greece (for November) has this primary surplus running at 2% of GDP. There are suspicions that the position has deteriorated since, but the key point is that – in theory – the Greek government could walk away from its debt and let its creditors go hang as it would no longer need to borrow money.

Bearing in mind the point about the currency, banking system and the rest, this surplus would likely not last very long in the event of a “Grexit”, so it isn’t that strong a negotiating point. It does, however, make such a decision appear less obviously stupid. This might well reduce the extent to which political will is bent to economic fear. The Greek situation today is therefore arguably more volatile than it was in 2011.

This is certainly not how it seems. The market reaction to Syriza’s election and Greece’s return to the repetitive circus of down-to-the-wire debt talks every few months has been pretty muted. The country’s ten year debt is priced at over 60 cents on the dollar, below the 80 cent level reached before last autumn but nowhere near reflective of the 74% loss incurred by bondholders in the 2012 restructuring. The Athens Stock Exchange index has fallen 24% over the past six months, but that is pretty tame compared to the 69% fall it suffered over calendar 2010 and ’11 – and it is actually some 3% up on the year to date.

The overall market view, then, seems to be either that the current talks are nothing to worry about, or that Grexit doesn’t matter very much. And besides, the Euro Stoxx 50 is up 11% since the end of 2014, last week’s GDP data for the eurozone was a little ahead of expectations, today’s stronger-than-forecast PMI numbers suggested the outlook here remains bright, and while it has bounced a bit recently the oil price remains about 45% lower than where it spent the first half of 2014. (If you add up the individual members you find that the eurozone, not the US or China, is the world’s biggest oil importer by some distance.)

It appears highly unlikely that another major debt restructuring is on the cards for Greece (as opposed to changes to its existing terms). On this basis the relatively sanguine market view looks right. Prime Minister Tsipras could of course decide to give the world a shock, but it remains clear on balance that this wouldn’t do his country much good.

20/02/2015 at 4:47 pm

Themes for 2015

With Christmas almost here and the New Year a little over a week away it is the traditional time for market observers to dust off their crystal balls and treat everyone to their insights on what will happen once that financially significant uptick in the Gregorian calendar has occurred. Accordingly, here are a few themes which this blog believes will be important in 2015.

Debt. Despite a return to the bond market this year, Greece has threatened to become a target of scrutiny again – but amid the wreckage of the credit crunch and Great Recession is far from the only show in town. The collapse in the price of oil this quarter is in part a reflection of the power of Saudi Arabia, with its huge balance sheet reserves, to weather it, as readers will know. On the other hand, those countries with big sovereign debt positions – most of us in the developed world – are hobbled by it.

The US for instance has $12.4trn of treasury instruments outstanding. These are already costing over $400bn in interest each year, a material amount for the budget of even the world’s largest economy. Of that $12.4trn, $4.9trn – almost 40% – matures between now and the end of 2016.

Interest rates. Emergency monetary conditions have already been pared back in many of the countries hardest hit by the events of the last seven years. In the US, the UK and elsewhere, zero or near-zero policy rates are now expected to rise again in the second half of 2015.

With interest payments already high for so many economies, rising rates are an issue, particularly for those whose debt positions are concentrated at the very short end of the yield curve. The burden of debt interest in these cases – already a hindrance to growth via austerity measures and tax increases – will get heavier.

Inflation. With huge capacity overhangs, massive labour market weakness and weak commodity prices, this has not been an issue for most major economies in recent years. However, labour markets in particular are now much healthier than they were even a year ago, and there have been tentative signs already that this has come to bear on price behaviour.

The move down in oil will once more serve to keep inflation in bed for some time, assuming that it does not reverse in the near term. But as economies continue to recover, internal rather than imported price pressures are bound to rise. Markets are not remotely concerned about inflation at the moment. Should this change there will be implications for interest rates across the yield curve and potentially for risk markets too.

Market selection. Risk on versus risk off continues to be an important general theme for markets which remain nervous. But the last couple of years have seen significant divergence between different market types and regions even within that context. In 2014 to date, the US has topped the equity charts for the developed world (+12%), while Asian markets, most notably China (+48%) and India (+31%), have leapt ahead of their emerging peers. More broadly, developed and emerging market equity indices have out- and under-performed each other at various times as the year has gone on.

There is every reason to expect this to continue over next year. As always, sentiment is unpredictable and one cannot plan for black swan events. But bearing in mind the dynamics for growth, the valuation picture and the possible importance of the themes we have already looked at, there are some interesting considerations for portfolios in this area on a fundamental view.

There are of course other questions to think about and apparent anomalies to ponder. These themes should be seen as undercurrents rather than any kind of directional forecast. Market noise aside, however, one or two of them could deliver some material surprises this coming year – pleasant or otherwise.

22/12/2014 at 4:59 pm

Political Economy

Yesterday’s Autumn Statement by UK Chancellor of the Exchequer George Osborne was as political as expected. Impressively – and in a break with recent tradition – some of it was not leaked in advance. And beyond the Stamp Duty Mansion Tax, road building in marginal constituencies, wealth fund for hypothetical shale gas production in some long-distant future and customary crowing about how wonderfully the British economy is doing, there were a few items of actual economic interest. (There is a good summary of all the key points from the BBC here.)

It’s great that growth for this year is expected to come in at 3%, up from 2.7% in March, but as has been widely noted, the level of debt will be higher than forecast in spite of this. It is worth quoting the Office for Budget Responsibility directly (all documents here):

[W]age and productivity growth have once again disappointed, while national income and spending have outperformed most in those areas that yield least tax revenue … For these and other reasons, this year has seen a sharp fall in the amount of tax raised for every pound of measured economic activity. As a result, despite strong economic growth, the budget deficit is expected to fall by only £6.3 billion this year to £91.3 billion, around half the decline we expected in March. That would be the second smallest year-on-year reduction since its peak in 2009-10, despite this being the strongest year for GDP growth.

Hmm. Wage growth has indeed been disappointing. As regular readers will know, UK wages have been falling pretty steadily in real terms since the Great Recession. This has been due to both sluggish growth in absolute terms, and – if you have been the Bank of England over the period – completely surprisingly high inflation. In fact, adjusting for RPI, average earnings are back down where they were in the summer of 2000. Putting this another way, British pay packets have not grown in real terms so far this century.

Part of the reason for this is that inflation has been pushed up by increases in VAT, necessary because of the vast level of government borrowing. Even in nominal terms, though, wage growth has averaged a measly 1.5% per year over the last half decade. Why so? Well, public sector wage growth has been capped at 1% for some time, a necessity arising from the vast level of government borrowing. Wages in the manufacturing sector have also been squeezed, which might be connected to the pace of demographic change in the recent past (the gap between real GDP growth and real growth in GDP per capita having risen to 0.8% over the last ten years, above even the high caused by the post war baby boom). And some higher-end pay, in areas of financial services for instance, has suffered too.

In other words, the higher taxes and lower wages caused in large part by the desperate state of the public finances have themselves contributed to a disappointing outturn for the public finances.

Lest one might think that, to coin a phrase, there is an alternative, remember this: the central government debt interest burden is projected to rise to £54bn this fiscal year and to £77bn by 2018/19, the year in which the government’s books might finally balance. Even this year the payments will be more than twice the total current budget for defence. Viewed sensibly, Britain’s debt is already out of control. Worsen the debt burden from here and it could end up entailing default.

This sounds a bit gloomy, because it is. However, was there anything in the statement to give encouragement?

In the context of sovereign debt, the only real positive is economic growth. So it is unfortunate that the anti-bank and anti-wealth elements of yesterday’s announcement will do nothing to stop London’s slide down the rankings of global financial centres in future years. Only a couple of weeks ago there was a survey out showing that New York’s lead over London as a good place for financial sector business had extended (London used to come top of these lists). Bits and bobs of capital spending were announced which will have some positive effects in the relevant areas over the medium term, but growth does not generally benefit from increased regulation of and taxes on business.

The UK is clawing its way slowly towards a balanced budget, having already amassed a punitively expensive burden of debt. Budgets and Autumn Statements / Pre-Budget Reports have been overwhelmingly dominated by political gimmickry for at least the last ten years. It is difficult now to remember budget speeches in which pound note figures for spending and receipts connected to policy changes actually got a mention (standard practice until the arrival of a Mr Brown in 1997). Our Chancellors have little leeway nowadays, but yesterday’s little attacks on banking and The Rich were fiscally unnecessary and potentially damaging. (Listed banks in the UK employ about 700,000 people, over 2% of the nation’s workforce, and that is already down from almost 900,000 in 2007.) Britain’s economic policy remains primarily a vehicle for electoral showmanship, and this is not encouraging.

04/12/2014 at 6:12 pm

Unbalanced Books

A while ago, we looked at the re-entry of Greece into the bond market and noted that it could mark the beginning of the end of the sovereign debt crisis. This week, new borrowing figures for the UK reminded us how big a millstone borrowing can be around a country’s neck

The government is borrowing more this fiscal year than it did last time. This was not supposed to happen: the economy is growing at a fair lick, unemployment is falling, welfare spending and public sector pay has been capped and so on. Reasons for the disappointing outcome include weak earnings growth, a slower-than-expected housing market and the lower oil price. (It is worth observing that real wage compression in particular has been a persistent affliction here in Britain, with inflation-adjusted wages at the whole economy level almost 10% lower today than they were five years ago.)

It is still likely that our debt to GDP will peak in the next three years or so and gradually climb down below 90% again (on a Maastricht basis). But even at this level, and with very low rates, interest payments for 2015-16 are forecast at £59bn – more than the education budget and about 8% of total government spending.

Of course Britain is not alone in this position. Look around the developed world and sovereign balance sheets are, as a rule, stretched. The increase in US debt to GDP, which saw it rise from 63% in 2007 to over 100% five years later, has levelled off, but in money terms the country owes the staggering sum of $17.9trn. For the American fiscal year just ended, interest on this debt amounted to just under $431bn. That is getting on for an eighth of the Federal budget.

Eurozone debt was 90.9% of GDP last year and it still likely to rise with growth in the economy as anaemic as it is. In Japan, debt to GDP stands at over 210%, and last year the Japanese were still running a massive budget deficit (over 9%). Controlling this has consequences, as we saw earlier in the year when the sales tax increase came in and shrank the economy.

Japan is an interesting case for another reason, however. It is one of the world’s largest holders of reserve assets, with some $1.2trn in the bank. Only China has more (almost $4trn). Another country with huge reserves relative to GDP is Saudi Arabia, with $735bn worth against total output last year of $745bn. Neither China nor Saudi have a material level of sovereign debt (22% and 12% of GDP respectively).

Some of the results of this situation are obvious. On the one hand, highly indebted nations will spend many years paying huge amounts of interest and struggling to grow their way to more manageable debt positions. On the other, those nations with little debt and healthy reserves will profit from the interest payments. China owns about $1.3trn of US government debt. If this reflected the market as a whole the average coupon would be around 2.5%, so Uncle Sam would be paying the Chinese $32.5bn per year.

More interesting, perhaps, are the less obvious effects. It might come as a surprise but Saudi Arabia increased production of oil by 50,000 barrels a day last month. The IMF estimates that the Kingdom requires a price of $83.60 per barrel to balance its budget, which is about where oil is at the moment, but with no debt to speak of and huge reserves the Saudis can manage a few years of low prices. After all, their oil is still very profitable to extract at this level. And if it hurts the competition in Russia, poses a distant threat to shale exploitation in the US and possibly destabilizes Iran, it seems unlikely that Saudi Arabia will mind very much.

The global debt position has changed the balance of economic power. In addition to political consequences there have been and inevitably will be consequences for markets, not all of which will be intuitive. Finally, it is rather gloomy to reflect that the UK is not among the stronger nations on any measure now: our high debt ratio is accompanied by lower reserve assets than Poland and less gold than Venezuela.

24/10/2014 at 5:40 pm


The United States has been a source of much consternation this year. First of all the Federal Reserve accidentally triggered a mild panic over one of its least efficacious policy programmes. Then Congress deliberately threatened to push the nation towards default to force the government’s hand over legislation passed by itself in 2010. It is almost as if elected representatives in Washington have become so disappointed with the failure of their European counterparts to provoke another global financial meltdown that they have decided to do the job themselves. This is an unusual attitude to American exceptionalism. And it is hardly intuitive to wave the cudgel of a selective default on US debt while claiming to do so in an attempt to bring US debt under control.

However, what Warren Buffett has rightly called the “extreme idiocy” of the present position has not had that much of an effect. This seems incredible given what might technically be at stake. Already, 70% of intelligence staff have been placed on unpaid leave; just enough employees at the Department of Energy have been left in post to discharge their responsibilities to supervise the nation’s nuclear stockpile; diplomacy has already been affected, though troops are still to be paid (and the postal service remains in operation). And yet the S&P 500 is only 2% off its record high of a couple of weeks ago. The trade weighted dollar has tumbled all of 1% over the same period. Credit default swaps – which are priced specifically to insure against the risk of sovereign default – have admittedly ticked up a bit, but only to 42bp. That isn’t even the high for the year. According to Bloomberg the US still prices in this market as the sixth safest debtor in the world (between Britain and New Zealand).

Compare and contrast this picture with the down-to-the-wire debt ceiling negotiations of July and August 2011. Back then there was pandemonium. President Obama and Congress between them hammered out a complex package of fiscal arrangements and at the eleventh hour managed to avoid the shutdown we’re now seeing – and markets collapsed. The meltdown which accompanied the events of that summer was truly savage (see this blog’s coverage here and here).

Something has clearly changed.

As was apparent from the start in 2011, the real trigger for the crash was not the political turmoil: it was downward revisions to US GDP, raising fears of a double dip recession. This occurred against the background of looming default for Greece, revolution across the Arab world, the obliteration of part of Japan’s east coast – in short, a climate of absolute fear.

And let us not forget that at that time, the US federal budget deficit was running at 8% of GDP.

Today the situation is very different. Markets are behaving with relative equanimity because the infighting on Capitol Hill really isn’t as important as the economic fundamentals – unless Buffet’s point of extreme idiocy is breached, of course. Today, the federal deficit is 4%, and falling. US GDP growth has been increasing (and the last set of backdated revisions saw the numbers go up this time). Unemployment is 2% lower, bank balance sheets are cleaner, the housing market has picked up, manufacturing is stronger – and Europe, too, seems considerably further from the brink of catastrophe than it was two years ago.

A particularly gifted politician might be expected to assimilate all these things without even thinking, adapting instinctively to the changed national mood. It certainly appears that the President has done so. In 2011 he conceded ground to avoid a shutdown which was posing an additional threat to confidence. This time round there have been no concessions. In fact, Mr Obama has ruled out negotiating with his opponents at all until the government is reopened and the debt ceiling raised. “I’ll negotiate with you only after you give me what I want.” It’s an insouciant stance to say the least, and so far, the damp squib shutdown appears to justify it.

We ought not to be one-sided. The healthcare reform so vehemently opposed by many Republicans has been controversial from the start and unwieldy to implement. And without their intransigence back in 2011 that budget deficit would likely not have been repaired to the extent that it has. The US debt burden is huge, and such a position brings with it expense and vulnerability.

Nonetheless, the President is on the right side of the markets’ mood and the economic undercurrents this time – so long as he can avoid a sovereign default. At that point, CDS at 42bp would begin to look like something of a bargain …

04/10/2013 at 5:31 pm

Unlucky Dip

This morning saw the release of the preliminary UK GDP estimate for Q4 2012. A quarterly fall of 0.3% rounded off a year of perfect stagnation.

It could have been worse. And according to the ONS, without a series of one-offs linked to maintenance problems with North Sea energy production and the unwinding of the effect of the London Olympics from Q3, quarterly growth would have been ever so slightly positive.

Still, the underlying picture for the UK economy is undoubtedly weak. We have noted before that a measure of luck can be thanked for the country’s safe haven status. Our sovereign debt burden, whose gross interest payments each year already outstrip the entire defence budget, is a millstone round the nation’s neck. Until last year, rises in indirect taxation pushed inflation up to the point where real wages were being materially eroded, with the result that the household sector re-entered recession in Q1 2011 (almost a year before this was reflected across the economy as a whole). And the strength of the pound last year saw the current account deficit reach its highest level as a percentage of GDP for over 20 years.

Nonetheless, there are reasons to be positive as the new year unfolds. The health of the eurozone economy is extremely important to Britain. This week we saw consumer confidence and the PMI composite indicator of current activity over the Channel rise more convincingly than at any time since last spring’s panic. And growth in Europe as elsewhere is generally forecast to rise this year – albeit modestly – which as we know is only to be expected given its disappointing level relative to trend. Furthermore, sterling is already 3% weaker on a trade weighted basis year to date; that’s the amount it gained over the whole course of last year.

Which brings us on to another source of risk.

Currency weakness, while beneficial at least in the short term to exporters, is another source of inflation. Only a month ago, the Bank of England’s governor elect gave a speech in which he mooted the idea of ditching the inflation target altogether in favour of targeting nominal growth. Readers will know the Bank already has a growth target, which while technically secondary to the target for CPI inflation has been making a lot of the running when it comes to making monetary decisions. And those decisions have failed: despite a near-zero base rate over the last four years and £375bn of “quantitative easing”, growth in real GDP has averaged a measly 0.2% per quarter since the end of the slump in mid-2009.

We live in a world which over the past few years has seemed even more imperfect than usual. All too often, the only ideal answer to the problems of a western social democracy with too much debt on its books has mirrored the old joke about the driver who asks for directions, only to be told: “if I were you, I wouldn’t be starting from here.”

Over the past few weeks, markets in risk assets saw the sun shining and have been making hay. Let’s hope they are right. But we need to remember that a return to economic norms will bring with it the risk of inflation, which in turn entails a threat to growth either by being left uncontained (as here in Britain recently) or by provoking a policy response seen as aggressive.

25/01/2013 at 5:20 pm

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