Speaker 1: Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2: Welcome to Meren Talks Money, the podcast and its people
Speaker 2: who know the markets to explain the markets. I am Meren,
Speaker 2: Somerset Web. We are recording this episode on September twenty fourth.
Speaker 2: Now this week I am speaking with Roger Lee. Roger
Speaker 2: is currently head of equity Strategy at UK based investment
Speaker 2: bank Cavendish. He's been in the equi market for a
Speaker 2: long time, nearly thirty years, spending time at HSBC, Deutsche
Speaker 2: Bank and JP Morgan. Most recently he was head of
Speaker 2: the UK equity strategy at Investork. He's got a lot
Speaker 2: of experience here. He's covered UK equities, European equities, US
Speaker 2: equities and of course crucially he's also a fellow of
Speaker 2: the Institute of Chartered Accountants, a physics graduate, and a
Speaker 2: frustrated politician. How's that for an intro. Roger, thank you
Speaker 2: so much for joining us today. I think we might
Speaker 2: all be frustrated politicians.
Speaker 3: Oh thanks, thanks very much for that wonderful introduction. In
Speaker 3: factor frustrated politician in fact, the least successful politician ever
Speaker 3: because I tried to get selected twice and failed both times,
Speaker 3: dismally frustrated, but not so frustrated now I have to say.
Speaker 2: Yeah, no one wants to be a politician right now,
Speaker 2: and that is exactly what we're going to talk about.
Speaker 2: And one of the reasons that I asked you on
Speaker 2: Roger Bisk is I've read some of the things that
Speaker 2: you've written about the fiscal situation of the UK and
Speaker 2: just how bad it is and whether there is a
Speaker 2: possibility that it is so bad that it genuinely does
Speaker 2: cause a fiscal crisis and possibly the downfall of this
Speaker 2: government in the UK. So it seems an extraordinary thing
Speaker 2: to say, given that this is a government with a
Speaker 2: huge majority. We look at them and you think, well,
Speaker 2: surely they'll go a full term. But actually, of course,
Speaker 2: as my colleague John Steppeck always says, we must try
Speaker 2: to think of this less as a majority government than
Speaker 2: a coalition government because of all the different viewpoints inside
Speaker 2: the tent, and with that in mind, and the fiscal
Speaker 2: position in things may be a little bit more tenuous
Speaker 2: than perhaps our Prime minister would like to think. So
Speaker 2: why don't we start by looking at the fiscal position
Speaker 2: in the UK and just run us through quite how
Speaker 2: bad this is.
Speaker 3: Let's just step back for a second and just think
Speaker 3: what a fiscal event is.
Speaker 1: Now.
Speaker 3: Most of us have lived through a fiscal event, which
Speaker 3: was clearly Lisztrust back in twenty twenty two, and a
Speaker 3: fiscal event is usually considered something when the guilt market
Speaker 3: gets very concerned and guilt yields rise very rapidly. In
Speaker 3: that particular instance, guilt yields went up one hundred basis
Speaker 3: points or one percent in a four day period and
Speaker 3: there had to be some sort of intervention from the
Speaker 3: Bank of England. And clearly European sovereign debt crisis was
Speaker 3: a series of fiscal events. They are uncommon, but they
Speaker 3: do happen, and it's usually characterized by government debt yields
Speaker 3: going out very rapidly, So that is a fiscal event. Now,
Speaker 3: again for background, there have been since this government came
Speaker 3: into power, there have been three mini fiscal events where
Speaker 3: guilt fields have gone up twenty basis pointser point two percent,
Speaker 3: so not anywhere near the one hundred basis points that
Speaker 3: you would cause some problems, but they have moved very quickly,
Speaker 3: in some cases in a matter of hours. And the
Speaker 3: three occasions were immediately after the October budget last year
Speaker 3: when the market got very concerned about growth outlook and
Speaker 3: increased issuance. In January when guilt yields went up partly
Speaker 3: because US treasury yields were going up, but also concerns
Speaker 3: about growth. And then of course during Rachel Reeves, our
Speaker 3: Chancellor's difficult day in the Commons, when gilt yilds went
Speaker 3: up twenty basis points in a matter of minutes. We
Speaker 3: have had three occasions when there has been some sort
Speaker 3: of stress in the guilt market in this administration. And
Speaker 3: what I think we're going to talk about now is
Speaker 3: what would prompt that to be significantly worse than just
Speaker 3: a zero point twenty basis point move. Okay, And so
Speaker 3: what I think prompted this and what is I think
Speaker 3: has prompted a lot of people's interest in what might
Speaker 3: happen is really following on from the public sector net
Speaker 3: borrowing numbers now to older listeners, that is used to
Speaker 3: be called the public sector borrowing requirement. So if I
Speaker 3: do mix the two up, they are essentially the same.
Speaker 3: So the public sector net borrowing requirement is really the
Speaker 3: funding requirement that the government has, or at least in
Speaker 3: this particular instance, it's obviously a deficit is that the
Speaker 3: government is spending more than they are receiving in tax revenues,
Speaker 3: and the OBR and the ONS publish this data every month. Now,
Speaker 3: in August, which was the data that was published last Friday,
Speaker 3: it was clear that the government is spending a lot
Speaker 3: more than they're generating in tax revenue. In fact, I'm
Speaker 3: not going to burden you with too many numbers, but
Speaker 3: I'll just give you some sort of context here. In August,
Speaker 3: the government had to borrow or the deficit between spending
Speaker 3: and tax revenue was eighteen billion pounds. Now, that compared
Speaker 3: to an OBR forecast for the month of just under
Speaker 3: thirteen billion pounds, so forty percent overshoot. Now, that in
Speaker 3: itself is not necessarily a problem. What is a problem
Speaker 3: is that for the first five months of the year,
Speaker 3: spending has overshot tax revenue by sixteen billion. That's for
Speaker 3: five months. Now, this isn't particularly complicated, so just bear
Speaker 3: with me. But if the government has overspent by sixteen
Speaker 3: billion in five months, that's just over three billion a month.
Speaker 3: If that run rate continues for the year, then that's
Speaker 3: clearly thirty six or thirty eight billion rounding up, So
Speaker 3: let's call that forty billion of overspend for the year. Now,
Speaker 3: that again isn't necessarily a problem, except compared to what
Speaker 3: the OBR are forecasting for the debt for this year.
Speaker 3: So the OBR are forecasting that debt levels actually start
Speaker 3: to come down, or the rate of the deficit slows
Speaker 3: towards the end of the year. There's always this kind
Speaker 3: of seasonal effect in this as well, because we are
Speaker 3: payout taxes in January, so borrowing does come down seasonally.
Speaker 3: But they're expecting debt to come down significantly from last year. Again,
Speaker 3: I'm sorry to give you some numbers, but I can't
Speaker 3: text it. I'm threatened. So last year the government borrowed
Speaker 3: about one hundred and fifty billion. That was the deficit
Speaker 3: last year, one hundred and fifty billion pounds, and this
Speaker 3: year the OBR are forecasting the deficit to be around
Speaker 3: one hundred and twenty billion pounds, so clearly less.
Speaker 2: Than Okay, hang on, to take me back a bit,
Speaker 2: how does that connect to the forty billion we were
Speaker 2: just talking about. I thought you said it was going
Speaker 2: to be around forty billion by the end of the year.
Speaker 3: So we're currently overspending by forty billion if we annualize
Speaker 3: the current overspend. But the OBR is expecting debt to
Speaker 3: be lower this year than the.
Speaker 2: Last year, so they're expecting it to turn into an
Speaker 2: underspend over the next seven months.
Speaker 3: Yes, or they're expecting the revenues to pick up and
Speaker 3: spending to slow. Absolutely. So the question I think people
Speaker 3: are beginning to ask themselves is what if spending doesn't slow,
Speaker 3: What if tax revenues don't increase. What happens if we
Speaker 3: carry on spending at the same rate as we did
Speaker 3: last year. Now, if that is the case, then last
Speaker 3: year we spent or overspent by one hundred and fifty pounds,
Speaker 3: So if we have the same outturners last year, that
Speaker 3: is still more the and the OBR are forecasting. But
Speaker 3: as we stand today, we're spending all the deficit is
Speaker 3: higher than it was last year. So there are two
Speaker 3: issues here. One why will the deficit come down in
Speaker 3: the second half of this year? And secondly, if it
Speaker 3: doesn't come down and the deficit run rate continues as
Speaker 3: it is in the first five months of the year,
Speaker 3: then the conclusion is that the deficit will be one
Speaker 3: hundred and fifty billion if it was the same as
Speaker 3: last year, but including the overspend or the increased deficit,
Speaker 3: increased run rate, however you want to describe it, that
Speaker 3: is an additional forty billion pounds.
Speaker 2: Okay, now we get to that turn.
Speaker 3: So the outturn could an ice stress could be closer
Speaker 3: to one hundred and ninety billion of deficit, not one
Speaker 3: hundred and twenty that the OBR are forecasting. So that
Speaker 3: is the kind of the punchline here, And it is
Speaker 3: not just me doing the numbers. And as I say,
Speaker 3: this is just purely arithmetic. It's not a forecast, it's
Speaker 3: not our house view, it's not a central case. It
Speaker 3: is just merely extrapolating the arithmetic that we've seen over
Speaker 3: the last five months and making a not unreasonable assumption
Speaker 3: that the deficit this year is going to be closer
Speaker 3: to the deficit that we saw last year, and then
Speaker 3: adding that overshoot onto us.
Speaker 2: Okay, let's carry on with this terrifying conversation by talking
Speaker 2: about what it is that the OBR expects to bring
Speaker 2: tax revenues up and spending down over this year and
Speaker 2: the extent, which is that may or may not happen.
Speaker 2: Are they expecting an increase in tax revenues for example.
Speaker 3: So there are essent three areas where the OBR are
Speaker 3: forecasting that tax or forecasting both tax will be higher
Speaker 3: and spending will be lower. And we can discuss the
Speaker 3: likelihood of whether this will actually come to pass. But
Speaker 3: the three areas that they're talking about is that capital
Speaker 3: receipts capital tax receipts will be higher in this fiscal
Speaker 3: year than last year. Now most economists think that might
Speaker 3: be the case. There is a possibility that could be the.
Speaker 2: Case, and that would be the case. Sorry, just to interrupt,
Speaker 2: that would be the case. Why because the rate has
Speaker 2: gone up, and because with markets doing very well, etc.
Speaker 2: And more people will be making capital gains because people
Speaker 2: are beginning to sell, for example, by to let properties
Speaker 2: they've held for quite a long time, and there'll be
Speaker 2: a rade of capital gains coming from those. So all
Speaker 2: these things combined, I think.
Speaker 3: That's the general argument. Yes, yeah, thank you. The second
Speaker 3: area where the OBR think that the deficit will start
Speaker 3: to fall is because lower debt interest, that is, the
Speaker 3: debt interest that the government have to pay to issue
Speaker 3: new guilts into the market. Now that the OBER, again
Speaker 3: broadly speaking, forecast tenure treasury yield are ten year guilt
Speaker 3: yields to be four and a half percent. Guilt yields
Speaker 3: are already higher than that today.
Speaker 2: What are they today at four point seven.
Speaker 3: And obviously thirty year guiltields are even higher at close
Speaker 3: to five and a half percent. So it is very
Speaker 3: difficult to see how lower funding costs are going.
Speaker 2: To help.
Speaker 3: This deficit issue. In fact, if anything, it will be
Speaker 3: the reverse. And the third area that the ober are
Speaker 3: still believing the world reduced the deficit, and this is
Speaker 3: a spent on the spending line again, is that they're
Speaker 3: expecting lower growth in welfare spending. Again, it's difficult to
Speaker 3: see how that is going to be the case, given
Speaker 3: that the welfare cuts that had been proposed clearly were
Speaker 3: rejected by the Labor Party back in July. So it's
Speaker 3: difficult to see why this deficit is going to come
Speaker 3: down in the second half.
Speaker 1: Now.
Speaker 3: What is perhaps easier to see is if the economy
Speaker 3: continues to slow as it's doing at the moment, and
Speaker 3: if the labor market continues to deteriorate, and we source
Speaker 3: some disappointing survey data earlier on in the week, If
Speaker 3: the employment market continues to slow, then growth will slow
Speaker 3: and therefore tax revenue will slow. So the income side
Speaker 3: of this might slow because of slowing growth, and the
Speaker 3: expenditure side might rise because of increased welfare payments in
Speaker 3: order to support those who are no longer in work.
Speaker 3: I've already seen an element of this in last Friday,
Speaker 3: which again I think is why last Friday's PSNB numbers
Speaker 3: were so interesting is we've already seen an element of
Speaker 3: this because one of the reasons that the Ober said
Speaker 3: for this overshoot in the deficit or overshoot in the
Speaker 3: borrowing requirement was because of lower VAT receipts. Now, lower
Speaker 3: VAT receipts are directly linked to demand, they're directly linked
Speaker 3: to growth, and they're directly linked to consumer confidence. And
Speaker 3: so what we're already seeing is that lower demand feeding
Speaker 3: through into lower purchases, lower basket sizes, and that is
Speaker 3: feeding directly through into lower VAT receipts. And AVIAT is
Speaker 3: one of the largest tax generators in the UK. Now, again,
Speaker 3: this is not a huge surprise, Lord Wolfson in his
Speaker 3: next report, which I think you referred to recently in one.
Speaker 2: Of you and I talked about it in one of
Speaker 2: our market round ups, because those reports are always incredibly insightful,
Speaker 2: so it was not something I wanted to read.
Speaker 3: He's so good, hugely, hugely insightful, And I think you
Speaker 3: cited the fall in vacancy rates and the issues that
Speaker 3: the lack of vacancies that next now have and the
Speaker 3: number of applicants that they have going up. What he
Speaker 3: also obviously cited right at the front of the report
Speaker 3: in his outlook statement was that he's concerned about slower
Speaker 3: consumer spending now that is already directly seen by the
Speaker 3: OBR in those lower V eight receipts. So again it's
Speaker 3: not a question of being sort of sensation list in
Speaker 3: any way. It is just know. What the ABR said
Speaker 3: on Friday was that net debt or debt had exceeded
Speaker 3: expectations by some forty percent, and the reason for that
Speaker 3: there was also elements of local authority thing, which is
Speaker 3: quite technical and has a habit of reversing anyway. But
Speaker 3: also but what was very tangible was lower V eight receipts. Now,
Speaker 3: I'm not sure anyone out there is forecasting a huge
Speaker 3: search in growth for the remainder of this year. In fact,
Speaker 3: I would suggest that most people that are forecasting the reverse.
Speaker 3: Most economies are forecasting the reverse.
Speaker 2: So sorry, carry on.
Speaker 3: I was I was always just going to conclude that
Speaker 3: if anything, the risks to given the risk to the economy,
Speaker 3: the risk therefore would would suggest that the actually tax
Speaker 3: revenue will be less than the A B R are forecasting,
Speaker 3: and also even less than last year, and the risk
Speaker 3: that wilfire spending will be higher.
Speaker 2: So for this to turn around, for the math to
Speaker 2: pan out differently, we either need a sudden, very unexpected
Speaker 2: surgeon growth, a sudden, also very unexpected massive decline in
Speaker 2: our spending, particularly on welfare, which is the obvious area study,
Speaker 2: or a sudden collapse in interest rates in guilt rates,
Speaker 2: and none of those things seem very likely right now.
Speaker 3: Yeah, well, that's an interesting one. Absolutely, to an extent.
Speaker 3: Government finances are very straightforward. They are very similar to
Speaker 3: our own personal finances. They have income from tax revenue,
Speaker 3: they have expenditure, which is what their spending programs are,
Speaker 3: and if there is a gap between the two of
Speaker 3: them a short for then they have to borrow. That
Speaker 3: is no different to any of us in terms of
Speaker 3: how we fund our data day expenditure. Now, instead of
Speaker 3: going to a bank. Clearly they do. They go to
Speaker 3: the Bank of England and or the Debt Management Office
Speaker 3: and they issue guilt. Now, one of the reasons why
Speaker 3: this is bound perhaps more relevant now and certainly why
Speaker 3: we have started talking about it a bit more. I
Speaker 3: stress again that this isn't necessarily a forecast. One of
Speaker 3: the reasons we have talked about a bit more is
Speaker 3: because our view was is that interest rates were going
Speaker 3: to fall quite sharply towards the end of the year.
Speaker 3: So our view was slowing economy as a result of
Speaker 3: the corporate changing behavior as a result of the last
Speaker 3: budget and the National Living Wage would result in a
Speaker 3: slowing economy, which is what we're seeing. There would be
Speaker 3: a response in the labor market, which is what we
Speaker 3: are seeing, and therefore the Bank of England would cut raids. Now,
Speaker 3: the Bank of England are clearly not going to cut
Speaker 3: rates because inflation is still very elevated in the UK
Speaker 3: three point eight percent, and arguably a lot of that
Speaker 3: is to do with the pass through of the National
Speaker 3: Living Wage and the national insurance contributions, particularly in the
Speaker 3: food sector and energy prices related to net zero, which
Speaker 3: again I think you've discussed at some detail in a
Speaker 3: recent PODCAG so I won't go down at and not
Speaker 3: going to add anything to that, suffice it to say
Speaker 3: so it locks in the market, certainly not expecting any
Speaker 3: interst rate cuts anytime soon. In fact, maybe only one
Speaker 3: more this year. Now that's very different to the forecast
Speaker 3: that we would have had two or three months ago. Yeah,
Speaker 3: that's so, that makes a big difference, and that is
Speaker 3: what has changed. What has changed is that we would
Speaker 3: have thought that the Bank of eng That were going
Speaker 3: to be able to cut rates quite aggressively. There is
Speaker 3: a fairly strong correlation between falling into strates and improving
Speaker 3: growth that would have stimulated the economy, and that perhaps
Speaker 3: would have been the surprise that you were just talking about.
Speaker 3: That perhaps would have been the surprise that you would
Speaker 3: have seen in terms of both the growth and therefore
Speaker 3: the tax take and obviously reduced wealthare spending and more important,
Speaker 3: perhaps reduced and clearly that would have had an impact
Speaker 3: on guilt yields now in terms of where the curve
Speaker 3: would have gone, and that would have reduced the funding
Speaker 3: cost it. So, if you wanted to really pin down
Speaker 3: what has changed, two things changed. One is that the
Speaker 3: interest rate cuts aren't likely, and we would certainly agree
Speaker 3: with that as well in the short term. And secondly,
Speaker 3: what's changed is the current spending dynamic is a lot
Speaker 3: worse and tax take dynamic is a lot worse than
Speaker 3: we were expecting. And it's those two stroke three factors
Speaker 3: that have changed.
Speaker 2: Yeah, and the marketer has definitely noticed this. I've talked
Speaker 2: about this a lot on the podcast. But the fact
Speaker 2: that debt costs in the UK are at the moment
Speaker 2: they are still higher than any other G seven economy.
Speaker 2: So even though our debt situation on the face of
Speaker 2: it is not necessarily worse than some other developed economies,
Speaker 2: we're still paying we're paying more for our debt than others.
Speaker 3: Irrefutable on a thirty year basis. In the ustrum some
Speaker 3: structural issues around the thirty year bond yielding, thirty year
Speaker 3: guilt yields. Now just give some context for this. Compared
Speaker 3: to the G seven for the thirty year bond yield,
Speaker 3: it's just around to five and a half percent. The
Speaker 3: US thirty year, which is the next highest, is four
Speaker 3: point seven percent.
Speaker 2: Yeah, it's a big difference.
Speaker 3: It's a very significant difference. Now there are I stress
Speaker 3: some structural reasons why that may be the case, but
Speaker 3: nonetheless it is quite clear that the global capital markets,
Speaker 3: which is where we get most about funding from, because
Speaker 3: up until now, relatively few people in the UK own
Speaker 3: guilts that we tend to save through bank deposits rather
Speaker 3: than buying guilts that is a compare and contrast with
Speaker 3: other countries, So we are very reliant on the international
Speaker 3: markets in order to fund this deficit, in order to
Speaker 3: fund our borrowing, and so therefore we are also very
Speaker 3: prone to how international bondhields move. But as things stand
Speaker 3: at the moment, the markets are clearly demanding a premium
Speaker 3: for a number of reasons, possibly this risk that we're
Speaker 3: talking about, and is partly that.
Speaker 2: Okay, So the question then that brings us to the
Speaker 2: crunch of the whole thing is how long before things
Speaker 2: get worse? And as we know, we've been talking on
Speaker 2: this podcast and various other places where John and I
Speaker 2: have written and spoken for years about the massive build
Speaker 2: up of debt across the developed world and how uncomfortable
Speaker 2: it is not just here but elsewhere. And we know
Speaker 2: you learn from how long you talk about it, that
Speaker 2: these imbalances can build up and up and not be
Speaker 2: a problem, and not be a problem, and not be
Speaker 2: a problem. Everything's fine, and it goes on for much
Speaker 2: longer than you could possibly imagine, and then suddenly it turns.
Speaker 2: And when it turns, it also turns much much faster
Speaker 2: than you could conceivably imagined before it actually happened. That's
Speaker 2: how we get We give, we become complacent, and then kubum,
Speaker 2: everything goes horribly wrong. And in a situation like this,
Speaker 2: you get to the point where the market says, well,
Speaker 2: we'll hang on. It's costing you so much just to
Speaker 2: serve at the stet you're in a big part of trouble.
Speaker 2: And so what happens next? How do we get to
Speaker 2: this point?
Speaker 3: Okay, well, there's a great quote, and I hope you
Speaker 3: haven't used this too recently, but there's a great quote
Speaker 3: that in economics, things happen slower than you would have thought,
Speaker 3: and then faster than you thought they could Exactly, I
Speaker 3: think is just so true. But what happens next? Now, again,
Speaker 3: just for the benefit of your life, listeners, is now.
Speaker 2: A forecast not a forecast.
Speaker 3: We're now just describing a possible scenario of what happens next.
Speaker 3: Maybe you will indulge me in this flight of fantasy,
Speaker 3: and I'll leave you to judge how real or not
Speaker 3: this may be. Now again, I have to give some
Speaker 3: credit here to Andrew's sentence and some of his great
Speaker 3: ex posts are on this, and he seems to think
Speaker 3: that this event could happen in Q three or Q
Speaker 3: four this year, and I'm going to just briefly talk
Speaker 3: about why that could be the case. So it comes
Speaker 3: back to this public sector net borrowing number that comes
Speaker 3: out every month. Now, if the debt profile of the UK,
Speaker 3: or the deficit profile of the UK continues on its
Speaker 3: current trajectory, as we talked about in some detail a
Speaker 3: few minutes ago, and it doesn't come down as we
Speaker 3: were suggesting, then each month we will get an overshoot
Speaker 3: to what the auber are forecasting. At some point, the
Speaker 3: market may extrapolate that through using the arithmetic that we
Speaker 3: have very simplistically done just a few minutes ago, and
Speaker 3: they may come to the same conclusion that if the
Speaker 3: run rate continues and the debt profile this year, deficit
Speaker 3: profile this year is the same as in twenty twenty
Speaker 3: four or five, and therefore we have a one hundred
Speaker 3: and ninety billion, or as android sentence described, one hundred
Speaker 3: and eighty five, so pretty close to our arithmetic. Now,
Speaker 3: that is a very big number. Again, I'm going to
Speaker 3: throw your listeners another number here. The total size of
Speaker 3: the UK economy is around two point seven trillion pounds,
Speaker 3: so two hundred billion of deficit is around seven percent
Speaker 3: of GDP. Wow, I mean that is a huge number. Huge.
Speaker 3: So of course, just to reference that, the ECB in
Speaker 3: as part of the euro criteria in system around a
Speaker 3: three percent deficit, and that would normally be what a
Speaker 3: normal economy should run at. These are just huge numbers. Now,
Speaker 3: if the guilt market remotely felt that the UK deficit
Speaker 3: was anywhere close to that number and therefore had to
Speaker 3: be funded by increased issuance, given that the last three
Speaker 3: occasions when there was a threat of increased issuance, the
Speaker 3: guilt market moved by twenty basis points point two percent. Suddenly,
Speaker 3: confronted with one of the worst deficits in the Western
Speaker 3: world and a funding requirement of something like eighty billion
Speaker 3: or seventy billion more than the OBR are forecasting more issuance,
Speaker 3: therefore price must ad just to that increase supply and
Speaker 3: guilt yields. The price of guilt will fall and the
Speaker 3: yields will rise, and this is how you get into
Speaker 3: this potential guilt yield spiral. So guilt yield start to
Speaker 3: rise in order to compensate the guilt holders for obviously
Speaker 3: more issuance is a simple supply demand dynamic, and at
Speaker 3: this point, then guilt yield start to rise. Now the
Speaker 3: problem you get, and there were some very specific instances
Speaker 3: around us, but what you then get is the cost
Speaker 3: of funding goes up as guilt yields go up. We
Speaker 3: talked about that briefly. It's one of the big swing
Speaker 3: factors in the government's p and L and finances. So
Speaker 3: guilt it'd start to rise, that increases the funding costs,
Speaker 3: That therefore increases the deficit, which means more issuance, So
Speaker 3: therefore guiltields go up again. This is when you get
Speaker 3: into the crisis of more issuance, higher yields, more issuance. Repeat.
Speaker 3: It's a vicious spiral and we've seen evidence of this
Speaker 3: around the world many times. And that then is the
Speaker 3: problem that the government will have to deal with. What
Speaker 3: you would expect to happen, and this is getting to
Speaker 3: the rub of this discussion, you would then expect the
Speaker 3: Bank of England to wintercede. Now, the primary duty of
Speaker 3: the Bank of England is a financial stability yields moving
Speaker 3: very rapidly. Again, we can remember what out in trust
Speaker 3: mortgages get withdrawn, financial markets start to suffer significant stress.
Speaker 2: Number would you put on guilt yields for it to
Speaker 2: hit the kind of level of crisis at the Bank
Speaker 2: of England would intervene.
Speaker 3: Oh, it's about one hundred basis points would probably be
Speaker 3: sufficient to cause this. And that's not based on sort
Speaker 3: of any scientific measure. It is merely observational of what
Speaker 3: happened during the trust what happened guilt yelds body yields
Speaker 3: in the periphery during the period of the European sovereign
Speaker 3: det crisis went up a lot more than that. I mean,
Speaker 3: you do treasure olds getting to four point nine percent
Speaker 3: in January, as I said this morning, the four points
Speaker 3: around four point seven. They got about four point nine
Speaker 3: percent in January, and that was beginning to raise alarm bells.
Speaker 3: If they went to five point seven, then I think
Speaker 3: you have a problem, okay, And I think most people
Speaker 3: would think you would have a problem. At that point
Speaker 3: that would be thirty year guilt yields at six and
Speaker 3: a half percent. These are big numbers and so at
Speaker 3: this point in this scenario, the Bank of England would
Speaker 3: be required or as part of its mandate, to ensure
Speaker 3: financial stability in the UK, and therefore would have to intercede.
Speaker 3: And the intervention would be again similar to what we
Speaker 3: saw with Trust, and that is that they would start
Speaker 3: some sort of Q program. They would start backstopping the
Speaker 3: guilt market. They would start buying guilt so that completely
Speaker 3: reverse their QT and have to start buying again. And
Speaker 3: they have the capacity to buy and do whatever it
Speaker 3: takes to use those words in order to stabilize the
Speaker 3: guilt market. The question comes at what price they would
Speaker 3: expect the government to pay for that? And I don't
Speaker 3: mean a financial price necessarily, but what financial discipline will
Speaker 3: they impose on the government. And again this is purely
Speaker 3: hypothetical fantasy, but it is difficult to imagine that the
Speaker 3: Bank of England would be happy to backstop a situation
Speaker 3: like this unless there was a significant can display a
Speaker 3: fiscal restraint by the government, and I don't think that
Speaker 3: is unreasonable. The risks of not forcing fiscal restraint on
Speaker 3: the government would jeopardize the reputation of the Bank of
Speaker 3: England as a fiscal constodient of our finances and.
Speaker 2: Such as it is, such as it is.
Speaker 3: And I you not your words, not mine, and I
Speaker 3: think that I think given their sort of recent track record,
Speaker 3: I think the last thing that the Bank of England
Speaker 3: would want to be accused of is fiscal irresponsibility. Would
Speaker 3: what normally happens here and again what we've seen in
Speaker 3: the periphery is that the Bank of England will insist
Speaker 3: on fiscal restraint and fiscal responsibility. So, just going back
Speaker 3: to those numbers I just talked about a two hundred
Speaker 3: billion deficit. Huge is a seven percent fiscal deficit for
Speaker 3: the UK. You could easily see the Bank of England
Speaker 3: insisting that behalved, and they would insist on that as
Speaker 3: part of this backstopping of the UK guild market.
Speaker 2: You get to the point where that.
Speaker 3: That is now getting into sorry, and that is now
Speaker 3: getting very painful for any sitting government. Again, just to
Speaker 3: give you the numbers, so that would be around deficit
Speaker 3: at that point, let's say keep the numbers very simple,
Speaker 3: be around two hundred billion and the banking will probably
Speaker 3: potentially insist on that deficit being halved two hundred billion
Speaker 3: through some sort of emergency budget.
Speaker 2: And this then, because where you run decision Okay, so
Speaker 2: then we go from maths to politics. So you get
Speaker 2: to the point where the government has to take an
Speaker 2: emergency budget to Parliament and ask its MPs that very
Speaker 2: large majority to sign off on one hundred billion quidsworth
Speaker 2: of cuts, a large amount of which would presumably because
Speaker 2: it's got to be quick, probably full on welfare I'm
Speaker 2: guzzing here, plus probably a sharp rise in an immediate
Speaker 2: rise in income tax to cover quite a lot of it.
Speaker 2: And you're going to ask people who've promised in their
Speaker 2: manifesto not to raise income tax and to as a
Speaker 2: party prefer to increase rather than degrees welfare spending. And
Speaker 2: then suddenly you get a budget that doesn't pass and
Speaker 2: you have a proper all crisis.
Speaker 3: Yes, that's that is very succingly port I think that
Speaker 3: is the issue. And again we can put some numbers
Speaker 3: about that and some sort of recent precedence to it
Speaker 3: saving one hundred billion pounds very quickly. That's the sort
Speaker 3: of austerity level that Osborne and Cameron did a post
Speaker 3: financial crisis in terms of over over several year period
Speaker 3: to get that into some sort of one hundred billion
Speaker 3: into some sort of context. As well, a penny on
Speaker 3: income tax raises about ten billion pounds, So you know,
Speaker 3: as you said tax risers, you could easily see a
Speaker 3: basic great of income tax going up several pence to this,
Speaker 3: and then you've got to address the welfare side of
Speaker 3: the equation. So let's say half of this was paid
Speaker 3: for by tax risers and the other half paid by
Speaker 3: spending cuts. That's fifty billion pounds worth of spending cuts.
Speaker 3: On one level, we spend about one point three trillion
Speaker 3: in the UK, so that is clearly less than a
Speaker 3: five percent cut. But politically, as you will recall from July,
Speaker 3: the government we're unable to get five billion pounds worth
Speaker 3: of spending cuts through, and we're now talking a figure
Speaker 3: hypothetically of ten times that amount. This would be very challenging.
Speaker 3: I would have thought for the parliamentary Labor Party to
Speaker 3: vote through very challenging. And it's this scenario that then
Speaker 3: leads to an interesting constitutional question. Clearly I'm not remotely
Speaker 3: pretending to be a constitutional expert, but if a government
Speaker 3: is unable to pass this emergency budget because they're sitting
Speaker 3: MPs refuse to do it, and this actually may be
Speaker 3: an unintended problem of having such a large majority. If
Speaker 3: they are unable to pass this budget, then convention suggests
Speaker 3: that at that point the government have to dissolve parliament
Speaker 3: and go to the country and have a general election.
Speaker 3: It's only happened once in the UK in nineteen oh nine,
Speaker 3: as it happens, but so we do have to go
Speaker 3: back quite a long time. I wasn't even in the
Speaker 3: market then and it has only happened once, but it's
Speaker 3: happened on a number of occasions in parliamentary systems that
Speaker 3: have a similar structure to Westminster. So being unable being
Speaker 3: unable to pass a budget is clearly fundamental to how
Speaker 3: you govern a country. And so if they are unable
Speaker 3: to pass a budget, then one would expect at that
Speaker 3: point a general election to be called and enters into
Speaker 3: a whole realm of other topics.
Speaker 2: Yeah, that would take us test straight onto what happens
Speaker 2: after that, which might be outside the scope of our
Speaker 2: imagination of Nigel Farah just talking about or thinking about
Speaker 2: expecting an election, and maybe twenty twenty seven. Maybe he
Speaker 2: might get his wish, and that would all be rather interesting.
Speaker 2: I mean, the key point being that you've run us
Speaker 2: through maths as opposed to politics. You've run us through
Speaker 2: what could happen given the numbers, as opposed to what
Speaker 2: anybody might want to happen. But nonetheless, it does feel
Speaker 2: that we are getting to this point where very slowly
Speaker 2: and then very quickly, and at some point either something
Speaker 2: massive has to change or we do need a crisis
Speaker 2: that forces that change. So there's a growing sense of
Speaker 2: inevitability of running at the edge of the cliff, isn't there.
Speaker 3: Yes, I don't think. No one's pretending that the fiscal
Speaker 3: situation in the UK is anything other than challenging. That
Speaker 3: is not a remotely contentious point to make, I don't think.
Speaker 3: And also I am not sure. And again I'm not
Speaker 3: sure this is a particularly contentious point either, that this
Speaker 3: situation of ever increasing taxes at the same time as
Speaker 3: ever increasing welfare spending without any growth is probably unsustainable.
Speaker 2: Well, it does get very difficult when you have no growth,
Speaker 2: because when there is no growth in an economy, you
Speaker 2: are constantly shifting the pieces of pie around between people,
Speaker 2: right and that is obviously going to cause conflict for us.
Speaker 2: When you have growth, there's more pie to share, so
Speaker 2: you don't get quite the same level of well anger
Speaker 2: as you do when there is no growth. The lack
Speaker 2: of growth is in itself a thing that creates conflict, right, Oh.
Speaker 3: Yes, it is. The lack of growth is the problem.
Speaker 3: The government are absolutely right to focus on growth, as
Speaker 3: was list trus. It's a question of how you achieve growth.
Speaker 3: But growth answers all of these problems. The problem is
Speaker 3: at the moment, we don't have any.
Speaker 2: Okay, now let's move on from this. Potentially you call
Speaker 2: it a it's not a zero risk event. It's slightly
Speaker 2: quite a lot more than zero at this point. But
Speaker 2: let's say that this is out there as a possibility.
Speaker 2: If this happens, if we end up in this kind
Speaker 2: of scenario, and again, so many moving parts, None of
Speaker 2: this can be sure. These are, as you said, not forecasts,
Speaker 2: simply as suggestions of possibilities. But if we do get
Speaker 2: this situation, when we have both a fiscal crisis and
Speaker 2: a constitutional crisis concurrently, what happens to markets, all that
Speaker 2: nice growth we've seen in the UK equitity market, It
Speaker 2: just leaves us in a wanner. What happens.
Speaker 3: That's probably the easiest question to answer that you will
Speaker 3: post me all day. They will go down. They will
Speaker 3: go down a lot. So let's just that's actually a
Speaker 3: bit of a facile answer, because some bits of the
Speaker 3: market will go up a lot and some bits of
Speaker 3: the market will go down an awful lot, and that's
Speaker 3: what we see. So let me just answer that, give
Speaker 3: me some give you your listeners a couple of ideas
Speaker 3: here and what happens if we know what happened in
Speaker 3: the two hours after Rachel Reeves's difficult day in Parliament,
Speaker 3: we don't obviously know what happened in the market then.
Speaker 3: And what happened was that the metals and mining sector,
Speaker 3: which obviously is international learners and it has gold within
Speaker 3: that and it has copper. That sector went up. I
Speaker 3: can give you the exact numbers. That sector went up
Speaker 3: four percent over that two hour period. The UK real
Speaker 3: estate sector and the UK house building sector went down
Speaker 3: six So in two hours there was a ten percent spread.
Speaker 3: These are big numbers. And we also saw you can
Speaker 3: go back to trust and see what happened there is
Speaker 3: that generally speaking, the two point fifty, The forty two
Speaker 3: to fifty, which is very much more domestically exposed, went
Speaker 3: down a lot, and the forts one hundred, which is
Speaker 3: obviously more internationally exposed, went down, but not as much
Speaker 3: because of clearly it has dominated by companies that have
Speaker 3: international earnings. Now that's not a complete defense in this
Speaker 3: environment because obviously it's the UK that the market is
Speaker 3: very concerned about at this point, and so even those
Speaker 3: international earners tend to fall, but just not as much
Speaker 3: as the domestic place. So we see the market moves.
Speaker 3: You know, these market moves are very pronounced, they are
Speaker 3: quite dramatic, and they are also quite extreme. But before
Speaker 3: that sounds all too frightening, there's also another aspect of
Speaker 3: this that is often ignored is that market crises do pass, yes,
Speaker 3: and they do pass. The tools are there. They may
Speaker 3: be painful for the current administration to administer, but someone
Speaker 3: will have to administer them, and that then creates a
Speaker 3: very interesting opportunity going forward, just as during trust created
Speaker 3: a very interesting opportunity for those who are able to
Speaker 3: or nimble enough and have the courage to buy through
Speaker 3: the crisis. The opportunities that result from this can be
Speaker 3: quite profound.
Speaker 2: So it's worth holding It's worth holding a little cash,
Speaker 2: a little more cash than you might have otherwise, next
Speaker 2: to your gold obviously, and the emeralds you're going to
Speaker 2: put in a hem of your skirts.
Speaker 3: Yes, not to give financial advice, but the writing having
Speaker 3: a bit of cash at the moment is certainly could be.
Speaker 3: If one is concerned about the outcome of this outcome,
Speaker 3: then having a bit of cash is probably no bad
Speaker 3: thing because it will throw up some very interesting investment opportunities.
Speaker 2: Yeah, Roger will have to give the studio back soon.
Speaker 2: But I just want to ask you a couple more things.
Speaker 2: In the first is is this contagious? Obviously, as we
Speaker 2: said at the beginning, while we're paying more to borrow
Speaker 2: than most of all of the G seven missions, nonetheless,
Speaker 2: on paper are our debt to GDP races are not
Speaker 2: particularly worse than other countries. So easy to possibility that
Speaker 2: if we reach some kind of fiscal crisis point in
Speaker 2: the UK that then causes so and bond investors around
Speaker 2: world to go, well, hang on, if the UK can't
Speaker 2: get this under control, then maybe France can't either, and
Speaker 2: the US can't either, et cetera, etc. And it becomes
Speaker 2: a rolling f score crisis.
Speaker 3: Yes, I think that's that's a very good question. Obviously,
Speaker 3: local financial markets are very interlinked. There is a competition
Speaker 3: for capital between all asset classes. As it happens, I
Speaker 3: think the contagion, to the extent there would be contagious,
Speaker 3: perhaps the other way around. I think another risk that
Speaker 3: we haven't really talked about it is maybe one for
Speaker 3: another day. I'm just I did touch on that in
Speaker 3: the little mini guilt scaree we had in January. That
Speaker 3: was partly because US treasury yields went up, and we
Speaker 3: obviously have to compete with capital against them. So the
Speaker 3: contagion could be the other way around. A trigger to
Speaker 3: this could actually be US treasure yields going up. It
Speaker 3: could be concerns about the US deficit. It could be
Speaker 3: concerns about presidential interference in the FED and the independence
Speaker 3: of the FED could cause international investors to demand a
Speaker 3: higher return from US from the US. Now, as it happens,
Speaker 3: the US treasure yields have actually recently stable. At the moment,
Speaker 3: some of those concerns perhaps have passed, So there's certainly
Speaker 3: a contagion the other way around that if something happens
Speaker 3: bad in the US debt market, then it would almost
Speaker 3: certainly have an impact on US. Likewise, another potential scenario
Speaker 3: which could cause contagion JGB, so Japanese government bonds. If
Speaker 3: the inflation outlook in Japan continues to be persistent, then
Speaker 3: jgb's will go up, yields will go up. And again
Speaker 3: this idea that everything's interlinked and all of sovereign debt,
Speaker 3: all of G seven sovereign debt goes up. So there
Speaker 3: are other factors here now, specifically on France and the UK,
Speaker 3: because obviously we are the two countries that are a
Speaker 3: rioter or in France for instances, right in the eye
Speaker 3: of the store, anyone who thinks that what I've just
Speaker 3: described is unreasonable or inconceivable, we only have to look
Speaker 3: nineteen miles away across from France and see that the
Speaker 3: political disarray that they're enduring now. France is in a
Speaker 3: slightly different situation to us. Obviously, it's part of the
Speaker 3: euro and it has the ECB sitting behind it. I
Speaker 3: think to an extent there is less of an element
Speaker 3: of contagion because of the ECB has more leavers to
Speaker 3: full leavers to poor. Because it's it's managing a zone
Speaker 3: of multiple different economies. So to an extent, I think,
Speaker 3: and this isn't particularly scientific, but to an extent, French
Speaker 3: government debt is slightly more protected because of the ECB
Speaker 3: as opposed to us on our own with just the
Speaker 3: Bank of England behind us. I think we have seen
Speaker 3: some very clear correlation between French oaths and guilt. So yes,
Speaker 3: that correlation probably works. I think the interplay between for
Speaker 3: US and the UK could be quite interesting in this scenario.
Speaker 2: Concerning should say, Okay, I love the way you use
Speaker 2: quite interesting as a euphemism for all sorts of things.
Speaker 2: Might make a list of that things, Roger, things are
Speaker 2: quite interesting.
Speaker 3: Things that strategist thinks are quite interesting, generally speaking.
Speaker 1: Are bad.
Speaker 2: Yeah, and the rest of us would call absolutely terrifying.
Speaker 3: And the more interesting and exciting markets get is usually.
Speaker 2: The word it is your living standards. Listen, let me
Speaker 2: just ask you one last question. Forty finished, are you
Speaker 2: reading anything interesting at the moment, reading a good book
Speaker 2: fiction and nonfiction that maybe our listeners should be picking up.
Speaker 3: I'm a bit of a nerd on this sort of
Speaker 3: things I'm reading we like I'm reading Dominic Sandbrook's History
Speaker 3: of the nineteen seventies.
Speaker 2: Oh, I've read that so good? What's so good?
Speaker 3: Two volumes of it? Yeah, and I'm almost through one
Speaker 3: volume of it, so yeah, No, I think that's very interesting.
Speaker 3: And again you can probably hear tell where I'm heading
Speaker 3: on this, but I over the summer I read Philip
Speaker 3: Zeigler's biography of Ted Heath, so you.
Speaker 2: Could obviously, Okay, I can see exactly where my.
Speaker 3: Thought process is going here at the moment.
Speaker 2: So yeah, maybe go back and listen to this podcast
Speaker 2: on Gold everybody, Roger, thank you so much for joining
Speaker 2: us today. We usually appreciated.
Speaker 3: Thank you.
Speaker 2: Thanks for listening to this week's Marin Talks Money. If
Speaker 2: you like our show, rate review, and subscribe wherever you
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Speaker 2: and John is John Underscores Epic. This episode was hosted
Speaker 2: by Me Maren's Sunset Web. It was produced by Summersidi
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Speaker 2: of course to Roger cle