The next bubble – government borrowing
December 19th, 2008
At Pan-Asset we worried prematurely that the UK government’s wish to borrow so much would cause strains in the government debt market. Indeed, we underestimated their intelligence in this respect.
Forecasting a huge surge in government borrowing from the £43 billion for 2007-8 heralded in the Budget to around £120 billion, I discovered that the government now thinks the true figure is an eye watering £157 billion for this year, or more than 10% of National Income (although most journalists and commentators continue to use the well-publicised £78 billion figure). This could have been more than markets would willingly lend, creating new strains on our currency and long term interest rates.
Instead, the worry today is that despite the huge increase in government debt we will witness a further increase in the size of the government debt bubble. Government debt prices have been rising. How can this be?
The government has taken strong steps to ensure lots of buyers for their debt.
They are instructing the banks to buy lots of gilts (government debt) to “increase their liquidity”. Much of the money the government has put into the banks to “strengthen” them will be lent back to the government at a loss!
They preside over a pensions regulatory system which will force many more companies to increase their pension contributions, and will encourage Actuaries and other advisers to insist this new money is stashed in gilts.
Taking interest rates down to very low levels will undermine the returns of most savers in normal deposits. Some of them will be tempted into government debt through National Savings and related products.
Injecting huge quantities of money into the system through the Bank of England will also create large amounts of liquidity to let institutions buy government stocks. They are creating a huge money go round, where the Bank of England bloats its balance sheet, to create the cash to power the government debt bubble.
In the short term the government has designed a system which will allow it to borrow colossal sums at low rates of interest. At some point this will have to be unwound. Just as the property bubble burst and the commodity bubble burst, so one day the government debt bubble will burst. In the meantime, we believe there may well still be benefits from investing in short to medium duration gilts but would avoid the longer-dated issues.
