Evercore Pan Asset

We have repeatedly warned about the dangers of the UK debt build up, and have advised investors to stay out of gilts or to sell them whilst the Bank of England is still buying. Yesterday Standard and Poors issued a warning about the rapid build up of UK government debt, saying that it could well go to 100% of National Income and stay at that high level for some time. They might in due course remove the AAA rating as a result.

It was in some sense quite a mild warning. We think UK state liabilities are much higher than the narrow definition of debt used in the S & P figures. If you add in off balance sheet debts, possible further losses on bank assets, and pensions liabilities, the figures soar well above the stock of borrowing narrowly defined.

There is currently no credible plan in place to start to tame the deficit and to bring it down in a timely manner. There are some overall figures in the latest budget documents, based upon assumed resumption of some growth, and some greater spending discipline. Most commentators feel more needs to be done. The economic forecasts are still optimistic for the longer-term, and the debt build up is now rapid.

One of the most important figures to watch will be the amounts spent on debt interest. We all know debt interest will increase rapidly, as a result of the large debt issue programme. The danger is that once quantitative easing stops, there could also be a further increase in interest costs, if interest rates have to go up to sell all the debt the government needs to place.

The gross issue programme of £417 bn in 2008-10 means £12.5 bn of annual interest charges if they raise the money at an average 3%. If longer-term rates rise further under the weight of the issue programme then the debt interest costs themselves will rise even more rapidly. We think investors should take note of the warning from the Rating Agency, and the logic of compound arithmetic, which makes controlling costs and debt difficult at these levels of deficit.

In the last few days markets have paused after a spirited rally. We think more money will go into shares from the combined effects of quantitative easing on both sides of the Atlantic in due course, to be followed sometime later by some evidence that the worst of the downturn is behind us in the leading economies.