Is the UK’s Debt Out of Control?

Is the UK’s debt out of control?

THINKING COALITION

I suspect that a lot of people are vaguely aware debt levels are getting fairly high in many Western countries — particularly the US and the UK — and that they are expected to get higher in the foreseeable future. Partly as a result of this debt and partly because the Bank of England has paused “quantitative easing” (explained below), the cost of government borrowing in the UK (and the US) is going up rapidly.

The increase in the cost of borrowing manifests itself in higher yields on government debt, yields being the market rate for government borrowing and which are inversely related to the market price of government bonds. The higher the yield, the lower the market price of a bond (bear with me on this, it will make sense).

Today’s slightly alarming headline was “UK long-term borrowing costs reach 28-year high”, so what does that mean for you and me?1

As someone who has been warning people about the dangerous nature of “safe” government debt, I felt some very fleeting satisfaction in the news that the market value of 30-year (and 10-year) UK government bonds (gilts) are weak.

I started warning about the unsafe nature of government bonds owing to the fact that annual nominal returns on U.S. Treasury bonds and U.K. gilts have been very low for a long time and way below the higher returns available from equities.

The headline “UK long-term borrowing costs reach 28-year high” means that bonds have transitioned from not just offering a return that is lower than inflation, but actually negative returns (price drops) in nominal terms. Had you owned the largest iShares gilt ETF over the past 10 years (2016-2026) you would have lost money .

The headline has triggered the predictable political mud slinging: Team Blue (a.k.a. the Fake Conservatives) shouted “bloody Labour” and promising that only they will return fiscal sanity to the UK when re-elected. Yet a large part of the reason that we are in this mess is that Team Blue and Team Red (and Team Yellow for that matter) worked together to push the UK into this debt trap.

Shutting down the economy during “COVID” added hundreds of billions onto government debt for the sake of achieving essentially nothing in terms of disease control2.

The best way to see this is to look at the size of monthly UK government debt (gilt) issuance over the period 2019 to 2026. The chart shows gross issuance and some of this new debt will be used to retire existing debt, as a rough rule of thumb since June 2023 around ½ of the gross issuance has been used to cover maturing debt and the other half to cover government overspending (borrowing). In May 2020 alone the “Conservative” government issued a whopping £ 62.5 billion in gilts3, equivalent to around £ 2,200 for every single household in the UK.

Gross issuance has failed to fall back to pre-COVID levels around GBP 8.2 billion (red line) and remains above the line. It’s what happens when you increase the absolute level of debt because you then need to issue more debt to covering maturing debt. Higher debt levels imply higher yields (market determined interest rates) meaning that you also need to issue more debt to cover a higher interest expense. At some point that process gets out of control, but we are a long way from that point as yet. As a result of this huge debt issuance, debt to GBP has continued to motor upwards.

This time around though, the Bank of England is noticeable by its absence. In 2020, the Bank of England bought up pretty well all of the bonds being issued via its subsidiary, the Asset Purchase Facility Fund (APFF) Limited. The chart below shows the gross issuance of debt by month, but this time compared to monthly changes in APFF’s total assets (effectively the amount of gilts it buys in any one month). It is pretty clear that APFF was essentially buying all issuance in 2020 and 2021, but since around January 2022 has been effectively running down its balance sheet and not buying new issuance. This timing corresponds exactly with the period yields started to increase very significant from around 1% to over 5% now when the APFF stopped buying more gilts.

Why is it different this time around?

Ostensibly the Bank of England is justified in not stepping in to save the 30-year gilt at a time when inflation is above its 2% target, because they can keep monetary policy reasonably tight by allowing yields to increase. Commercial investors are now playing an increasingly important role in the bond market and they, quite reasonably, demand higher interest (yields) than the Bank of England.

Personally I have a slightly more cynical view about monetary policy and that is that quantitative easing is primarily about allowing the wealthy to maintain and expand their wealth. As I pointed out in an unloved post called “The Great Lockdown Swindle” the wealth of the top 0.1% in the United States expanded by USD 6.0 trillion between 31-March 2020 and 31^st March 2023 according to official data from the Federal Reserve4. The chart below shows just how powerfully quantitative easing (orange line – Federal Reserve assets) drove up the wealth of the top 0.1% (blue dotted line).

Nobody has ever really been able to convince me that making the uber-wealthy wealthier has any real “trickle-down” benefits. I am convinced though that mass money printing creates a huge penalty for ordinary folk who are faced with increased costs (inflation) and who for the most part do not own equity portfolios.

Whilst the various non-executives involved in the oversight of the Bank of England may be fine people, they are drawn from the “great and the good”. Achieving high levels of seniority in their chosen field (mainly banking and private equity) is important but it also means that many of them are likely to be very wealthy with extensive equity portfolios. Disclosure of their financial interests is somewhat limited but only one of the twenty four non-executives in the various committees has disclosed a financial interest in gilts (UK government debt). Almost all of the others have disclosed equity interests and/or funds under discretionary management, which will likely be heavily invested in equities.

Their interests will very likely diverge from those of the average person and I can hazard a guess that the value of financial assets (meaning equities) will be a lot more relevant to them than the price of a loaf of bread.

As I suggested in my last note, I believe that much investment “common wisdom” about the desirability of holding government debt (efficiency, safety, risk free rate etc.) have been propagated in order to justify stuffing collective pension schemes with low-return government debt. So bond losses, like the ones we are now seeing, will largely be imposed on the great unwashed.

Rather than getting bitter and twisted about this reality, I have chosen to “take things as I find them” and have been suggesting to clients that we look at their pension holdings and get out of government debt, as far as that is possible (unfortunately in many cases this is very hard to do). Having done that, the next task is to avoid expensive branded asset management products. In fact this advice is exactly the advice that Warren Buffet gave in the Berkshire Hathaway shareholder’s letter of 2013.

The times ahead are clearly going to be tumultuous and if you are seriously interested in avoiding large potential losses and even making gains then please contact me on [email protected]

Many thanks

Alex

(thanks again to Mark Halliday Sutherland for reviewing)

Caveat

Any discussion is for informational and educational purposes only. It does not constitute investment advice, financial advice, or a recommendation to buy, sell, or hold any securities or investments. The information presented is based on publicly available data and the author’s own analysis as of the date of publication. All investments involve risk, including the potential loss of principal. Past performance is not indicative of future results. Readers should not rely on any information contained in this article/discussion as the basis for making any investment, financial, or other decisions. You should consult with a qualified financial advisor or conduct your own independent research before making any investment decisions. The author and any affiliated parties expressly disclaim any liability for any loss or damage arising from the use of, or reliance on, the information in this article/discussion.

Alex Kriel is by training a physicist and was one of the first people to highlight the flawed nature of the Imperial COVID model. He spent his career in consultancy and fund management including a long stint in Russia. His last job was in one of the world’s largest pension funds where he handled corporate governance issues and shareholder voting over a portfolio of 2,300 equity investments. He is a founder of the Thinking Coalition which comprises a group of citizens who are concerned about government overreach and are developing practical solutions to protect inalienable individual liberties (www.thinkingcoalition.org)