“We will do whatever it takes”
The words of Mario Draghi, the then President of the ECB on 26th July 2012 as the spiralling Greek debt threatened to ruin the Eurozone and with it the EU itself. And it worked, as markets were calmed sufficiently to allow the fiscal stimulus time to stabilise the system.
Roll the clock forward to Rishi Sunak on 23rd March 2020 and, once again, ‘We will do whatever it takes’ accompanied by a fiscal package of an eye-watering size and scope estimated to cost £50bn on top of the £20bn of measures announced the previous week. We do not know the final bill, and it is not helpful to speculate. But we can and should think about how the ‘blank cheque’ is going to be funded in the absence of a magic money tree!
Governments have two sources of funding – tax and borrowing. We know about the first and, also, that in times of recession, as now, there is an inevitable fall in receipts. The second comes from the gilt market. They issue debt with a fixed coupon (interest) and repayment date. Theoretically, they can do as much of this as they need but remember, for every £1 of debt raised, there has to be a buyer of that debt. It is a zero-sum game.
Theoretically, there has never been a better time for the Government to raise money this way. The ten-year gilt now yields 0.29%, so it costs the Government almost nothing to borrow at that rate. All well and good while there are buyers. Long may that continue.
It is well documented that inflation has been quelled by the twin forces of globalisation and the adoption of technology, both of which have driven prices for goods and services down over the last quarter of a century. Equally, but perhaps less well acknowledged, an excess of global capital has played a huge part, buying debt at increasingly low returns even in the face of money printing (in any of its electronic guises) as the Great Financial Crash of 2008/09 shook the global banking system to the core.
We do not question the Government’s moral responsibility and conviction to ‘do whatever it takes’. And we trust that, for now, the buyers will stand firm and help finance the debt, both here and abroad. Never before in peacetime has the government taken such a central role in our lives as now.
No judgement, political or otherwise, should be made at a time of a global health crisis that puts our clients, staff, families and loved ones at risk. This remains front and centre of our thoughts. We do, however, have to consider the world beyond lockdown and COVID 19. A world where – whisper it quietly – taxes may have to rise, where globalisation is pared back somewhat, and buyers of government debt may want a bit more return for their money.
This all makes us just a bit more wary of assuming that inflation is a thing of the past. It is too early to make assumptions, and a bit of inflation might finally start to erode the value of some of this debt away. The right equities are of course as good a hedge against inflation as any asset.
Please stay safe.