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The Borrowers

8 September 2020

If this were a game of charades you would expect me twiddle my hands around to indicate a book and a film. Both were pleasant little comedies if you enjoy that sort of thing. I’m not quite sure how you mime “government” but that is today’s borrower, and a big one too.  Its debt has risen to 100% of GDP and is destined to rise further as the consequences of the self-imposed Corona lockdown, and the variety of social restraints that have followed, take their toll on the economy. There are those that regard the government’s performance in the face of this pandemic as something of a charade but that’s probably a bit unfair. The whole world is still learning about the deadly virus and countries that thought they had it licked are now seeing its resurgence. The final reckoning will only be clear in hindsight a year or two down the road.

In the meantime, Boris and Rishi have to plot a course for both the protection of the remaining economy and its recovery. The cost of the former has already been enormous and the confidence necessary for the latter is not helped by the daily sniping by the press, opposition and “experts” seeking their five minutes of fame. But real recovery won’t come without confidence and that will require still more spending. Where is it all going to come from?

First of all, a bit of perspective. The current debt/GDP ratio might seem uncomfortably high but, historically, in times of war it has been far higher – more than twice this level during the second world war and this is a war, of sorts. The big bonus for the government is that, following a prolonged period of the world tackling the demon of deflation, interest rates are close to zero and, in some countries, even below that. Economic recovery must not be stifled by higher taxes, despite the views of the Treasury economists, who have a pretty poor record over a prolonged period anyway. Short-term borrowing is pointless as it will have to be refinanced in a few years, no doubt at markedly higher rates than pertain today. Surely the answer is to borrow big and borrow long whilst the government can, locking in today’s miniscule coupon for forty, fifty years or more. I can recall War Loan, which was basically a perpetual debt instrument issued in 1917 finally being redeemed only five years ago by George Osborne. (No, I didn’t say I recall its actual issue). It was redeemed at par with a 3.5% coupon having been just a fifth of that value in the high inflation/high interest days of the 1970’s. Looking at the yield curve the government could currently get away with a coupon less than 0.75% on fifty-year debt. Seems a no brainer to me.

Having said that, the private investor should leave such an issue, should it come, well alone. In the War Loan example above, the stock could be bought for 20p in the pound in the 1970’s on a yield of 17.5%. Inflation might not rip as it did in that decade but it is certainly destined for higher ground. US Federal Reserve Chairman, Jay Powell, has already indicated a looser policy with regards inflation and historically the convenient way for governments to ease the debt burden is to inflate it away. However, even a more accommodating inflation stance will see interest rates rise at some point. Private investors should leave any such debt issue to the institutions and pick it up in the secondary market a few years down the road on a more attractive yield basis.

For the government, by far the best way to reduce the debt is by strong economic growth and that can only be achieved by keeping the tax burden as low as possible, at least during the momentum-building early stages. Let’s hope Boris and Rishi are strong enough to resist the Treasury mandarins.


ITV Update

 What a fuss the press make about something pretty minor. Reading last week’s newspapers you would think that ITV leaving the FTSE 100 was the end of the world. Here we are a week later and what has changed? Not a lot. The shares came off a few pence as the remaining FTSE 100 trackers were forced to sell and then put them back again as the FTSE 250 trackers bought them. The fact remains that on a likely multiple of less than eight times this year’s depressed earnings, and highly geared to economic recovery, at 65p ITV shares look very cheap on a two-year view, for those prepared to bet that a recovery materialises.