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Today's episode is brought

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Welcome to Many Happy Returns,

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where we aim to make you

0:16

a better investor. I'm Roman, and

0:18

I'm Michael. Liz trust as many

0:20

budgets has become a bogeyman for

0:23

all physical policy. And once again,

0:25

guilt yields rose following the autumn

0:27

budget as markets absorb sharp rises

0:29

in investment, taxes and borrowing. Do

0:31

we really need to be scared

0:33

of the bond vigilantes? And in

0:36

today's dumb question of the week,

0:38

does public investment crowd out or

0:40

crowd in private sector activity? Okay,

0:44

let's get into it. So last week

0:46

we had the autumn budget, Labour's first

0:48

budget in 14 years, and it was

0:50

a big budget. Big increases in spending,

0:52

large tax rises, and a lot

0:55

of government borrowing penciled in for

0:57

the coming parliament. While the Chancellor

0:59

was speaking, all seemed pretty calm in

1:01

markets. But then, in the days that

1:03

followed, guilt eels did the thing everyone

1:06

doesn't want them to do and

1:08

started to creep upwards. And we saw

1:10

headlines which referenced bond

1:12

vigilant vigilantes. Here they are, they've come

1:14

to get us. But Romin, what is a

1:16

bond vigilante? Well the idea is

1:18

that there are bond investors who when they

1:21

see a budget come along and it has

1:23

policies which they think will hurt their

1:25

investment, they sell their government bonds

1:27

and they do it in large

1:30

size. So presumably these are institutional

1:32

investors who want to kind of

1:34

punish the government supposedly for their

1:37

policies. Inevitably we've got a

1:39

million headlines about the markets

1:41

on Halloween. But I'm a little

1:43

bit skeptical of these bond vigilantes.

1:45

Are they a real thing? Is

1:47

this a coordinated action by some

1:50

sort of shadowy cabal of bond

1:52

market investors? Well, I think if people

1:54

want conspiracy theories, this is the wrong

1:56

podcast. So I tune out right now.

1:58

But look, I think that... That's unlikely.

2:00

I think one of the things that

2:03

people really should bear in mind is

2:05

that bond investors will always act in

2:07

their own interest because that's their job.

2:09

If they're a fund manager and they

2:12

think that yields are going to rise,

2:14

well, they're going to sell some of

2:16

their guilt because they don't want to

2:18

take that hit or shorten duration, for

2:21

example. So really I wouldn't blame the

2:23

bond investors for doing what's rational for

2:25

bond investors to do, which is acting

2:28

in their own interest. It's kind of

2:30

like blaming a lion if you stick

2:32

your head into its jaws. You know,

2:34

it's going to eat you. There's no

2:37

question. So I don't think we should

2:39

blame bond investors. And I don't think

2:41

there's a compile of bond investors going

2:44

around trying to punish governments. It's just

2:46

them doing a rational thing. Do you

2:48

think Rachel Reeves did stick her head

2:50

into the metaphorical lion's jaws though? I

2:53

think she would reject that analogy. She

2:55

would say the UK needs investment, and

2:57

that means, at least in the short

3:00

term, borrowing more. I'd say it's kind

3:02

of the opposite. I feel as if

3:04

every government now is going to be

3:06

terrified of lions and simply shirking any

3:09

kind of increase in spending because they're

3:11

worried that they're going to get a

3:13

repeat of what Kwateng and trust managed.

3:15

But I think that's the wrong message

3:18

to take home and I think it's

3:20

going to actually be detrimental to growth

3:22

because people will be too scared to

3:25

do something really radical in order to

3:27

stimulate growth. Interesting. Because I think the

3:29

mini budget that Liz Truss had, where

3:31

we saw a really, really sharp rise

3:34

in guilt yields, and a kind of

3:36

doom loop which the Bank of England

3:38

had to save us from by stepping

3:41

into the market and buying gills, that

3:43

wasn't really an episode of bond vigilantism,

3:45

if you want to put it like

3:47

that. It was more the case that

3:50

she stumbled into a strange market where

3:52

British pension funds had done this liability

3:54

matching thing. and a rise in interest

3:57

rates meant they had to sell guilt

3:59

mechanically, and it created this kind of

4:01

death spiral. Like she lit the match,

4:03

but the explosion was not really the

4:06

free market. And in a sense, the

4:08

explosion had already happened. If you look

4:10

at UK guilt yields leading up to

4:12

that budget, they'd soared. And what that

4:15

mini budget did was simply to make

4:17

them soar a little bit more, actually

4:19

quite a lot more, because of this

4:22

LDI problem. but also because of the

4:24

rate of increase of guilt yields because

4:26

I think that budget was so poorly

4:28

telegraphed and so poorly designed. Remember this

4:31

was a time of high inflation, there

4:33

were unfunded tax cuts which of inflationary

4:35

of course, and they didn't have any

4:38

input from the OBR to give some

4:40

kind of veracity to the numbers. So

4:42

I think part of the problem was

4:44

that some people sold bonds initially very

4:47

rapidly. and then it got a second

4:49

win the sell-off because of the LDI

4:51

problems and the fact that people had

4:54

margin calls and they had to sell

4:56

guilt to fund those and then we

4:58

got this downward spiral. Thankfully that structure

5:00

of the pension market is no longer

5:03

there so you shouldn't get that doom

5:05

loop dynamic at least from that corner

5:07

of the market but weirdly I think

5:10

the mini budget from Liz Truss is

5:12

kind of a blessing and a curse

5:14

for chance for chancelors nowadays. It's a

5:16

curse in that... Bond markets are watching

5:19

UK budgets very closely to see how

5:21

much they're going to borrow. But also

5:23

it's a blessing because even when we

5:25

get a bit of a negative reaction

5:28

like this time, everyone goes, well, it's

5:30

not as bad as Liz Trust the

5:32

lettuce. And if we look at the

5:35

yield change for this latest sell-off, it

5:37

isn't anywhere near as bad as it

5:39

was for the Quatine trust budget. So

5:41

for example, if we look at the

5:44

10-year guilt, and we track yields 20

5:46

days before and after the budget, There

5:48

was a 1.6 percentage point increase after

5:51

the Kwatang budget. Now it's early days,

5:53

we're only about a week into this,

5:55

and the UK tenure is currently about

5:57

25 basis points higher, so 0.25 percentage

6:00

points in other words. Is that the

6:02

way to measure it? Because I've seen

6:04

some people... saying yields now on the

6:07

10-year are higher than they were at

6:09

the time of Liz Trust. Surely this

6:11

is worse, but like you say, it's

6:13

the scale of the reaction, isn't it?

6:16

Rates are higher now across the world.

6:18

That's right. So that's not a UK

6:20

thing. That's a global phenomenon. Now I

6:22

have seen some people say that this

6:25

time round, it's all due to global

6:27

effects. It's the US election and yields

6:29

have pushed higher in the US and

6:32

across the world. But that's not true

6:34

either. It's somewhere in the middle right.

6:36

If you look at the spread of

6:38

guilt to Bunds, this is German government

6:41

bonds, they are at their highest now

6:43

since the Liz Trust mini budget, the

6:45

UK's borrowing costs relative to the rest

6:48

of the world have increased. Now what's

6:50

kind of interesting, if you look at

6:52

that spread, is that before that budget

6:54

it was around 100 basis points or

6:57

less. Then we got the Liz Trust

6:59

budget, it spiked above 200 basis points.

7:01

Briefly it dipped down. but then from

7:04

May onwards it spiked back up to

7:06

pretty much where it was previously and

7:08

it's been hovering at around 150 to

7:10

200 basis points ever since. So I

7:13

think this has only been a slight

7:15

increase to about 210 basis points from

7:17

about 160 before. So this seems to

7:19

be a new thing which is that

7:22

the UK treads that a spread to

7:24

Germany and it's a fairly large spread

7:26

compared to history. And weirdly I think

7:29

it's not all about the UK. the

7:31

German economy has real problems right now

7:33

and some deflationary dynamics which would depress

7:35

their interest rates. So it's kind of

7:38

like the German rates going down really

7:40

while the UK rates going up. But

7:42

I think it's fair to say the

7:45

Treasury was a little bit surprised that

7:47

the market did react negatively. And I

7:49

say that because Rachel Reeves made an

7:51

unscheduled appearance on Bloomberg TV, which is

7:54

unusual for a Chancellor and she reinforced

7:56

that her number one commitment, I quote,

7:58

is economic and fiscal stability. They maybe

8:01

were a little worried that they rushed

8:03

the Chancellor in front of the cameras.

8:05

Yeah, I think it's good that she...

8:07

did that because it's clear that they

8:10

have to say something to keep yields

8:12

down. What they didn't say is there's

8:14

more to come. I was equating saying

8:16

the day after the mini budget. Yeah

8:19

they didn't pour fuel on the fire

8:21

and they'd been very clear in their

8:23

messaging all through right so I don't

8:26

think there were many surprises. So I'm

8:28

surprised actually that the yield increase was

8:30

that large given the size of the

8:32

spending increase and how careful they've been.

8:35

not to let debt get to a

8:37

huge level relative to GDP. So they've

8:39

still got these really strong fiscal rules.

8:42

Well, let's talk through that, because, Robin,

8:44

this might be a rare case where

8:46

you and I disagree. Because I watched

8:48

your YouTube reaction video to the budget,

8:51

which was really good. And to sort

8:53

of misquote you slightly, you said something

8:55

like, Rachel Reeves didn't do enough, right?

8:58

She should have borrowed more, the markets

9:00

are relatively tame in reaction, this show

9:02

she could have gone further and invested

9:04

more. But when I look at the

9:07

figures, she is investing quite a lot

9:09

more than was planned previously. So spending

9:11

is budgeted to increase by 70 billion

9:13

pounds annually. And the stat that blows

9:16

my mind is that if you look

9:18

at total public spending, so this includes

9:20

the day-to-day expenditure and the investment, by

9:23

the end of this Parliament, that is

9:25

forecast to be around 44% of GDP.

9:27

If you compare that to before the

9:29

pandemic, that's 5 percentage points higher. That's

9:32

a massive increase in the size of

9:34

the state as a share of the

9:36

economy. But if you look at other

9:39

huge spending increases in the past, if

9:41

you look at what's really required to

9:43

take a country which is effectively not

9:45

growing, which is pretty much where we

9:48

are, growth has been so poor, and

9:50

if you look at wage growth over

9:52

the last decade, again, there's been hardly

9:55

any real wage growth. Well, it takes

9:57

a really big kick to turn that

9:59

around. And okay, this is a big

10:01

budget, but I think it could have

10:04

been bigger bigger. a market response in

10:06

my opinion is that it is fairly

10:08

muted. I think they could have gone.

10:10

further in terms of debt issuance. But

10:13

look, it is positive. And I think

10:15

the fact that they actually care about

10:17

growth and they've made a huge spending

10:20

increase in order to start it is

10:22

a positive. Don't get me wrong. I

10:24

just think in terms of degree, they

10:26

could have gone even further. But could

10:29

they? So you said they changed the

10:31

fiscal rules, which is true. So the

10:33

first fiscal rule says day-to-day spending has

10:36

to be met by tax revenues. That's

10:38

kind of uncontroversial. But then the big

10:40

change was to the second fiscal rule,

10:42

where Rachel Reeves adopted a different measure

10:45

of public debt. So it moved from

10:47

just a plain measure of public sector

10:49

net debt, less the Bank of England

10:52

liabilities, to something called persnuffle, which is

10:54

public sector net financial liabilities, which basically

10:56

allows you to offset some of the

10:58

government's future revenue from financial assets, things

11:01

like student loans, against the debt that

11:03

they're taking out. And this is a

11:05

looser fiscal rule. this allows you to

11:08

borrow more it flat as the public

11:10

finances because you're looking at some of

11:12

the assets and not just the debt.

11:14

But even with this looser rule, the

11:17

headroom on it according to the OBR

11:19

is almost non-existent so just 16 billion

11:21

by the end of the forecast period.

11:23

So to say she could have borrowed

11:26

more, well yes she could of course

11:28

she could but she'd have had to

11:30

have an even looser fiscal rule to

11:33

be allowed to do that and I

11:35

think that would have been a risk.

11:37

But that's what I think she should

11:39

have done. I think she should have

11:42

said, look, this five-year target is bullshit,

11:44

because if you want your country to

11:46

grow, thinking over five-year terms is, I

11:49

think, unrealistic. I think you should have

11:51

an even longer-term view. And of course,

11:53

if you're a politician, you think in

11:55

five-year chunks, because you're not going to

11:58

get reelected. So that was the worry,

12:00

I think. Ten-year person for you. Yeah,

12:02

I think Pentennia pus snuffle would be

12:05

much better than five. I actually think

12:07

you might be onto something there, but

12:09

I can see why they do it

12:11

in five-year chunk. and they're actually going

12:14

to start reducing it to a three-year

12:16

target because that is the period over

12:18

which a government does a detailed budget

12:20

and you get this weird fiction really

12:23

in budgets where they front-load everything all

12:25

the spending it's front-loaded so it looks

12:27

like the departments we've got lots of

12:30

money over the next three years but

12:32

then for the two years at the

12:34

end of the forecast period where they

12:36

don't have to like line-by-line say what

12:39

they're going to spend they're going to

12:41

be way less those two years. All

12:43

chancellors do this. So she's going to

12:46

try and avoid that in the future

12:48

by moving to a three-year target. And

12:50

fuel duties is the standard joke here,

12:52

isn't it? They always say they're going

12:55

to put it back up, but of

12:57

course they never do. Yeah, we've had

12:59

fuel duties frozen temporarily for 14 years,

13:02

but they're budgeting in them to rise

13:04

in real terms in all future periods,

13:06

as did conservative chancellers. And it never

13:08

happens. And the OBR in their report

13:11

has some relatively sarcastic commentary saying things

13:13

like, we cannot rely on these revenues.

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slash pension graft. So going back to

13:45

the market reaction, we've said on one

13:47

hand it's nowhere near as bad as

13:49

following Liz Trust's mini budget, but it's

13:52

also not nothing. Something's happened in markets,

13:54

something's happened in markets in markets. and

13:56

they have reprised UK borrowing costs. Is

13:59

that a rational reaction? Is what the

14:01

Chancellor unveiled sufficiently... expansionary or costly to

14:03

mean that government borrowing costs should have

14:05

gone up by 30 basis points? I

14:08

think it's always helpful to place these

14:10

things in a context of what's the

14:12

better investment for investors. Now at the

14:14

moment you've still got 4.95% on Sonia.

14:17

So if you're in a money market

14:19

fund you can earn more than the

14:21

entire guilt yield curve. So gilts are

14:24

just not attractive for your average investor

14:26

in the UK retail investors at least.

14:28

you can earn more by just plunk

14:30

it in a money market fund and

14:33

waiting. So that means that there isn't

14:35

a level of support at the moment

14:37

at least until the Bank of England

14:40

starts to lower that short-term rate. Now,

14:42

was the market reaction rational? It's difficult

14:44

to say what the market was pricing

14:46

in. I don't think there's a credit

14:49

risk premium here. I think what we're

14:51

talking about is pricing in perhaps higher

14:53

growth. that's certainly one aspect of it

14:56

at the long end of the curve.

14:58

So maybe the market was actually believing

15:00

what was going to happen. Certainly there's

15:02

a degree of inflation expectations. We saw

15:05

inflation expectations increase and that's also priced

15:07

in at the long end of the

15:09

curve. That increases yield too. So I

15:11

think it was a combination of those

15:14

two. Maybe a bit more inflation than

15:16

growth expectations. And if you look at

15:18

the one year past of the curve.

15:21

That's moved up quite a bit because

15:23

what people now expect is at the

15:25

Bank of England will have to keep

15:27

rates higher for longer and yields rose

15:30

at the one year past of the

15:32

curve in anticipation of that. Yeah I

15:34

agree with you. I saw a lot

15:37

of commentary saying well this is a

15:39

negative verdict from markets on the budget.

15:41

Markets don't like it. I don't think

15:43

that's true. I think that's a misreading

15:46

of the situation. I'd see this more

15:48

as markets just pricing in the cost

15:50

of the budget. The government's going to

15:53

borrow more. a lot more, to be

15:55

frank, and that means probably a little

15:57

bit higher interest rates and inflation. That

15:59

has costs for the economy, and it

16:02

has benefits, there's a genuine trade. off

16:04

there and so markets go, rates are

16:06

going to be higher. It's not a

16:08

bad verdict, it's not saying we're going

16:11

to go into this death spiral and

16:13

rates are going to soar to the

16:15

sky. It's just saying you've made this

16:18

choice, you're going to go for growth

16:20

at the expense of a little bit

16:22

higher inflation and rates. Well this is

16:24

what it's going to cost you from

16:27

the bond market. And again if we

16:29

compare the one year yield and compare

16:31

it with the quatting budget, it moves

16:34

up about 80 basis points the one

16:36

year yield. And so far at least

16:38

for the Reeves budget, it's moved up

16:40

49 basis points. So about five eights

16:43

as much. That's a much closer reaction

16:45

to what we got with the Guatang

16:47

budget. And I think that's based on

16:50

this expectation of inflation. If you look

16:52

at the forecast from the Office for

16:54

Budget Responsibility, the OBR, they did up

16:56

their forecast for inflation and interest rates,

16:59

but not by much. So they said

17:01

bank rate would be roughly a quarter

17:03

of a percentage point higher over the

17:06

period. versus their previous forecast, and they

17:08

expect inflation to pick up to 2.6%

17:10

next year. And it's important to stress

17:12

this is versus the previous forecast, that

17:15

expectation around bank rate. So it's not

17:17

that rates are going to go up

17:19

from here. They still expect the Bank

17:21

of England to cut. It's just that

17:24

they'll cut a little bit less or

17:26

a little bit more slowly. But I

17:28

don't want to be too complacent. Like

17:31

I think this budget does represent a

17:33

genuine gamble, and there are risks here.

17:35

So the first one we've mentioned is

17:37

that there is very little headroom against

17:40

those fiscal targets, the fiscal rules that

17:42

the Chancellor has set. And in fact,

17:44

the OBR estimates that there's only a

17:47

54% chance that the government will hit

17:49

its fiscal mandate. So maybe that's one

17:51

reason that the markets have demanded a

17:53

higher yield for guilt, is that there's

17:56

a reasonable chance here, a coin flip

17:58

maybe, that the government's going to have

18:00

to come back and borrow more money

18:03

than they've said. Because they have committed

18:05

to certain things which they haven't specified

18:07

a date for it, things like increasing

18:09

defence. spending to 2.5% of GDP. That's

18:12

going to be really tricky to do

18:14

unless they get considerable growth ahead. They

18:16

haven't said when they're going to do

18:18

it, they just said at some future

18:21

fiscal event, which is pretty vague. But

18:23

if something like interest rates increase, that

18:25

increases the debt servicing cost, well, there

18:28

goes your fiscal headroom. And that's not

18:30

always under the government's control. But there's

18:32

another risk here, which again we kind

18:34

of touched on, which is the front

18:37

loading of spending. So if you look

18:39

at the budget. Day-to-day public service funding

18:41

is set to be almost 5% higher

18:44

this year than last year, and then

18:46

they've budgeted for it to grow another

18:48

3.1% in real terms next year. But

18:50

after that, for the last three years

18:53

of the Parliament, they've only budgeted in

18:55

a rise of 1.3% per year. That

18:57

seems tough given how threadbare public services

19:00

have been over the last 10 years.

19:02

And if that's unrealistic, unrealistic, if they

19:04

do have to spend more money to

19:06

stop real terms cuts to some departments.

19:09

Because remember, health spending is going to

19:11

have to rise by more than that.

19:13

As is welfare spending, probably. So that

19:15

would mean real terms cuts to a

19:18

lot of departments. So to avoid that,

19:20

they'd either need more tax rises, which

19:22

they haven't talked about, or they need

19:25

to go to the bond market and

19:27

sell more bonds. Yeah, the big gamble

19:29

here is growth. If they don't get

19:31

the growth, they're in real trouble, because

19:34

they've assumed they're going to get the

19:36

growth. And it may not materialise, or

19:38

at least it might take longer than

19:41

people expect, because a lot of these

19:43

effects are very long term. If you

19:45

improve infrastructure, it takes a while for

19:47

that to feed through into higher GDP

19:50

growth. And the OBR is negative on

19:52

growth. They forecast weak growth for this

19:54

whole parliament. There's a little bit of

19:57

a tick up over the next year

19:59

or two, as some of that front-loaded

20:01

spending comes into effect. But they don't

20:03

think this budget has a meaningful impact

20:06

on UK growth. by the end of

20:08

the five-year forecast. So the ABR is

20:10

forecasting that in 2030 at the end

20:12

of the period will have real terms

20:15

GDP growth of just 1.6% which would

20:17

be disappointing given how much money is

20:19

being spent here. Now I think one

20:22

of the things which I have issues

20:24

with is just using one forecast to

20:26

predict what's going to happen to UK

20:28

growth. Now we had a great conversation

20:31

with Sir David Spiegelholter. who has done

20:33

a huge amount to teach people about

20:35

basic statistics, inference, how statistics works, and

20:38

how modeling works, and a lot of

20:40

his work has been combining models and

20:42

trying to make your inferences better because

20:44

of that combination of different outlooks. And

20:47

I think one thing that the government

20:49

currently doesn't do is any kind of

20:51

model mixing, combining models, comparing different views,

20:54

to see what could happen in future.

20:56

And depending on just one forecast, the

20:58

OBR, I think is a step forward,

21:00

don't get me wrong, but I think

21:03

having multiple forecasts would be a better

21:05

way of doing it. Yeah, I really

21:07

enjoyed speaking to David, and the line

21:09

that sticks in my head from that

21:12

whole conversation is model combination is more

21:14

important than model choice, which is exactly

21:16

what you're saying here, because the OBR's

21:19

forecasts are pessimistic. And there are other

21:21

people forecasting what's going to happen as

21:23

a result of this budget who are

21:25

much more optimistic. The IMF is positive

21:28

and they see this budget as sustainably

21:30

raising revenue with a focus on boosting

21:32

growth, which is good. And I've seen

21:35

some research from Cast and Jung at

21:37

the Institute for Public Policy who forecast

21:39

significantly high growth in the OBR. So

21:41

I guess the question is why is

21:44

the OBR pessimistic, given that the government's

21:46

ramping up investment so much? Well if

21:48

you listen to what the government says

21:51

and what the OBR says, the phrase

21:53

that keeps on popping up from the

21:55

government is crowding in, whereas everything in

21:57

the OBR's report is crowding out of

22:00

private investment. That's a huge difference between

22:02

what the government... and what the OBR

22:04

says. The OBR doesn't say crowding in

22:06

once in their report. No, I read

22:09

that OBR report, and the first thing

22:11

that jumped out to me was that

22:13

you talk about maybe Reeves could have

22:16

borrowed more and invested more. That wouldn't

22:18

have made a difference to the growth

22:20

forecasts within this Parliament. Because their model

22:22

assumes the economy is near capacity right

22:25

now, unemployment's low, real wages are rising,

22:27

and demand is not particularly weak. they

22:29

basically offset any increase in public investment

22:32

against private sector activity. So yeah, Reeves

22:34

I don't think could have made these

22:36

forecasts look much better by ramping up

22:38

borrowing even more. But the thing is,

22:41

all of these assumptions are based on

22:43

something called the output gap, which is

22:45

the difference between current growth or projected

22:48

growth if you like, and a rate

22:50

at which you assume the economy could

22:52

grow. And basically, if you ask 10

22:54

different economies, you'll come up with 12

22:57

different answers on what the output gap

22:59

could be. If only we had a

23:01

prize-winning economist to speak to right now

23:04

and not. Steady. Don't be too modest.

23:06

You are a prize-winning economist now. Yeah,

23:08

because I love economics so much. Are

23:10

you going to have to stop slanging

23:13

economist off? No. But look, the overall

23:15

picture, I think, is one of an

23:17

OBR which is too gloomy. a very

23:19

strong set of assumptions in their outlook,

23:22

which is based on this view about

23:24

the output gap. And I think it

23:26

would add a lot if we had

23:29

other forecasters included into the forecast. Imagine

23:31

how controversial get though, if you sort

23:33

of override the OBR to some degree

23:35

by mixing in more optimistic models. Whether

23:38

markets are going to like that, I

23:40

don't know. I agree from a statistical

23:42

point of view, it makes sense to

23:45

have a range of forecasts. But economics

23:47

is so subjective that I think if

23:49

you don't have more than one model,

23:51

it's very misleading. But don't you think

23:54

the clues in the title right, office

23:56

for budget responsibility? That sort of implies

23:58

they should be a little bit pessimistic.

24:01

stick a little bit cautious and conservative

24:03

and not let the public finances have

24:05

too much of a risk of runaway

24:07

debt. Yeah I think that's true but

24:10

if you're going to ask Eor his

24:12

opinion on what the budget's going to

24:14

mean you want to ask Tigger as

24:16

well. I like that I'd ask I'd

24:19

ask owl. Owl as well but not

24:21

poo I mean he's just so stupid.

24:23

But even if we are only asking

24:26

Eor I want Eor. to be competent.

24:28

And there was a pretty big oversight

24:30

from the OBR, which did materially affect

24:32

what Reeves was allowed to do in

24:35

the budget. So, as we said, she

24:37

changed the fiscal rules to a kind

24:39

of looser on this personuffle thing. And

24:42

ahead of the budget, everyone said, if

24:44

she does this, it's going to buy

24:46

her a huge amount of headroom, something

24:48

like 50 to 60 billion pounds of

24:51

headroom. And everyone was saying, if she

24:53

spends that all at once, markets are

24:55

going to freak out. And then we

24:58

came to the budget and she did

25:00

change the fiscal rules and there was

25:02

no headroom left. Did she spend all

25:04

this money? A crazy amount of money?

25:07

Well, no she didn't. And the reason

25:09

why is because the OBR said, oops,

25:11

my bad, that 60 billion I said

25:13

last time was going to be the

25:16

headroom. It's actually more like 40 billion.

25:18

Sorry, there's 18 billion missing. And when

25:20

I say they owned up to it,

25:23

they squirled it away in a little

25:25

footnote at the bottom of one of

25:27

their pages. It took Bloomberg to point

25:29

it out, didn't it? Yeah, that was

25:32

awful. But maybe that's one of the

25:34

reasons why the market reaction was relatively

25:36

negative, is that they saw the fiscal

25:39

target change and yet there's no headroom

25:41

left. Yeah, that was atrocious. And the

25:43

fact that it was just a footnote,

25:45

they should have fessed up big time.

25:48

But I couldn't believe that it wasn't

25:50

even in headlines even in headlines after

25:52

that. But coming back to the mixture

25:55

of forecasts, I think the other notable

25:57

one was from Moody's, which was quite

25:59

pessimistic. Yeah, I think that... added to

26:01

the worry a little bit, didn't it?

26:04

Moody said, in our view, the increase

26:06

in borrowing, which is in part supported

26:08

by a new measure of debt under

26:10

the fiscal framework, will pose an additional

26:13

challenge for what are already difficult fiscal

26:15

consolidation prospects. They're basically saying that there

26:17

is a risk that debt could get

26:20

out of control here, if growth doesn't

26:22

come. Yeah, so I'd say that's a

26:24

bit pigletish and still a bit miserable.

26:26

Because if you look at what the

26:29

US has done. and they've got quite

26:31

a lot of crowding in. Moving chip

26:33

manufacturing back to the US that's employed

26:36

lots of people, thousands of people, and

26:38

I think it's a very positive thing

26:40

for the US to do. Plus they've

26:42

got all of the infrastructure spending which

26:45

has also boosted their growth. A large

26:47

part of that, if you look at

26:49

some of the analysis of it, is

26:52

due to crowding in. So they haven't

26:54

seen huge amounts of crowding out, they

26:56

have seen crowding in. So they've created

26:58

these incentives for companies to invest, that's

27:01

part of it, but also direct subsidies.

27:03

So that's what I think has been

27:05

very effective in the United States, and

27:07

I think we can replicate that here

27:10

too. But if you ask the Office

27:12

for Budget Responsibility, they'll just say, well,

27:14

it'll take ages to pay off. Yeah,

27:17

and when you say ages, really, we

27:19

do mean ages. So they forecast. a

27:21

1.4% boost to annual GDP growth. Wohoo,

27:23

that's pretty damn good, but not really

27:26

kicking in for almost 50 years, like

27:28

the 2070s they think you'll get up

27:30

to 1.4% boost. And if you look

27:33

at the graph, there's a massive error

27:35

around that. Which is fair, like who

27:37

knows right? And I don't want to

27:39

be too negative on the OBR. I

27:42

don't think it's out of the question

27:44

at all that we have weak growth

27:46

going forward. Like we've had weak growth

27:49

for the last 15 years for the

27:51

financial crisis since the financial crisis. To

27:53

believe it's going to change now, I

27:55

think comes down to do you think

27:58

the government is going to spend that

28:00

money well. Just looking at those seven

28:02

pillars of growth that we've announced, I

28:05

think, yeah, that sounds quite promising. It's

28:07

a sort of Keynesian wish list. Any

28:09

Keynesian will say, yeah, that's the stuff

28:11

which should fix the growth problem. I

28:14

saw that Kier Stammer was asked, well,

28:16

why is the OBR's growth forecast weak?

28:18

And he basically said, well, all the

28:20

reforms we're bringing in are entrained, but

28:23

haven't been modeled yet by the OBR.

28:25

And the big one being planning reform,

28:27

where Starmer says, and I quote, a

28:30

big build. could become as transformative for

28:32

working people as the big bang was

28:34

for the city of London in the

28:36

1980s. Plus I think devolving some of

28:39

the decisions to local governments to regional

28:41

mayors I think that's a good idea

28:43

because they've probably got a better idea

28:46

of how to spend it than central

28:48

government. So a lot of it I

28:50

think is not tangible not something you

28:52

could enter into a model but I

28:55

think promising. There would also be a

28:57

lot of upside from tax reform and

28:59

simplification. deregulation of certain industries may be

29:02

and you know the big one which

29:04

we're never allowed to speak about closer

29:06

trade links with the EU would be

29:08

helpful. Which they won't go whole hog

29:11

with of course because that would reverse

29:13

Brexit but they are taking baby steps

29:15

in that direction. But in terms of

29:17

public investment I think there's a thinner

29:20

line between day-to-day spending and investment spending

29:22

that you might imagine. Labour is obviously

29:24

going to come under pressure from unions.

29:27

and NIMBs and lots of other narrow

29:29

interest groups to direct a little bit

29:31

of cash their way or to stymie

29:33

the reforms, they need to find a

29:36

way of spending that money to boost

29:38

productivity and to get the private sector

29:40

to come with them. That's the big

29:43

challenge. And moreover, they need to find

29:45

a way to keep the market on

29:47

side because although we've been a bit

29:49

dismissive of bond vigilantes today, they can

29:52

cause a problem if your borrowing costs

29:54

do rise fast fast. then obviously you're

29:56

going to breach your fiscal rules because

29:59

your debt servicing costs will be really

30:01

high and you just won't be able

30:03

to borrow to fix the problems. I

30:05

mean, look back on the sovereign debt

30:08

crisis in Europe, and I think the

30:10

peripheral spreads widening was justified. There was

30:12

profit spending, and people didn't care about

30:14

debt to GDP, but markets did. So

30:17

I think this error correction mechanism that

30:19

you get in the bond market is

30:21

not necessarily a bad one, and I

30:24

think it's a rational one from the

30:26

point of view of the bond investors,

30:28

and it keeps governments in check, which

30:30

itself is a good thing. But if

30:33

you do get a dose of bond

30:35

vigilantes, then the aftermath can be incredibly

30:37

painful and very long-lasting. I was looking

30:40

at a graph of unemployment in Greece

30:42

recently and it was very high for

30:44

such a long time. So I think

30:46

it's difficult to overestimate how much pain

30:49

economic pain Greece has felt as a

30:51

result of those economic decisions in the

30:53

early 2010s. So once you do fall

30:56

foul of them, Yeah, you can certainly

30:58

feel the pain. And this is a

31:00

very powerful force. Feels like we've not

31:02

thought about that force for quite a

31:05

long time, since the sovereign debt crisis

31:07

in Europe probably. Is that because QE,

31:09

quantitative easing, kind of killed off the

31:11

bond vigilantes, right? If the central bank

31:14

is buying bucket loads of the government's

31:16

debt, well, bond vigilantes don't really have

31:18

enough fire power to push up yields.

31:21

But now central banks are selling government

31:23

debt. We've got QT the opposite. Does

31:25

that give more of an opening to

31:27

bond vigilante if they believe the government's

31:30

being too profligate? I think so. But

31:32

only if they very rapidly sell. And

31:34

of course you're assuming that bond vigilantes

31:37

exist. I'm not convinced they do. You've

31:39

just got boring fund managers sitting on

31:41

a pile of debt just thinking, oh,

31:43

am I going to lose more money

31:46

on these guilt? I know that you're

31:48

not a bond vigilante. You're kind of

31:50

the opposite, right? You were hoping guilt

31:53

yields rise further so you could buy

31:55

bonds. Yeah, I was hoping there was

31:57

going to be a big sell-off in

31:59

guilt, but it was a... very disappointing.

32:02

It was tiny in magnitude and it's

32:04

still not attractive relative to something like

32:06

a money market fund. So yeah, I

32:08

just was very disappointed. I thought this

32:11

would be an opportunity to fill my

32:13

boots with guilt, but no. For governments

32:15

looking for a new head of

32:17

the Bank of England, someone who

32:20

will institute fish depression. Robin is

32:22

yeah, no, you're going to step

32:24

in, by by by. But I think that's

32:26

a natural safety valve if you reach

32:28

something like 5%? then yeah at that

32:30

point it becomes really attractive to

32:33

buy gills and that would probably

32:35

slow the sell off considerably. Now

32:37

you've probably noticed that

32:39

we've been talking about whether it's

32:41

worthwhile buying gills and a question

32:43

that crops up a lot at

32:45

the moment is when it's going

32:48

to be worthwhile switching from money

32:50

market funds to gills. Join that

32:52

conversation, discuss it with us and

32:54

you can do that as part

32:56

of our membership. to learn more

32:58

just go to pensioncraft.com slash membership.

33:00

Okay, today's dumb question of

33:03

the week. Does public investment

33:05

crowd out or crowd in

33:07

private sector activity? Now we've

33:09

said that in terms of modeling

33:11

the implications of this budget

33:14

on growth, the key question is

33:16

whether you believe an increase in

33:18

spending from the government is

33:20

going to squash the private sector

33:22

or actually boost the private

33:25

sector. What do you reckon? So let's

33:27

begin with what crowding out and crowding

33:29

in is. Perhaps we should have said

33:31

that earlier. But the idea is that

33:34

if the government spends a certain amount

33:36

of money on the economy, the

33:38

question is, will the private sector

33:40

also chip in? Or having seen that

33:43

the government's spending on this

33:45

infrastructure say, will they stop spending?

33:47

So they'll be crowded out. And

33:49

there's a big debate about which of

33:52

those happens. Clearly the OBR

33:54

favours the crowding out

33:56

hypothesis. If you look at the White

33:58

House and the US. seeing what's happened

34:01

with their stimulus. Yes, it

34:03

seems as if the private sector

34:05

has crowded in and spent in

34:08

infrastructure alongside the government, but it's

34:10

not a clear-cut thing. But it really

34:12

boils down to working out whether

34:14

the economy is running it close to

34:16

capacity. And that itself depends on

34:18

something called the output gap. Yeah,

34:20

I think it's fair to say there's evidence

34:23

for both these things. They can both

34:25

happen. It could be crowding out and

34:27

they could be crowding in, depending on...

34:29

where we are in the economic cycle,

34:31

and whether there's room in the

34:33

economy in effect for the government

34:35

to spend more without having to

34:37

suck resources away from the private

34:40

sector. So let's take the scenario where

34:42

the economy is at or near capacity.

34:44

If the government increases public

34:46

spending, how does that cause crowding

34:48

out? Well one way is it

34:51

generates higher interest rates, which as

34:53

we know depresses private sector investment,

34:55

as an aside there. private savings in

34:57

the economy are more likely to be

35:00

going into buying government bonds rather than

35:02

funding private sector investment with

35:04

higher rates. There's also increased competition

35:06

from the government for resources, for

35:08

workers, for one, for raw materials,

35:10

all this stuff, and therefore there's

35:12

less for the private sector to work with.

35:14

And also if the government's piling into certain

35:17

markets, like if they set up a state

35:19

bank or a state healthcare system, these things

35:21

might be good, but there's therefore increased

35:24

competition competition against... private

35:26

companies in those sectors. So that's

35:28

the kind of theory of crowding

35:30

out. Those kind of effects working

35:32

together to mean that the government captures

35:35

a bigger share of the economy

35:37

at the expense of the private sector.

35:39

Now the idea with crowding in is

35:41

that it assumes that there is some

35:43

kind of output gap. In other words,

35:46

actual GDP is well below something called

35:48

potential GDP, you wonder. Well,

35:50

it's something which is estimated

35:53

by economists. based on historic

35:55

rates of growth. You might

35:57

also look at things like...

36:00

capital stock, how much of existing

36:02

capacity is utilized. You could look

36:04

at the labour force, you could

36:06

look at wage growth. All of

36:08

these things would factor in to

36:10

this measurement of potential output, but

36:12

it is a very difficult thing

36:14

to estimate and there won't be

36:16

agreement on what the actual number

36:18

is. So that's why I think

36:20

anchoring your expectations about growth on

36:22

an imaginary number is difficult and

36:24

problematic and you need more than

36:26

one model to estimate it. But

36:29

let's assume that there is an

36:31

output gap and the economy is

36:33

running below capacity, maybe we're in

36:35

a recession, or a period of

36:37

very weak growth. What's this crowding

36:39

in then? So the idea here

36:41

is that companies will not be

36:43

operating at full capacity and that

36:45

there will be people in the

36:47

labour force who they can employ

36:49

to increase their output. And that

36:51

means that the stimulus will have

36:53

a bigger multiplier effect, if you

36:55

like. So every pound or dollar

36:57

that the government spends will have

36:59

a bigger effect on growth. So

37:01

that's the idea around a kind

37:03

of macro stimulus. There's more money

37:05

in consumers' pockets and in a

37:07

period of weak demand. That's good.

37:10

It's not going to lead to

37:12

very high inflation. And the other

37:14

side of the coin, I guess,

37:16

is that if the government spends

37:18

on building better infrastructure, things like

37:20

roads, energy infrastructure... broadband, all this

37:22

stuff, then that can improve productivity

37:24

and make businesses more efficient effectively

37:26

and can help grow the economy.

37:28

And there's also an element of

37:30

confidence here, so if you do

37:32

get the government spending, that can

37:34

improve business confidence and consumer confidence,

37:36

and that makes businesses and consumers

37:38

spend more, that's a little bit

37:40

more of a psychological animal-spirity type

37:42

argument. But I guess the question

37:44

of... Will you get crowding out

37:46

or crowding in? If we believe

37:48

it comes down to this assessment

37:51

of the economy and whether there

37:53

is spare capacity, whether there is

37:55

slack in the economy, that is

37:57

a judgment call. very hard to

37:59

make. It's interesting that the OBR's

38:01

model, when you look at real

38:03

wage growth, is forecasting it to

38:05

be very poor still. They said

38:07

the last parliament was basically the

38:09

worst real wage growth on record.

38:11

They think this parliament is going

38:13

to be the second worst. It's

38:15

just marginally better. We'll see, I

38:17

guess. I mean, let's hope the

38:19

OBR's wrong in that, but I

38:21

don't want to be too harsh

38:23

on them. Like, who knows? Economics

38:25

is not an exact science. But

38:27

I think the wrong response to

38:29

uncertainty is to do nothing and

38:32

that simply wouldn't have been acceptable

38:34

and things I think probably would

38:36

have got worse in terms of

38:38

infrastructure in the UK. And if

38:40

you live here, you realise how

38:42

bad things are. Even if it

38:44

all goes wrong, at least we'll

38:46

have a fast way to get

38:48

to crew. Thank

38:50

you for joining us for many

38:52

happy returns. Do send us your

38:54

questions no matter how dumb at

38:56

the email address, MHR, at pensioncraft.com.

38:59

And do remember to check out

39:01

pensioncraft.com for all the information about

39:03

our membership and investment coaching options.

39:05

Many happy returns is a pension

39:07

craft production. Co-hosted and executive produced

39:09

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39:11

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39:13

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39:16

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39:18

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39:28

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