Is the UK in a 'death debt spiral'?

The UK remains a very popular target for the world’s talking heads. Most prominent this week was Ray Dalio warning of a “death debt spiral”. The hedge fund founder and philosopher king has previous on the subject of debt. Nonetheless, his comments on the UK’s troubled outlook provide a good opportunity to tackle some of the key themes of the moment, in particular debt, demographics and the value of specialists.

Debt

Debt is understandably an emotive subject. There is little appetite to get to the nuanced nub of it amongst the commentariat, with reductive shock and awe invariably preferred. At the core of most misunderstandings of the subject is a neglect of the other side of the ledger. If we are indeed borrowing collectively from our future, who is lending from that same future?

The subtlety here is that if someone is being allowed to spend more than they earn now as a result of the loan, then on the other side of the transaction, the reverse must be true. Ultimately those roles will reverse as the loan is repaid.

Until we manage to syndicate debt intergalactically (strap in future Mars colonists), both sides of this transaction will live on earth. Put another way, the world’s liabilities have to match its assets. Furthermore, the ability to neatly divide earth’s creditors from her debtors and pitch them against each other is an illusion. We are all a mix of both, whether we know it or not - by some distance the largest owner of the UK government’s debts are the UK’s pension funds.

That doesn’t mean you can’t get in to trouble of course. Reckless borrowing/lending will always be a feature. Such recklessness can even be fuelled by the periods of calm, as Hyman Minsky famously argued. More often though, the problem is liquidity rather than solvency.

We know that money and all its many derivations are in essence a global confidence trick. A globally recognised (and respected) story that allows us to transact across borders and societies. That confidence can disappear fast, as we know from the devastating experience of the great financial crisis (GFC). As confidence slumped, investors switched from worrying about return on capital to return of capital. (Figure 1)

Solvency problems often follow as the financial system heart attack ricochets outwards. Apportioning the losses in the aftermath of these shocks tends to sap considerable economic, political and societal energy for years, even decades. In trying to predict such moments, a focus on levels of debt can be instructive. More often than not, it is a dangerous red herring.

For the UK specifically, there are clearly some challenges at the moment. Rebuilding public finances from the necessary largesse of the pandemic will take time. On current evidence, investors appear minded to grant this government that time. The repricing of US interest rates, amidst evidence of stronger growth, is having a knock-on effect to UK borrowing costs. However, there is no sign of disorder or disfunction in markets and indicators of stress appear benign so far.

It doesn’t take much imagination to see that the years following the GFC may be an inappropriate template to apply to the UK’s next decade or so. The opportunity provided by the technological frontier is just one of the differences. That has important implications for how much hair you should shed worrying about debt and deficits - The long-term path of the debt stock is minutely sensitive to your trend growth assumptions for the UK. If, say, the UK economy managed to use the gathering technological revolution to return to its post war pre GFC growth rate, the public debt could conceivably vanish as a percentage of GDP in little over half a century (in the unlikely event that policy makers could find no use for further borrowing).

Demographics

Another returning favourite of the doomers is the ageing society. Much like debt, this subject provides fertile ground for those looking to generate maximum impact from minimum thought. Going back to first principles, we need to move away from the idea that our chronological age, or even the number of fellow earthlings within certain brackets of chronological age, are useful pieces of information.

For that to be the case, we would need a firmer grasp on how life expectancy, health, later life physical and mental vitality will all evolve. We should be less sure of those things than we’ve ever been in the context of the incoming biomedical revolution. If we are looking for areas of current market debate that could turn out to be wasted breath, demographics is right up there with decimal places on growth and inflation data.

BUT…

Perhaps less time worrying about demography and more on the increasing political encroachment of the Broligarchy would be wise for long term investors. We’ve flirted with this problem in many guises down the years. There are periods of development when political and business leaders joined at the hip can make rapid strides. However, history also speaks of caution.

If politicians become more open to capture, you change incentives for your all-important entrepreneurs. Such individuals face a choice between making their money through “exploitation of political opportunities that increase their share of income without increasing (or even reducing) the overall level or getting rich by the socially beneficial exploitation of technological or commercial opportunities.”[1] In many ways this was the victory won by the European enlightenment and the institutions that were constructed in its wake. Entrepreneurs switched in ever increasing numbers to the latter, as the former became less profitable.

Some would argue further - The failure of the world to generate net progress for the thousands of years running up to the industrial revolution was a function of insufficient shackles on the political ambitions of entrepreneurs. There were spurts of progress, but they mostly died on entrenched interests. The entrepreneurs of their time were ultimately able to get rich enough to acquire political and thereby regulatory power. Ultimately, they were incentivised to keep things as they were rather than giving the next batch of innovators the space to continue upending the economy as they had before them. Stagnation returned.

With regards to today and the best use of our precious fellow humans, it is surely a greater respect for the work of specialists and those looking for more than glib social media wins. As the world gets wealthier and more connected, the number of wealthy and successful people is happily multiplying.? However, there doesn’t have to be a correlation between wealth and wisdom (apart from those reading this article of course).

That is not to talk down on the brilliance of entrepreneurs. As finance legend Aswath Damadoran wryly observed – if the world were run by actuaries, we would still be in caves. Progress is founded on the necessary overconfidence and bravery of entrepreneurs reaching for the moon. However, it is worth remembering that wealth, status, and wisdom are often best scored separately from each other. They can come as a package in certain individuals, but that may be simply good fortune rather than a necessary condition for their success.

The reminder here is that the global economic setting remains attractively poised for the diversified investor. Be sure to abandon your playbook from the pre pandemic years. There is no requirement for the same assets to win and lose. The valuation starting point is in many cases quite different, as is the world economy they reflect. (Figure 2)

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*This article is for information purposes only. It is not intended as a product offer or investment advice

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