Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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October 29, 2023

Money Delusions & Crowding Out


The present has been persistently improved at the cost of the future. Dealing with public debt has always been the next politician’s problem. Yet now, toward the later stages of a long-term debt cycle, we’re beginning to reach the point where the problems are materialising in the present. Lyn Alden, Broken Money: Why Our Financial System is Failing Us and How We Can Make it Better.

In times of rising geopolitical tension, investors seek safe havens, such as sovereign bonds and precious metals. Not surprisingly, the gold price has been rising in recent weeks and looks poised to move to new highs. However, Treasury bond prices have moved lower (their yields have increased) despite the heightened geopolitical tensions and growing noises from the Fed that their policy tightening is starting to work, and their rate pauses are set to continue.

Critically, investors know that the world’s supply of gold will barely change from the 2-3% pa of the last few millennia but have grown fearful of the rate of future bond issuance. Bond market vigilantes have taken over from the central banks and continue to tighten financial conditions by pushing yields higher. Investors need higher yields in compensation for their increased supply. The Treasury and the UK’s Exchequer have an incurable debt dependency, risking their loss of control of the yield curve. Welcome to the world of fiscal dominance and crowding out, and prepare for the world of financial repression.

In her book Broken Money, Lyn Alden gives a clear account of how we got to this point from the perspective of a trained systems engineer and investment strategist who lacks the ideological biases one might expect from a trained economist. She says that our current problems started when we ditched the hard money of the gold standard and transitioned to modern diktat, or fiat money, a period from 1913 (the establishment of the Federal Reserve) to the ending of full Dollar convertibility in the teeth of the Vietnam War in 1971. Subsequently, we have been in the era of what she terms fiat ledger entropy, characterised by monetary inflation (currency debasement) and an ever-larger debt dependency. Successive politicians have kicked so many cans down the road we have reached the point where we get buried in aluminium.

Ryan Bourne said in the Times last week, “To avoid forecasting catastrophe, modellers have to assume that politicians eventually will slash spending or raise taxes to avoid an explicit default or an implicit one.” But how can we be sure this will happen? Politicians need to get reelected, and after a period where interest rates approximated zero for over a decade, we have built a legacy of half-buried deceits and delusions that are now revealing themselves under the pressure of hugely increasing borrowing costs.

HS2 is a case in point. Approved initially to carry passengers at high speed from London via Birmingham to Manchester and Leeds at an estimated cost of £32bn, it seemed like a courageous project to assist with the UK’s Northern Powerhouse initiative (which predated levelling up), and Parliament voted it through by 350 votes to 35. Fast forward a decade, and the project will only ever get one-third finished for an estimated £53bn, which will make it the most expensive high-speed rail line per mile ever built.

However, the delusion of HS2 is nothing compared to the misallocation of capital and mal-investment caused by the enforced energy transition, enshrined in the UK government’s commitment to net zero carbon emissions by 2050. HS2 had costings attached that went up progressively until all contact with the concept of cost-benefit analysis was lost. In contrast, our legally binding agreement to reach net zero in twenty-seven years has no agreed or reliable costings attached to the legislation. It is the ultimate “ends justify the means” spending commitment that carries the can for its extreme can-kicking credentials.

Free money has permitted many popular delusions, and the normalisation of rates has yet to surface many of them. But this situation will change as government debt servicing costs escalate.

Also, in the Times last week, economist Stephen King pointed out in his article Surging inflation exposes the truth about West’s fiscal incontinence, that “There are only so many ways out of this “debt trap”… boosting growth (and, hence, the debt denominator) via either targeted infrastructure projects (step forward, Sir Keir Starmer) or tax cuts (take a bow, Liz Truss)…(or) a sustained dose of austerity. Default is a third option. A fourth is what is often known as “financial repression”. Regulations are changed to allow governments to jump to the front of the credit queue.”

As sovereign bond yields rise, private demand for capital becomes crowded out. The UK equity market has seen twenty-seven months of capital outflows partly because higher-yielding “safe assets” have become too tempting for investors to ignore. Absent a credible economic growth plan, the crowding-out will have to be enforced by stricter regulations of our savings and investment activities, condemning the stock market to a lower return environment and UK-listed companies to a higher cost of capital for many years to come.


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