The Chancellor has set out what he hopes is a realistic roadmap through to the next stage of the worst economic crisis in three centuries. Naturally, the Government’s first concern had been around protecting people and they are now focused on reinvigorating employment. But very soon this too is going to change and the need for sustainable economic growth is going to become all-consuming. Here the challenges are perhaps even more intractable.
Estimates vary, but the Government has already spent in the order of £166 billion fighting the virus, through programs ranging from furloughing workers to bounce-back loans, to plans to improve employment and encourage consumer spending. This level of activity is only possible as more or less every other developed economy is following a similar path and central banks are directly or indirectly financing this spending spree. But just as Covid itself was exceptional, so too are the circumstances which are making this scale of state spending possible, and soon enough the Government is going to have to square a very difficult circle: avoiding austerity, staving off tax rises, and retaining a good degree of fiscal credibility.
It is instructive to look back into history and look at how the post-war debt was paid off. A long-term program of growing the size of the state less rapidly than the economy itself saw debt-to-GDP levels fall from 243% in 1947 to 21.5% in 1991. However, in looking to repeat this plan there is a source of significant uncertainty: the assumption that we will have a long period of sustained economic growth of the sort we experienced in the 1950s and 1960s. While such an outcome would be extremely welcome, a far more credible approach to tackling our debt would be to put forward a plan that paid it off in less than ideal circumstances, as well as under more optimistic economic scenarios.
A credible approach would first of all set out limits to the amount of debt, ringfencing the issuance in order to demonstrate that the Covid debt was exceptional, not a waypoint to some sort of profligate new normal. Covid debt, eventually likely to amount to something like £200 billion, would therefore be gathered together and a line was drawn that this was the end of programs to be financed through these exceptional circumstances. A specific series of securities would then be set to fund this debt. Let’s call them Sunak Securities. Then comes the innovation: these would be 50-year securities and crucially, unlike normal gilts, they would amortise. That is, they would simultaneously pay back interest and principal.
Such an approach would mean three things:
Firstly, there is a cost. Yes, as principal is being repaid, annual repayment costs would be higher than they would be otherwise. However, the UK government presently has run up debts of £1,822 billion (before accounting for Covid 19), the interest alone on this debt costs £42 billion per year, an average interest rate of 2.3%. Compare this to the cost of an amortising security in today’ markets. A straightforward amortisation schedule would mean that £200 billion would cost £4.5 billion a year for 50 years, so the annual cost of servicing this debt, depending on the interest rate, would be 2.2%. Sunak Securities would cost the taxpayer less than the interest being paid on the present stock of debt and at the end of their life, Sunak Securities will have been repaid in full.
Sunak Securities would attract international credibility. During this crisis governments around the world have been adding to the burden of debt by more than $2 trillion a month. At the moment at least, few politicians seem concerned about how this money is going to be repaid. Savvy investors are not so sanguine. Presenting investors with a debt plan whose sustainability does not rest on hopeful assumptions about future economic growth or crippling taxation is not just something that is nice to have, it would become the critical differentiator. A credible repayment plan also allays the other unspoken fear. As it becomes apparent that traditional debt repayment plans might not be sustainable, governments might be tempted to engage in financial repression, concocting rules which effectively force investors to finance debt at below market rates.
Finally, investors would love Sunak Securities. Interest rates – and with them investment yields generally – have fallen to levels never imagine as being possible, let alone sustained for more than a decade. And this has happened at a time when the developed world is ageing and ageing populations are after income, not growth. One of the many implications of this is that insurance companies and pension funds are ever keener on safe instruments that give them a useful yield. Sunak Securities, paying out 2.2% per annum would be the ideal low-risk instruments for income-hungry insurance companies and pension funds.
Finance ministers over the centuries have sought innovative ways for the state to continue to borrow well beyond any level of prudence. It never ends well. Sunak Securities would be an orderly and credible way to tackle the expense of a once-in-a-lifetime Covid pandemic, placing debt on the most sustainable of all paths, keeping any rises to the tax burden in check and giving investors a higher and more certain income stream. Although he has been in office for less than six months, the Chancellor is already showing the country that he is willing to be creative. Now is his chance to show his financial creativity and credibility to the world.
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