November 24, 2025 • 58 mins
UK consumers used to save very little — now they’re saving a lot, perhaps too much. Why? Kallum Pickering, Peel Hunt chief economist, joins host Merryn Somerset Webb to explain. He points to a “wealth shock”: when gilt yields surged in 2022, pension values fell sharply. At the same time, mortgage rates climbed and house prices stalled.
This shift matters. It’s one reason the UK economy remains sluggish. But it’s not the only factor — our strained public finances and the sheer size of the state also play a role.
Can it be fixed? Kallum thinks so. He shared his long-term ideas for turning things around — and even offered a few suggestions for Chancellor Rachel Reeves.
Correction: At the end when Kallum discusses financing pensions, he refers to a policy that includes a one-year tax cut for young people at £2,000. That is incorrect. His calculations account for £2,000 cuts for years one and two for pensions, and £1,000 cut in healthcare. It starts for everyone at age 20 but anyone under 40 would get the chance to partake.
See omnystudio.com/listener for privacy information.
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Episode Transcript
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Speaker 1 (00:02):
Bloomberg Audio Studios, podcasts, radio news. Are you a Bloomberg
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Money Distilled. Yours get access to all the brilliant reporting
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onto the show. Welcome to Meren Talks Money, the podcast
(00:34):
and most people who know the markets explain the markets.
I'm Meren Sumset Web. This week I am speaking with
Callum Pickering Peel Hunt, chief economist. How close are we
do an economic crisis in the UK? If you ask me,
I say closer than we've ever been in my career
of the financial journalist. If you ask Cullum, not quite
as close as it feels to me. He argues at
the nation and particularly the government, just don't fully understand
(00:56):
the nature of the problem with the UK economy. In
a recent research note titled why is UK Growth Sluggish?
Callum lays it out his thesis. We talked about that
note in this conversation, as well as getting his take
on the upcoming budget. What exactly is going to happen? Callum?
Welcome back, to myrin drugs.
Speaker 2 (01:13):
Money, my pleasure. Thank you so much for having me.
Speaker 1 (01:16):
Right, and we're gonna have one of our usual super
upbeig conversations about the UK economy and UK politics.
Speaker 2 (01:22):
Right, that's right. Well, you know, I'm always trying my best,
at least to just not be counter narrative on purpose,
but just to kind of question the narrative a little bit.
The last one, of course, everybody was focused on the
price of energy. I tried to make my case that
it's really the supply. This time around, I've taken issue
with two things. The first is the idea that the
economy is stagnating. It's actually not stagnating. Has some issues,
(01:46):
but stagnation is not the right word. And second that
the problems are uncertainty and confidence. I consider these to
be symptoms of a problem rather than the problem in
of itself, And in this this lady's piece of research,
I've tried to unpick some of this a little.
Speaker 1 (02:01):
Okay, well, let's start at the very beginning. When you
say it's not stagnating, what is it that you mean,
Because you know, growth rate of under two percent for
quite some time, that looks like stagnating to me.
Speaker 2 (02:13):
So UK potential growth is probably in the sort of
mid one to two range. Let's get I think it's
probably around one point six one point seven percent. If
I look at the last two years of UK economic
performance so late twenty twenty three, which roughly coincides with
the normalization of the acute gas supply shock in Europe
and the Bank of England stopping graizing interest rates, We've
(02:35):
had annualized economic growth since then of one point seven percent.
It's been predominantly driven to my by domestic oriented services. Now,
this is not stagnation over say a full business cycle.
If you had the normal fluctuations with growth above two
for a while and then a period of recession, I
think we'd be somewhat happy with this. To put it
(02:57):
into context, between twenty ten two nineteen, growth was two
point one percent annualized, with with bit better growth on
things like exports and industry. But I think there's a
kernel of truth, at least from the market's perspective, in
the view that the economy is stagnating for the following reason.
When I look at the components of this one point
(03:18):
seven percent growth, what I see is a big expansion
in government spending and declines in cyclical sectors like new
housing construction, like durable goods expenditure, like broad construction in
the private sector, which suggests to me and I call
this kind of the flat white economy, the steady state,
people buying coffees, people paying their bills. That stuff is
(03:42):
actually ticking over, okay. But the cyclical bit of the economy,
which markets tend to look forward to, which companies need
to react to by raising capital in order to then
do a little investment, that bit is actually not stagnating,
but in many respects it's in decline. And I think
the crux of the economic problem lies in trying to
better understand why we have this absence of cyclicality right
(04:06):
at the start of an economic cycle. And I put
this on fiscal policy makers. I say that the policy
makers fundamentally are lacking the credibility to get benchmark interest
rates to where economic fundamentals need them, and because they're
obstructively high, probably to the tune of about one hundred
basis points on the ten year, we are crowding out
(04:28):
these cyclical parts of the private sector. And this is
essentially the heart of the issue that the UK's facing
and why these budgets matter so much.
Speaker 1 (04:37):
Okay, we're going to come back to your three points
on why you think the UK economy is sluggish, if
not stagnating, But I do want to make the point
before we do that that you're looking at GDP as
a whole, and a lot of our listeners very interested
in looking at population adjusted. So it's GDP per head
and if you look at GDP per head, as you know,
this is barely budged for years, and that is stagnant.
Speaker 2 (04:58):
Well, I have to push back on that again. If
I look at the living standards of workers, so real incomes,
real wages, they're rising nicely and have been for three years.
It pays to work in the UK. What we have
is a problem integrating new immigrants into the labor force,
and therefore we have this ratio of output to population
(05:22):
which is unchanged. But within that what you see is
for workers, living standards arise in and for people that
are not participating in the labor market, living standards are declining.
And so the problem is not that we are not
producing a means to raise living standards in the UK.
It's that actually we are not properly integrating people into
(05:42):
the labor market so that more and more people can
participate in that wage story and lift per capita GDP okay.
Speaker 1 (05:49):
So it's rising levels of non participation as opposed to
stagnating levels of productivity.
Speaker 2 (05:54):
Per worker wages per worker. We have to be a
little bit careful with the productivity statistics at the moment.
But for wages in the UK, inflation adjusted wages have
been growing at a nice clip for the past two
to three years. If I look at real disposable income
for the household sector as a whole, we've had faster
growth over the past three years, about one point eight
(06:15):
percent year over a year, than we have had in
the whole post GFC period. You have to go back
to the pre Global Financial Crisis period and this is
where you start to find some of the signs to
what may be going on. So we've had this rise
in real disposable income for the household sector since twenty
twenty two, which is which is when inflation, of course
(06:37):
peaked at eleven percent and it's come down.
Speaker 1 (06:39):
Do you know I'm going to interrupt you sorry, kind
of briefly say that not all of our listeners are economists.
So when you say real disposable incamp per household. Can
just break that down for us and explain to listeners
what is is you, This.
Speaker 2 (06:52):
Is the total amount of income which can be spent
post tax, adjusted for prices. So we have had this
rise over the past three years, but since twenty twenty
two we've had a doubling of the savings rate in
the UK from about five percent to ten percent. Now
what's important to understand here is that conventional wisdom, which
(07:16):
is households are saving more because they're uncertain about the future,
they're lacking the confidence to spend, does not fit the
fact on a relative basis. So what I mean by
that is, suppose you were to compare the UK household
to the US household. US households are saving just four
percent of their income compared to ten percent in the UK,
(07:37):
and we, of course have had this increase both sectors,
both household sectors have had a nice increase in inflation
adjusted incomes. What I don't see is additional weakness in
British confidence versus US confidence. If I look at things
like the index of economic pulsy uncertainty of course, with
trade wars and the uncertainty around Trump's policy agenda. We
(08:02):
report more uncertainty in the US than in the UK,
so the facts don't fit the picture that confidence and
uncertainty explain this saving trade isn't.
Speaker 1 (08:11):
One of the important things here that there is not
a regular expectation in the US that there will be
a consistently rising tax burden, whereas in the UK we've
had for the last three or four years a constant
expectation of a rising tax burden. And that's particularly relevant now.
So that's one big difference between the US and the
UK in terms of individual continence.
Speaker 2 (08:32):
No, I don't think so. And actually, if I just
think about the size of the deficit in the US,
the fiscal deficit, it's sevenercent of GDP, it's actually almost
twice what it is in the UK. And at least
in the UK's instance, it's likely to decline over time,
whereas it's likely to remain around seven percent of GDP
In America. That deficit is a signal that at some
point taxes have to go up. For Americans, that's a
(08:54):
much stronger signal in the long run that taxes need
to be adjusted upwards.
Speaker 1 (08:58):
Sure, but that what ordinary people listen to. They listen
to the political conversation as opposed to looking at the
size of the deficit. If we're thinking about the ordinary person,
not the economist, not the professional investor, not someone who
understands the bond market, not someone who looks at how
bigger deficit is or isn't. What they're looking at is
the political conversation. And here the political conversation is all
(09:21):
about your taxes are going up, And in the US
the political conversation is absolutely not like that. Of course
you live in.
Speaker 2 (09:28):
New I suspect that part of the story maybe that
people anticipate taxes going up, but there's just something much
more fundamental taking place, which is since twenty twenty two,
UK household net wealth has declined appreciably. In the US
it's up almost fifty percent. And what you find is
in credit based economies, consumer oriented economies like the US
(09:51):
and UK, trends in household spending are influenced greatly by
trends in household net wealth. So take the experience in
the UK, for instance, ten twenty nineteen, we had a
dramatic appreciation in house prices. We had a dramatic appreciation
in guilt, which is what drove interest rates down over
(10:12):
that period we also saw actually quite a decent rally
sustained rally in UK equities. This supported net wealth and
it meant over that period, even in the ghastly uncertainty
of the post financial crisis period, when in twenty twelve
we had a horrible budget, the Omni shambles budget, with
(10:35):
the weak confidence and the uncertainty, and in the wake
of the Euro crisis, UK households were reducing their savings
rates with weaker income growth because in net wealth terms
they were becoming much better off. So when you had
this dramatic upturning net wealth, you had this corresponding reduction
in saving This time around, you see from twenty twenty
(10:55):
two onwards, roughly coinciding actually with the big fiscal event
which was the Trust budget wobble in the bond market,
you have this crash in household net worth to the
tune of a trillion pounds, mainly in pensions, coincide with
this sudden adjustment upwards in the household savings rates. So
what I maintain here is we try to apply narratives
(11:18):
about uncertainty over taxes, uncertainty over economic policy confidence which
I can't spot a clear trend in the fact. But
then I see this very clear fact in front of me,
which is households are actually poorer in net wealth terms
in the UK, they've responded by saving more. In the US,
where we often see similar patterns of household behavior, households
are saving much less, but they've had a dramatic increase
(11:39):
in net wealth, which means households are rational. They are
reacting to being poorer by saving more. This is why
this fiscal problem that we have comes at such a
bad time, and we should get into a conversation about
what is underpinning higher interest rates in the UK. But
these higher benchmark rates versus what you would act expect
(12:00):
given economic fundamentals and given rates in other countries, are
holding back asset prices by pushing mortgage rates, by holding
down the underlying value of the bonds, and by forcing
equity analysts to apply a discount rate that is higher
than it ought to be to equities.
Speaker 1 (12:18):
Okay, so most people will recognize that fall in their wealth.
I mean, if you look at the shifts in the
bond market, a lot of people will feel that only
through their pension portfolios, right, and not everybody looked at
their pension portfolios. Not everyone will be aware of that shift,
but enough people will be.
Speaker 2 (12:37):
Plus the story in UK equities, plus the story we
see in house prices.
Speaker 1 (12:42):
But of course most people aren't very exposed to UK equities,
and we see that across all portfolios that they tend
to be much more exposed to the US, irritatingly than
to the UK, particularly inside a pension portfolio if it's
one of their auto enrollment portfolios or something like that,
where they might be slightly more exposed to the US
than the old fashion pension to the UK. Then old
fashion pensions are still it's a minority of their holding.
(13:05):
So they should be seeing rising well from their US
portfolios and from the UK portfolios this year definitely, so
they will be feeling it in the main through their bonds.
Speaker 2 (13:14):
We'll we've seen it in the main through their bond exposure.
And I suspect if you inflation adjust, most people's house prices,
especially in London and the Southeast, house prices have declined
appreciably over this period. And again, just to get out
of the abstract economics for a second, what we all
know is true and it's why QI worked so well
to stimulate the recovery is people on a Friday night
(13:36):
at their dinner parties like to say, Oh, I'm feeling
frightfully well off. My house price has just gone up
by fifty thousand pounds in the last month. I'm going
to go and borrow some money to do some repair
maintenance improvement on my extension or whatever. This is not
happening in the UK, and so this net wealth shock,
which is persisted because we have these obstructively high interest rates,
is holding back the normal cyclical momentum. Let me just
(13:59):
come at this from two day two different ways, because
the thing that's really important when you have economic problems,
which we do, is to demystify and to just sense
check the narrative. And that's why I think it's important
to push back on these notions of confidence and uncertainty
and tax worries when we can see this real effect.
Consider this in a different way. If I look at
(14:20):
consumer confidence for the UK and I look at it
across age groups. The GfK index is split by four
different demographics under thirty, under fifty, fifty to sixty five,
and then sixty five and over. You can see the
picture for these cohorts all the way back to the
year two thousand and if you think about all the
things that have happened since the year two thousand, you
(14:41):
of course had the dot Com bus, we had nine
to eleven, We had the Globe of financial crisis, the eurocrisis,
we had Brexit, we had COVID, we had the Russian
invasion of Ukraine. And at every single one of these
events we have seen a co movement in cohort confidence
younger people, and I think this is the the silver
lining in all of this. Remain and always are more optimistic.
(15:03):
So young people are just looking forward to the future.
I think that's great news. But very recently the last
two years we've seen for confidence among young people, so
those under fifth day rise to the extent that for
the youngest cohort it's actually close to its all time high,
but for those aged over fifth day it's declining. Now. Again,
it's where we apply a narrative in the UK without
(15:24):
thinking about the underlying fundamentals. The common view is this
is driven by political preference. That we have a left
wing government and young people are happy about that, and
the older voters that would have preferred perhaps a conservative
government are unhappy that the Conservatives are no longer in office,
then I say, okay, let's ignore the narrative and look
at what we can see in the under fundamentals. Two
(15:47):
things that we've already established. The first is we've had
decent income growth in inflation a just in terms for
the last three years, but we know the asset prices
have suffered. For young people, so under fifth day, they
typically either don't own many assets, or the assets that
they have, such as a house, they tend to have
debt associated with it, so they're not as sensitive to
(16:07):
these net wealth effects. They're much more sensitive to income effects.
For older voters that have gone through their lifetime earnings growth,
that have accumulated assets, they tend to be sensitive to
asset prices. And what you see is a decline in
inflation adjusted house prices coincides with this weaknessing confidence among
all the cohorts and explains confidence over a long period.
(16:31):
The rise in real wages over the past two to
three years explains the rising confidence among young workers and
younger cohorts, and this is what the divergence is capturing
in the confidence data, which means just returning to the economy,
the wage driven income driven parts of the economy day
to day spend in are doing okay, that's the reason
you have this one point seven percent mostly services oriented growth.
(16:55):
But the stuff that's really asset sensitive, where we need
to feel better off before we go out and borrow
and speculate. The people with the real purchasing power at
the older, richer end of the income spectrum, they have
such depressed asset values that they are reluctant to go
out and drive the kind of CycL collectivity. And the
reason that this is such a confusing concept, I think
(17:17):
is because at the start of a cycle we are
viewing an economy that is entirely, entirely the inverse of
what we typically see the start of a cycle. We
normally have high unemployment, low real wage growth, low inflation,
and rapid falls in interest rates, which spur on asset
price inflation. And the first sectors that usually signal that
there's a recovery to come are things like the housing sector,
(17:41):
things like credit. Okay, credits kicking up, let's get excited
about economic growth. This time around, we have the opposite.
We have interest rates elevated. We also have elevated real
wage growth, and so the pattern that's emerging at the
start of the recovery is very different. And the kicker
in all of this is to say, I don't think
(18:01):
that this is a one off in the UK's case.
We have been here repeatedly through history and the fiscal
framework that we need to understand in this context is
that the UK goes through cycles of strong credibility in
face of markets and it outperforms, followed by periods of
(18:24):
weakness and impaired credibility that it needs to correct. And
I'll stop because I suspect there's a question in here,
but I want to just go through the history to
help people understand why this is.
Speaker 1 (18:35):
Fiscal matters so much I'd like to do that. I'd
like to do that, So I just want to want
to go back. So we're talking about the reasons that
you've given in your latest piece about why the UK
economy is looking sis luggage, not stagnating. So we've talked
about one of the things on your list, which is
this high household savings and self consumption since twenty twenty two,
(18:56):
which are the result of this wealth shock in twenty
twenty two, which is connection to the one markets, et cetera.
But the other major thing that you pull out is
this idea that our policy making credibility is damaged. And
that's a problem, And this is where you want to talk.
I think about the long term history of our cycle
of credibility effectively exactly right.
Speaker 2 (19:17):
So just the one line to keep in mind here
is I do this and I'm not drinking. I don't
have milk in my coffee because it's apparently it's not bad.
It's not good for you. But we're all warned about
the health these healthy lifestyle choices that we should make now,
and if we don't make them, it gives us inflammation
in our body. This is the same with the economy.
Poor policy choices lead to inflation in the economy. It's
(19:41):
exactly the same thing. When you have persistent inflation, it's
a signal somewhere that you're organizing your economy badly. Historically,
the UK, the data I look at starts in the
late seventies, and just a quick history lesson the late
seventies the early eighties, the u K underperformed the G
(20:02):
seven so advanced major economies excluding the UK of course,
in a major way, and our bond yields rose relative
to other countries. We then got back on track through
the eighties until the late eighties, when we had another
inflationary crisis in the late eighties early nineties and we
underperformed again. We then through the nineties right up until
(20:23):
two thousand and seven, go through a long period of outperformance.
Then we underperformed through the financial crisis. We then outperform
from two thousand and about twenty eleven to two thousand
and eighteen. We then start to underperform again. What's the
consistent theme here? In nineteen eighty one, following the underperformance
(20:44):
of the late seventies and the early eighties, the Conservative government,
recognizing that markets feared another decade of huge inflation in
the UK, issued index link guilts for the first time. Basically,
we will compensate you for any inflation that we create.
Will transfer the cost of bad policy choices from the
(21:05):
people that lend to us in markets to taxpayers, but
de facto to government. We'll guarantee a real rate of
return that established credible commitment to low inflation. The UK
then sees its bond yards come down, the economy outperforms.
This inflation to crisis the late eighties early nineties gives
(21:25):
way to another loss of credibility and rise in bond
yo olds. We join erm to try and stabilize and
reassert credibility. It doesn't work. In September nineteen ninety two,
of course we crash out Black Wednesday. Very famous people,
I think forget that. In October nineteen ninety two we
introduce inflation targeting for the first time. We say we'll
(21:48):
commit to inflation between one and four percent retail prices
excluding mortgages. The banking Land, of course wasn't independent at
that point, but the Conservatives were viewed as credible enough
that it helped to restore confidence bring yields down. Then
into ninety seven when labor Win Gordon Brown makes the
Bank of England operationally independent and reduces the inflation target,
(22:09):
switches to CPI and this once again strengthens the commitment.
He also introduces fiscal rules for the first time, which
at that point we viewed as credible. The UK then
continues to outperform. We then get to global financial crisis,
which reveals the policy mistakes of the past on banking regulation,
on fiscal policy and some other such things. George Osbourne
(22:31):
leading the Coalition government in twenty ten introduces the Fiscal
Sustainability Pact. He legislates to reduce the deficit for five
years in a row. He makes the Office for Budget Responsibility,
which is our independent budget scoring commitment, an independent institution
to check to budget score the government. This works, Bond
(22:51):
yields come down, the UK economy continues to outperform, and
then we start to undo this credibility with a succession
of policy mistakes. We mismanage breaks it. We have the
trust fiasco, We create too much inflation through COVID, and
so the failure. Now we come to present day of
Rachel Reeves and the Chancellor in the government is not
so much that they've and this is true by the
(23:16):
way they chosen their first budget the wrong kinds of
tax increases. It's that she is the first chancellor following
a significant period of damaged credibility and underperformance that has
not tried to introduce some fresh new commitment to credible
money in the UK, to sound money.
Speaker 1 (23:35):
Okay, she's filled around the edges of the old stuff,
but she hasn't introduced a new system. And you think
that that would change things.
Speaker 2 (23:42):
Would change things, or you need such a big policy
change to re establish your commitment to sound money. Now
it begs the question to what extent are we actually
seeing this as a problem. So the UK is a
mid atlantic economy geographically. It's also in its behavior sort
(24:02):
of mid atlantic. It's not quite as sclerotic as the Eurozone,
but it's also not dynamic like the US. It has
faster growth than the Eurozone, but it doesn't quite grow
as quickly as the US. It's small state relative to
the Eurozone, but not small state relative to the US.
It really fits this mid atlantic picture and for that reason,
historically UK ten year bondials are fives or twos or
(24:25):
even bank crepe tends to sit somewhere between the average
of well US and the Eurozone. Today. If I look
at markets, French ten is sort of two and a half.
Excuse me that German ten is two and a half.
The French ten is three and a half. So the
eurobone basically three. US is at four point one, we're
at four point five. We should be around three point five.
(24:47):
The maths there is we have a two percent inflation
target and potential growth probably around one and a half
one point six percent. You can add inflation to potential
growth and roughly get your ten year bondial. So we're
above to one hundred basis points and you can see
the moment when we jump above this G seven range.
It's October twenty twenty two with the List Trust bond crisis.
(25:09):
This is when we dispense the credibility that we had
earned after the GFC period and with the Labor government
winning the election and having a chance to restore credibility
not taking it. And is said, reminding everyone that the
UK is badly managed and we had the additional inflation
thanks to the last budget has just validated market expectations
(25:30):
that the UK is still not an economy which properly
commits itself to sound money. And so this one hundred
basis points extra is the reason why we don't have
the cyclical momentum and we need some renewed commitment to
bring these rates down. And this for me is not
about borrowing, so which is it's actually about inflation?
Speaker 1 (26:13):
Okay, so if we were too I mean, this is
something that a lot of people say that the reason
why UK bond deals are so high is because there's
no expectation of a change in policy that will take
inflation out of the system or that will bring spending down.
But you think it's not really about expense about spending.
Speaker 2 (26:29):
We have lots of evidence where advanced economies with very
low potential growth can run huge deficits for a long time,
so long as inflation is under control, as long as
lenders feel like the money that they give will be
roughly the same in value to the money that they
get back. Japan is a point in case. Japan is
(26:51):
only now facing some fiscal issues because inflation is returned
to its economy. If I compare an and again you
don't need to take my forecast. Just look at the
economic consensus function on a Bloomberg terminal. What you'll see
is the UK has probably over the next three years,
(27:13):
the US will be the fastest going to economy, followed
by Canada because markets tect to pick up in twenty
twenty seven. Then it's the UK and then it's everyone else.
So third fastest in the G seven, second or third
lowest debt to GDP, and second or third lowest deficit,
and we're the only country where the deficit is actually
declining over this period. Even with all the uncertainty over
(27:36):
fiscal policy, markets still expect this, so it doesn't seem
to be a fiscal issue. But if I compare the
UK economy, say, over the last ten years to the
G seven, we've had extra inflation to the tune of
about one hundred basis points. In that sense, markets are
mostly rational. They're pricing in this inflation. And again we
can just we don't need to guess narratives. We can
(27:58):
see the evidence before our eyes. The market liked the
idea of an income tax increase because an income tax
increase would have depressed demand, depressed inflation, and yes, reduced borrowing.
That's important, and it would have happened immediately. It wouldn't
have hinged on the Office Budget Responsibilities forecast relative to
(28:20):
the government's target being correct three years out, which is
when the fiscal targets kick in, and so you'd have
had this immediate recommitment to disinflation by fiscal policy makers.
And we've had this jump in bond yields as the
government's abandoned this plan, And it just reminds us actually
that fiscal credibility is a serious problem in the UK.
(28:44):
We are paying a real price for this, and I
think the challenge for policy makers to understand is just
because we're not facing an immediate crisis now, doesn't mean
that these rates, which are obstructively high for the private
sector to get going, are not a serious, serious problem
and a serious dysfunction in the private sector.
Speaker 1 (29:05):
Okay, And the third thing that you talk about in
this report that we've been discussing is an extension of
that to say that interest rates, obviously they have this
effect on asset prices and make people feel bad, but
also crowding out exactly.
Speaker 2 (29:22):
So, crowding out is kind of a bit of a
technical concept, but it happens in two ways. One quite
simply that interest rates are prohibitively high because of fiscal
policy for interest rate sensitive parts of the economy to
get going. And so, for instance, the government's unwillingness to
address either it's excessive spending excessive borrowing or the inflation
(29:46):
that it's creating as a result of those two policies
is basically on a collision course with its housing markets.
Speaker 1 (29:51):
One step back, one step back. So it is the
fiscal policy that creates the inflation, it's the borrowing on
the spending.
Speaker 2 (29:58):
That's exactly right, that's exactly right. Of course, you can
you can, you can make some adjustments here or there.
But this is this is this is the this is
the problem. In that sense, the real limit on an
advanced economy when it comes to borrow in is inflation. Right,
It's not the overall level of debt. You can carry
huge debts in a low inflation economy, you can carry
very little debt in a high inflation economy. Markets care
about getting their money back in inflation just in terms.
(30:21):
So the interest rate effective, of course is significant, and
we can see that with the weakness that we see
in the housing market. We can see that in the
weakness that we see in other interest rate sensitive sectors
like manufacturing, investment and so on. The second way we
see this effect, and this is where this problem lends
(30:42):
itself to a broader theme which I which I which
I think we just need to get into a little
which is to say that the government is much less
price sensitive when it comes to spending than the private sector,
and so the government, when it spends, strips away scarce
resources for the private sector to use, and so the
(31:05):
crowding out takes place through the interest rate, but also
as spending rises as a share of GDP over time.
What we're doing is We're reallocating more and more scarce
resources away from a private sector which is not as
productive as it used to be in growth terms, but
it's still growing its productivity and towards a public sector
where productivity has been stagnant for more than two decades.
(31:26):
And so we're creating more dysfunction through this rising share
of government spending as a center of GDP, and it
comes through the way the government consumes resources that could
be used by the private sector to do something that
would be much much more productive.
Speaker 1 (32:00):
I've got a lot of problems here. What should happen
on November twenty six at the budget? What choices can
Rachel Reeves make that can at least mitigate some of
the damage or actively improve the state of zulkcare.
Speaker 2 (32:18):
I think identphasize three things here. Let me go one
point on the immediate problems, one point on the long problems,
and then we should discuss capital spending. The first thing
is to say, think of the budget like a traffic light.
There's a green outcome, there's an amber outcome, and there's
a red outcome. The green outcome is the best outcome.
(32:39):
It's where government recognizes that it demands on the economy
are simply too large, and we will cut spending in
order to close the borrowing gap. And by cutting spending,
we'll depress demand and we'll depress inflation and it will
get markets on side. And you could do that through
addressing something like welfare or departmental spending. The advantage with
(33:00):
welfare is if you cut it in the right place,
you can reset incentives for participation in the labor market,
especially among young people, where we know we have a
problem politically. That's going to be very, very difficult YEP.
That's close to a zero probability event. I suspect the
Amber outcome, which is where I think we were for
basically a month, which is where the government realizes, actually
(33:25):
we need to counteract the inflationary narrative that we introduced
a year ago by doing a big policy change that
is clearly disinflationary and create space for market interest rates
to fall and for the Bank of England to be
more aggressive with interest rate cuts, which was the advantage
(33:45):
with the income tax increase on its own, this is
not a good policy. As you mentioned, consumers are skittish
and they're not spending enough anyway, so why hit them
with an income tax increase. However, because this interest rate
problem is such a big deal, you can have this
setting effect. It's kind of the Clinton Rubin approach in
the early nineties. You raised taxes, the Fed cut's interest
(34:05):
rates in the economy kicks on. Markets would have reacted
well to that because you would have had this Bank
of England offset. That's the amber out comen. I call
that amber because it's contingent. It's contingent on the Bank
of England doing something. I fear the government's abandoned this
and yeah, last Friday, and the challenge is that understanding
(34:29):
what quite happened. I suspect the government realized that it
needed to do a lot, convinced itself that it's one
option was the income tax increase, decided we better signal
this to market since we're breaking our manifesto commitment into
households and to businesses who have all factored in this expectation,
and adjusted bondials declined over this period, which validated the
(34:51):
idea that this was actually a good policy. The governments
then received a new forecast from the OBR seen that
with lower bond deals everything looks better. We don't need
to we don't need to do so much taxation and
decided to U turn as opposed to saying, well, perhaps
we cut stamp duty stuty on shares, or cut stamp
duty on housing or something like this. This is unbelievable.
(35:12):
So this Amber outcome is now off the table. We're
now in what I would consider to be the red zone.
But again this traffic light idea, where we have this
horrible patchwork of anti growth tax measures which, even if
on the face of it are not inflationary, if they
land on businesses, businesses may try to pass them on
(35:33):
to final prices. But I fear that government is going
to go after things like pensions and assets. And as
I think I've established with quite a lot of evidence convincingly,
it's the weakness in asset prices and the desire to
offset that through higher saving that is causing the underlying
problem in the economy. So if you go after assets,
what you're doing is you're agitating the fundamental problem that
(35:54):
the economy is facing. So I think this is a real,
real issue, and what we're doing is unfortunately by being
in this red zone is base case for me into
next year would be in this scenario, growth still around
one and a half percent, very little sickly cality. Inflation
will come down mechanically because we just have a disinflationary trend.
The Bank of England, i think, will cut three more times.
(36:16):
We might get ten years down to a little below
four percent, but the income tax increase would have add
two or three more cuts to the Bank of England.
Take benchmark interest rates down by one hundred basis points,
revise your growth forecast up to two percent. We've taken
away this very clear upside risk which the government had
set about. So this is the frustration, and now we're
(36:40):
left with a real danger that the economy just has
this slow motion puncture into next year. Growth dwindles, we
get a bit more inflation than we like because businesses
try to pass this on the Bank of England finds
it hard to cut even three times. The bomb market's
not convinced, thinks we're going to have to come back
for tax increases next year, so bond yield stay l elevated,
(37:01):
and the frustration that the economy is producing for people
leads to impatience in the labor party. That then leads
to the uncertainty that could have erupt around leadership challenges
and all that kind of stuff. So that's now the
downside risk, which has become real. So in one week
we've replaced a very real upside risk with the downside risk.
So in the short run they just need to somehow
(37:21):
pick one or two big policies that close the gap
in a disinflationary way that avoid this. They've called it
a Shmaugus board, but I don't think that's right. I
think it's an anti growth patchwork of taxes.
Speaker 1 (37:35):
I mean, this is the problem. And then every single
one of those new fiddle taxes, because that's what we fiddles, right,
every single one of them will come with a furious
lobby group and so the fight back against every single
one will be much harder than if they had just
come out, as you say, with one big tax across
the board.
Speaker 2 (37:55):
That's right. And I think, just to add another dimension
to this, the government seems to have traded off the
opportunity to reassert credibility now with an income tact increase
in April, and to not just be a passive observer
in this disinflationary narrative into next year, but actually, in
(38:17):
the market's eye, the driver of the disinflationary narrative to
now a budget which will rely on the obr's ever
optimistic forecast being right on borrowing, growth and inflation, and
the market is tired of it's going to happen tomorrow, right.
The amount of foreign investors I've been sort of everywhere
(38:37):
in the last few months, including far away places like
Singapore and Australia. They say, why does the OBR keep
including this fuel duty increase when it's been delayed for
fourteen years, which never happens. This is the kind of
thing that is eroding credibility. So it's it's now no
longer it's going to come tomorrow. Tomorrow never comes. Do
(38:58):
something today. A week ago we thought we were there,
Now we think we're not there. This is a this
is a real policy failure.
Speaker 1 (39:07):
What do you think that the smalls that sense again,
Smagas Board, what do you think the Smagat Board of
tax changes is going to involve.
Speaker 2 (39:18):
I think it's anyone's guess at this point. I hope
that they do a little bit on the spending side,
maybe after the spending round is over, as hume lower
departmental spending. I think they'll probably they should spend a
couple of hundred million to try and reduce tax avoidance
and things like that. The OBR might reward them with
(39:38):
sort of three or four billion. I think they'll freeze
in contact thresholds from twenty twenty eight, which is sort
of sensible, But again it's it's in the future. Then
I think we're probably looking at something on pension contributions.
We're probably looking at the changes to council tax bans,
we might be looking at the bank leve fuel duty
(39:59):
make up. But when you're faced with a complicated economic scenario,
where again I don't want to make the case that
the future is so certain, it's just that uncertainty doesn't
seem abnormally high in the UK, what you need is
a clear narrative income taxes up, interest rates down, economies
actually were sorted, get over it and beyond and beyond,
(40:22):
and then come back in a year with a load
of head we've given up that. Then there are the
two other issues. So let's address capital spending first and
then tackle what is the problem not just for the
UK but for all advanced countries, which is this rising
debt to GDP public debt to GDP as the population
ages that you mentioned before me before we had our
online chat. You were discussing at what point is the
(40:44):
government just put up against the war by bomb markets
to say fix things. I think that's where the problem looks,
so we should touch on that. But just on capital spending,
I'm really taking issue actually with this abstract view that
if only you raise capital spending in the economy, we'll
see more productivity growth. Okay, this is a nice sentence
(41:08):
to include in a policy report, but what this means
in the real world is businesses increase their current spending
in capital goods and energy and commodities. They combine those
factors of production to produce capital stock that can then
be plugged in, receive some energy from the grid, and
(41:29):
make workers more productive. The problem is when you have
a regulatory system which says you can't dig that commodity
up from the UK, we can't use the energy that
we produce in our market. You can't build on that land,
we won't produce those capital goods, so you have to
import all of this stuff. Productivity is just the ratio
of GDP to workers. If when you raise capital investment
(41:53):
you have to import all of this stuff, yes, you'll
get some benefit, but what you really into subtract that
benefit is all the inputs you're sending capital abroad. You
can't have a proper productivity revolution that is driven by
capital expenditure unless you permit yourself to use your own
domestic factors of production. The UK is an economy with
(42:14):
huge factor endowments. It's the reason we had the industrial revolution. First.
This is what people forget. We have this stuff underground.
We just have a lawmaker saying you can't use that mind,
you can't use that energy field, you can't build there.
And now with the employment rights build you can't employ
this person under certain circumstances. This is economic suicide. It
(42:35):
doesn't work. And so we won't transform this ambition to
have higher capital spending into higher productivity unless we radically
deregulate the domestic economy to allow that capital spending to
go towards extracting our own domestic factors of production and
combining them in a productive way. And again, this is
(42:55):
just one of those problems where in the UK we
have concent census around another narrative, and yet governments repeatedly
try to fit their policies with this narrative. We heard
under Osborne, we're going to increase capital spending. We heard
under Boris, we're going to increase capital spending. We now
hear it under Rachel Reeves. And yet the productivity statistics
(43:17):
are just not showing the rise that we want to see,
which means there's something fundamentally going wrong in our understanding
of the economy. It's not that if we just do
cut more capital spending eventually we'll force our way to
higher productivity. The chain of events that we think is true,
the narrative is not wedded in the fact in the
right way. And this practical problem that I mention, you know,
(43:37):
escaping this weird abstraction that economists do is where I
think the root of the problem lies. And it's why
you see the best productivity growth in the economies that
are open to using their own domestic factors of production.
The US is a point in case, but look at
what you see in the Middle East, look at what
you see in parts of the emerging world, where they're
digging up stuff from their own economy, they're combining it,
(43:58):
and they're making their workers more productive. Until we accept
that we have to do this, we won't see a
reacceleration in productivity growth.
Speaker 1 (44:06):
Interesting now you say, as you say, we're having a
conversation before we started recording about all these things, and
we were discussing your view that the UK is not
in crisis mode or not near crisis mode, but is
in a state of serious dysfunction, is what you call it.
And I definitely agree with you that we're in a
state of serious dysfunction, no doubt about that. But look
(44:28):
at what you've just said about about CAPEX and about
you know, increasing capital spending and why we won't use
our own stuff, and what you said earlier about capin
welfare spending and why that simply isn't going to happen.
It slightly feels as though all the solutions are there.
You know, you're very good. You've written a marvelous report.
It's all absolutely true. Can't disagree with you on any
(44:48):
of it. But no one in government is listening, and
there doesn't appear to be any political appetite at all
in the UK to shift on any of the things.
Be it a bit well, there, be it at zero
beard any any of these things. Although this shift on
immigration is kind of interesting. Maybe that's the door opening
to some rational thinking in government, but nonetheless without the
(45:12):
feeling that there is any kind of political appetite for change.
It feels that the point at which the bond market says,
do you know what enough and as you said, puts
so you get up against a wall is significantly closer
than it has been for a long time now, is
that we may move from dysfunction to crisis faster than then.
Speaker 2 (45:32):
Of course I might be front run here by what's
happening in US tech. But my guess is, and this
is this is not the first time I've said this.
I've happily said this three or four times on the
show this year, that the government debt problem that we
have around the advanced world, and this is where the
UK just is ordinary, not in a good way, is
the root of the next crisis for sure. The reason
(45:55):
why I think governments are in the UK and elsewhere
this is a broad point, but let's just us the
UK's point in case. Governments are reluctant to address this.
So so for anyone listening, what is going to happen
in these in our advanced economies is we have made
legal commitments. And by the way, I think this is
the right thing to do. So to be absolutely clear,
(46:19):
rich societies should not be inflicting poverty and health related
indignities on retired people. We can avoid that problem if
we get our act together, no question. So this is
not about saying we're not going to look after you.
But as we see an aging population and the share
of dependence rises, especially at the upper end, our public
(46:46):
debt to GDP ratios are going to rise as far
as the eye can see. In the UK's case, we
have one hundred percent debt to GDP today. The OBR
thinks we'll get to two hundred and fifty percent within
our lifetimes. I just don't think the market's going to
let us get there, by the way, but this is
driven by dramatic increasing health spending, dramatic increasing things like
pensions and welfare. And this is true across the advanced world.
(47:09):
And we're just at the foothills of this debt mountain.
And just as we reached the foothills, the natural buyers
of government debt, things like pension funds, which already saw
this problem far in advance and had to prepare and
money risk for it, have basically decided we've got enough
of this paper we don't need any more, and so
the price that the market is charging us to issue
(47:31):
more debt is too high relative to to again what
the private sector would would prefer to really get going. Okay,
Why why are governments not addressing this? Is as the
central economic problem. First is governments don't distinguish between chronic
(47:51):
problems and crises, and so you'll often see that policy
makers simply taken as given UK is a an economy
with slow potential growth, as if this is just normal,
we should just accept this and we should just manage
around it. So you need to raise taxes. We remember
the New Statesman title early this year. Just raise tax Hey,
(48:11):
that's the solution, accept it, raise tax You're a slow
growth economy. Make sure you can fund the state. Okay.
So there's there's there's a degree of naivety in that view.
The second problem for me is that and of course
in the absence of a crisis, you just kind of
never have your priers on this front challenge. The second challenge,
(48:33):
which for me is more important, is policymakers, I think
overestimate the positive impact which government spending has on GDP
under conditions of normal balance sheet strength in the private sector,
which is roughly what we have now, which is to say,
in the middle of a financial crisis, do you want
to cut government spending? No? When you have a fundamentally
(48:55):
healthy private sector with full of smart people, low levels
of debt, and clear opportunity to raise productivity through things
like AI, should government fear just pulling back a little
bit in not small ways to rebalance fiscal policy. No.
But I think they fear if they could spend in
they'll tank their economies into recession and that will mean
(49:18):
they'll be out of office. I think this gets it
exactly the wrong way around because of the way that
I explained this crowding out effect. So what's going to
happen I suspect is at some point these policy choices
will these bad policy choices which have compounded over time.
It's not just the labor government's previous conservative government too,
(49:40):
and the previous labor government before that will erupt into
another bout of inflation and the bomb market will say
that's enough and governments will be forced. And actually I
quite liked the idea that Andy Halding, in the previous
Chief Economist that the Bank of England came up with
this week's say, you should say we'll raise taxes by
a pound, we also cut spending by a town. This
(50:01):
is a nice handy rule of thumb. You will be
forced to dramatically cient fiscal policy in near term or
say we need a better way to manage these long
term liabilities. The result will be markets I suspect and
governments will fear recessions. The actual consequence will be the
(50:23):
bond market. We'll see much less issuance, much less inflation.
It will reward governments that fix these fiscal problems, drive
down interest rates, and then the private sector will start
to do much better, which is why you see so
many instances where bloated states suddenly decided to austerity and
the private sector comes alive. I mean, Argentine is our
(50:45):
point in case today, Britain, in the eightiers, We've seen it, Canada, Sweden,
There's lots of examples. But we actually have a better
option here in my view, which is to say, we
have not properly managed our public services for the past
fourteen years, and justifiably so, people are uhappy with things
like education and health and welfare. Is there a solution
(51:07):
where we don't have to cut this? Yes, I think
we can address these long term issues. What we need
to do is find clever ways to address our long
term pension commitments, our long term health commitments, which mean
that yes, debt will rise, but instead of getting to
two hundred and fifty percent, maybe it gets to one
hundred and fifty percent and rolls over. And I'm going
(51:28):
to stop. But if you want, I think I have
a solution to this.
Speaker 1 (51:33):
Yeah, you have to stop there, so I can ask
you what are these clever ways? Everyone wants to know
the clever ways where we cannot have to cut spending,
okay and not end up at two hundred.
Speaker 2 (51:45):
And for me, let me kill a lazy narrative here
first to say that you often hear naively that government
debt is less risky than private debt. This is fundamentally
wrong in a properly regulated economy, and roughly speaking in
the UK, basically is now, when a bank issues a loan,
(52:07):
it will have done the due diligence to make sure
that the borrower is using that loan for something good.
And when it comes to big loans generally it's like
are you actually investing? Are you increasing the value of
your house? Right? So, there's there's a there's an income
generating asset that goes with the loan, and so that
the net yield, the net return is positive, which means
(52:30):
on the private sector, yes, you have rising debt over time,
but you tend to have rising assets and you generate
an ever greater positive net wealth position, which is which
which is why we can tolerate ever growing levels of debt.
With the public sector, it's completely different. What we've had
actually across the advanced world is this ratcheting effect where
to avoid recessions in the short run, which would have
(52:53):
had some bad consequences, but also some good consequences. They're
great cleansing events. We have increased debt substantially to fund
current spending just to avoid the recession. The result of
this ratcheting effect is we've had a succession of crisis
where we've just added and added to debt and we
have no assets that are productive on the other side
(53:15):
of it. If we would have raised all of this
debt to GDP to expand energy and infrastructure and minds
and all the rest of it, Okay, I'm not in
favor of making everything statement, that would have been a
very very different result so now we have a situation
where we have no assets to go alongside of all
of this debt. But the debt itself requires an interest
(53:37):
which is now aheadwind. We spend one hundred billion pounds
a year. Okay, so we need to start re evaluating
the way we think about government debt so that we're
generating assets and actually again to an extent, Rachel Reeves
adjusting her fiscal rules to not exclude capital, to exclude
capital spending sort of gets there, and to look at
a net wealth measure. But take the two big costs
(54:00):
that people will impose in retirement on the public. First
is their pension. The second is health costs. With pension,
it's through their entire period out of work. With health costs,
for most people it's sudden increases very late in life
or in one or two instances. What we should do
(54:23):
is recognize there's a difference between government providing pensions in
healthcare and guaranteeing it. And so what I would like
to see in the UK when people enter the workforce
for the first time, and you could probably apply this
to anyone under the age of forte you get a
two thousand pound tax cut in your first year, that
(54:46):
two thousand pounds goes into pick something. Take an ETF
fifty percent global, fifty percent UK. It'll give you anywhere
between eight and ten percent per year. You con pound
that until you retire, and that is your pension pot,
and you will get a big number. By the time
you're seventy you'll be anywhere between three hundred and fifteen
four hundred thousand pounds. You'll be better off than if
(55:07):
you've got your your state pension today in a lump sum.
And that small tax cut generates a huge asset that
takes off the liability side of the government balance sheet
funding your pension either through taxes or borrowing. When you
actually get to that point in the second year, you
get another thousand pound tax cut. It goes into the
same instrument, but it's used as a pot of money
(55:31):
that can finance health costs, and you can spend that
however you like. When the time comes go to the
private sector, you can spend it on the NHS. It
really doesn't matter. But what you do is you de
risk those sudden health costs from the taxpayer. But I
think with both of those things, what you can actually
say is if you don't use these parts, your children
(55:52):
can inherit them, which means on the health side, you're
incentivized to make good lifestyle choices, which is something that
we need to seriously talk about in order to get
fiscal sustainability. But then on the pension side, it will
induce people to contribute more to their private pension so
that there's more that can be inherited down the line.
(56:13):
And so we're addressing some of these fundamental issues. And
I think once the market sees these credible commitments to
longer run sustainability, you then don't need to be up
against the wall every six months, every twelve months to
find ways and to resolve all these very very bitter
and politically tense issues around welfare and the like.
Speaker 1 (56:33):
Yeah. I mean, I love this idea, callum, but I'm
going to add it to the list of things that
simply aren't going to happen.
Speaker 2 (56:39):
Under this government nobody. Eventually, I suspect we will reassert
credibility in these clever ways at some.
Speaker 1 (56:44):
Point this kind of thing will have to happen. But
I mean, that's the other side of the crisis, isn't it,
Because that's that's giving giving money away, that's so we
thought and I did that already it's there, And of
course it's too long term because there are the positive
results of that fit into the five year four cust
And who's gonna do anything that doesn't fit into the
five year four cust that's it. So filing that under
(57:08):
an excellent idea, marvelous tuns great never gonna happen.
Speaker 2 (57:11):
In this budget. No, I suspect in future. That's we
will get to these kinds of places in the end.
Speaker 1 (57:18):
Well, callum, I guess we will pin our hopes not
on this month, but on the future, when hopefully a
government will start reading your reports and acting.
Speaker 2 (57:29):
You're speaking be from Edinburgh. There's a statue of Adam
Smith with his great quote fear not, there's a great
deal of ruin in a nation. If we can get
one or two things right, suddenly this gloomy narrative will
turn positive. And so it's incumbent upon us to just
solve these one or two big issues. And it's amazing
how much then we can tolerate day to day.
Speaker 1 (57:50):
Oh okay, well, fingers crossed, Callum, thanks so much for
joining us today.
Speaker 2 (57:55):
Oh my pleasure, thank you, thanks for listening to.
Speaker 1 (58:04):
This week's Marin Talks Money. If you like our show,
rate review, and subscribe wherever you listen to podcasts, and
keep sending your questions or comments to Mirror Money at
Bloomberg dot net. You can also follow me in John
on Twitter or x I'm at marins w and John
is John Underscores Stepic. This episode was hosted by me
Mary Zumset Web is produced by Someersadi and Moses, and
sound designed by Blake Maples and Aaron Casper especial thanks
(58:26):
of course to Callum Pickering
Bloomberg Audio Studios, podcasts, radio news. Are you a Bloomberg
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Money Distilled. Yours get access to all the brilliant reporting
from our many colleagues. It's a very worthy investment. Okay,
onto the show. Welcome to Meren Talks Money, the podcast
(00:34):
and most people who know the markets explain the markets.
I'm Meren Sumset Web. This week I am speaking with
Callum Pickering Peel Hunt, chief economist. How close are we
do an economic crisis in the UK? If you ask me,
I say closer than we've ever been in my career
of the financial journalist. If you ask Cullum, not quite
as close as it feels to me. He argues at
the nation and particularly the government, just don't fully understand
(00:56):
the nature of the problem with the UK economy. In
a recent research note titled why is UK Growth Sluggish?
Callum lays it out his thesis. We talked about that
note in this conversation, as well as getting his take
on the upcoming budget. What exactly is going to happen? Callum?
Welcome back, to myrin drugs.
Speaker 2 (01:13):
Money, my pleasure. Thank you so much for having me.
Speaker 1 (01:16):
Right, and we're gonna have one of our usual super
upbeig conversations about the UK economy and UK politics.
Speaker 2 (01:22):
Right, that's right. Well, you know, I'm always trying my best,
at least to just not be counter narrative on purpose,
but just to kind of question the narrative a little bit.
The last one, of course, everybody was focused on the
price of energy. I tried to make my case that
it's really the supply. This time around, I've taken issue
with two things. The first is the idea that the
economy is stagnating. It's actually not stagnating. Has some issues,
(01:46):
but stagnation is not the right word. And second that
the problems are uncertainty and confidence. I consider these to
be symptoms of a problem rather than the problem in
of itself, And in this this lady's piece of research,
I've tried to unpick some of this a little.
Speaker 1 (02:01):
Okay, well, let's start at the very beginning. When you
say it's not stagnating, what is it that you mean,
Because you know, growth rate of under two percent for
quite some time, that looks like stagnating to me.
Speaker 2 (02:13):
So UK potential growth is probably in the sort of
mid one to two range. Let's get I think it's
probably around one point six one point seven percent. If
I look at the last two years of UK economic
performance so late twenty twenty three, which roughly coincides with
the normalization of the acute gas supply shock in Europe
and the Bank of England stopping graizing interest rates, We've
(02:35):
had annualized economic growth since then of one point seven percent.
It's been predominantly driven to my by domestic oriented services. Now,
this is not stagnation over say a full business cycle.
If you had the normal fluctuations with growth above two
for a while and then a period of recession, I
think we'd be somewhat happy with this. To put it
(02:57):
into context, between twenty ten two nineteen, growth was two
point one percent annualized, with with bit better growth on
things like exports and industry. But I think there's a
kernel of truth, at least from the market's perspective, in
the view that the economy is stagnating for the following reason.
When I look at the components of this one point
(03:18):
seven percent growth, what I see is a big expansion
in government spending and declines in cyclical sectors like new
housing construction, like durable goods expenditure, like broad construction in
the private sector, which suggests to me and I call
this kind of the flat white economy, the steady state,
people buying coffees, people paying their bills. That stuff is
(03:42):
actually ticking over, okay. But the cyclical bit of the economy,
which markets tend to look forward to, which companies need
to react to by raising capital in order to then
do a little investment, that bit is actually not stagnating,
but in many respects it's in decline. And I think
the crux of the economic problem lies in trying to
better understand why we have this absence of cyclicality right
(04:06):
at the start of an economic cycle. And I put
this on fiscal policy makers. I say that the policy
makers fundamentally are lacking the credibility to get benchmark interest
rates to where economic fundamentals need them, and because they're
obstructively high, probably to the tune of about one hundred
basis points on the ten year, we are crowding out
(04:28):
these cyclical parts of the private sector. And this is
essentially the heart of the issue that the UK's facing
and why these budgets matter so much.
Speaker 1 (04:37):
Okay, we're going to come back to your three points
on why you think the UK economy is sluggish, if
not stagnating, But I do want to make the point
before we do that that you're looking at GDP as
a whole, and a lot of our listeners very interested
in looking at population adjusted. So it's GDP per head
and if you look at GDP per head, as you know,
this is barely budged for years, and that is stagnant.
Speaker 2 (04:58):
Well, I have to push back on that again. If
I look at the living standards of workers, so real incomes,
real wages, they're rising nicely and have been for three years.
It pays to work in the UK. What we have
is a problem integrating new immigrants into the labor force,
and therefore we have this ratio of output to population
(05:22):
which is unchanged. But within that what you see is
for workers, living standards arise in and for people that
are not participating in the labor market, living standards are declining.
And so the problem is not that we are not
producing a means to raise living standards in the UK.
It's that actually we are not properly integrating people into
(05:42):
the labor market so that more and more people can
participate in that wage story and lift per capita GDP okay.
Speaker 1 (05:49):
So it's rising levels of non participation as opposed to
stagnating levels of productivity.
Speaker 2 (05:54):
Per worker wages per worker. We have to be a
little bit careful with the productivity statistics at the moment.
But for wages in the UK, inflation adjusted wages have
been growing at a nice clip for the past two
to three years. If I look at real disposable income
for the household sector as a whole, we've had faster
growth over the past three years, about one point eight
(06:15):
percent year over a year, than we have had in
the whole post GFC period. You have to go back
to the pre Global Financial Crisis period and this is
where you start to find some of the signs to
what may be going on. So we've had this rise
in real disposable income for the household sector since twenty
twenty two, which is which is when inflation, of course
(06:37):
peaked at eleven percent and it's come down.
Speaker 1 (06:39):
Do you know I'm going to interrupt you sorry, kind
of briefly say that not all of our listeners are economists.
So when you say real disposable incamp per household. Can
just break that down for us and explain to listeners
what is is you, This.
Speaker 2 (06:52):
Is the total amount of income which can be spent
post tax, adjusted for prices. So we have had this
rise over the past three years, but since twenty twenty
two we've had a doubling of the savings rate in
the UK from about five percent to ten percent. Now
what's important to understand here is that conventional wisdom, which
(07:16):
is households are saving more because they're uncertain about the future,
they're lacking the confidence to spend, does not fit the
fact on a relative basis. So what I mean by
that is, suppose you were to compare the UK household
to the US household. US households are saving just four
percent of their income compared to ten percent in the UK,
(07:37):
and we, of course have had this increase both sectors,
both household sectors have had a nice increase in inflation
adjusted incomes. What I don't see is additional weakness in
British confidence versus US confidence. If I look at things
like the index of economic pulsy uncertainty of course, with
trade wars and the uncertainty around Trump's policy agenda. We
(08:02):
report more uncertainty in the US than in the UK,
so the facts don't fit the picture that confidence and
uncertainty explain this saving trade isn't.
Speaker 1 (08:11):
One of the important things here that there is not
a regular expectation in the US that there will be
a consistently rising tax burden, whereas in the UK we've
had for the last three or four years a constant
expectation of a rising tax burden. And that's particularly relevant now.
So that's one big difference between the US and the
UK in terms of individual continence.
Speaker 2 (08:32):
No, I don't think so. And actually, if I just
think about the size of the deficit in the US,
the fiscal deficit, it's sevenercent of GDP, it's actually almost
twice what it is in the UK. And at least
in the UK's instance, it's likely to decline over time,
whereas it's likely to remain around seven percent of GDP
In America. That deficit is a signal that at some
point taxes have to go up. For Americans, that's a
(08:54):
much stronger signal in the long run that taxes need
to be adjusted upwards.
Speaker 1 (08:58):
Sure, but that what ordinary people listen to. They listen
to the political conversation as opposed to looking at the
size of the deficit. If we're thinking about the ordinary person,
not the economist, not the professional investor, not someone who
understands the bond market, not someone who looks at how
bigger deficit is or isn't. What they're looking at is
the political conversation. And here the political conversation is all
(09:21):
about your taxes are going up, And in the US
the political conversation is absolutely not like that. Of course
you live in.
Speaker 2 (09:28):
New I suspect that part of the story maybe that
people anticipate taxes going up, but there's just something much
more fundamental taking place, which is since twenty twenty two,
UK household net wealth has declined appreciably. In the US
it's up almost fifty percent. And what you find is
in credit based economies, consumer oriented economies like the US
(09:51):
and UK, trends in household spending are influenced greatly by
trends in household net wealth. So take the experience in
the UK, for instance, ten twenty nineteen, we had a
dramatic appreciation in house prices. We had a dramatic appreciation
in guilt, which is what drove interest rates down over
(10:12):
that period we also saw actually quite a decent rally
sustained rally in UK equities. This supported net wealth and
it meant over that period, even in the ghastly uncertainty
of the post financial crisis period, when in twenty twelve
we had a horrible budget, the Omni shambles budget, with
(10:35):
the weak confidence and the uncertainty, and in the wake
of the Euro crisis, UK households were reducing their savings
rates with weaker income growth because in net wealth terms
they were becoming much better off. So when you had
this dramatic upturning net wealth, you had this corresponding reduction
in saving This time around, you see from twenty twenty
(10:55):
two onwards, roughly coinciding actually with the big fiscal event
which was the Trust budget wobble in the bond market,
you have this crash in household net worth to the
tune of a trillion pounds, mainly in pensions, coincide with
this sudden adjustment upwards in the household savings rates. So
what I maintain here is we try to apply narratives
(11:18):
about uncertainty over taxes, uncertainty over economic policy confidence which
I can't spot a clear trend in the fact. But
then I see this very clear fact in front of me,
which is households are actually poorer in net wealth terms
in the UK, they've responded by saving more. In the US,
where we often see similar patterns of household behavior, households
are saving much less, but they've had a dramatic increase
(11:39):
in net wealth, which means households are rational. They are
reacting to being poorer by saving more. This is why
this fiscal problem that we have comes at such a
bad time, and we should get into a conversation about
what is underpinning higher interest rates in the UK. But
these higher benchmark rates versus what you would act expect
(12:00):
given economic fundamentals and given rates in other countries, are
holding back asset prices by pushing mortgage rates, by holding
down the underlying value of the bonds, and by forcing
equity analysts to apply a discount rate that is higher
than it ought to be to equities.
Speaker 1 (12:18):
Okay, so most people will recognize that fall in their wealth.
I mean, if you look at the shifts in the
bond market, a lot of people will feel that only
through their pension portfolios, right, and not everybody looked at
their pension portfolios. Not everyone will be aware of that shift,
but enough people will be.
Speaker 2 (12:37):
Plus the story in UK equities, plus the story we
see in house prices.
Speaker 1 (12:42):
But of course most people aren't very exposed to UK equities,
and we see that across all portfolios that they tend
to be much more exposed to the US, irritatingly than
to the UK, particularly inside a pension portfolio if it's
one of their auto enrollment portfolios or something like that,
where they might be slightly more exposed to the US
than the old fashion pension to the UK. Then old
fashion pensions are still it's a minority of their holding.
(13:05):
So they should be seeing rising well from their US
portfolios and from the UK portfolios this year definitely, so
they will be feeling it in the main through their bonds.
Speaker 2 (13:14):
We'll we've seen it in the main through their bond exposure.
And I suspect if you inflation adjust, most people's house prices,
especially in London and the Southeast, house prices have declined
appreciably over this period. And again, just to get out
of the abstract economics for a second, what we all
know is true and it's why QI worked so well
to stimulate the recovery is people on a Friday night
(13:36):
at their dinner parties like to say, Oh, I'm feeling
frightfully well off. My house price has just gone up
by fifty thousand pounds in the last month. I'm going
to go and borrow some money to do some repair
maintenance improvement on my extension or whatever. This is not
happening in the UK, and so this net wealth shock,
which is persisted because we have these obstructively high interest rates,
is holding back the normal cyclical momentum. Let me just
(13:59):
come at this from two day two different ways, because
the thing that's really important when you have economic problems,
which we do, is to demystify and to just sense
check the narrative. And that's why I think it's important
to push back on these notions of confidence and uncertainty
and tax worries when we can see this real effect.
Consider this in a different way. If I look at
(14:20):
consumer confidence for the UK and I look at it
across age groups. The GfK index is split by four
different demographics under thirty, under fifty, fifty to sixty five,
and then sixty five and over. You can see the
picture for these cohorts all the way back to the
year two thousand and if you think about all the
things that have happened since the year two thousand, you
(14:41):
of course had the dot Com bus, we had nine
to eleven, We had the Globe of financial crisis, the eurocrisis,
we had Brexit, we had COVID, we had the Russian
invasion of Ukraine. And at every single one of these
events we have seen a co movement in cohort confidence
younger people, and I think this is the the silver
lining in all of this. Remain and always are more optimistic.
(15:03):
So young people are just looking forward to the future.
I think that's great news. But very recently the last
two years we've seen for confidence among young people, so
those under fifth day rise to the extent that for
the youngest cohort it's actually close to its all time high,
but for those aged over fifth day it's declining. Now. Again,
it's where we apply a narrative in the UK without
(15:24):
thinking about the underlying fundamentals. The common view is this
is driven by political preference. That we have a left
wing government and young people are happy about that, and
the older voters that would have preferred perhaps a conservative
government are unhappy that the Conservatives are no longer in office,
then I say, okay, let's ignore the narrative and look
at what we can see in the under fundamentals. Two
(15:47):
things that we've already established. The first is we've had
decent income growth in inflation a just in terms for
the last three years, but we know the asset prices
have suffered. For young people, so under fifth day, they
typically either don't own many assets, or the assets that
they have, such as a house, they tend to have
debt associated with it, so they're not as sensitive to
(16:07):
these net wealth effects. They're much more sensitive to income effects.
For older voters that have gone through their lifetime earnings growth,
that have accumulated assets, they tend to be sensitive to
asset prices. And what you see is a decline in
inflation adjusted house prices coincides with this weaknessing confidence among
all the cohorts and explains confidence over a long period.
(16:31):
The rise in real wages over the past two to
three years explains the rising confidence among young workers and
younger cohorts, and this is what the divergence is capturing
in the confidence data, which means just returning to the economy,
the wage driven income driven parts of the economy day
to day spend in are doing okay, that's the reason
you have this one point seven percent mostly services oriented growth.
(16:55):
But the stuff that's really asset sensitive, where we need
to feel better off before we go out and borrow
and speculate. The people with the real purchasing power at
the older, richer end of the income spectrum, they have
such depressed asset values that they are reluctant to go
out and drive the kind of CycL collectivity. And the
reason that this is such a confusing concept, I think
(17:17):
is because at the start of a cycle we are
viewing an economy that is entirely, entirely the inverse of
what we typically see the start of a cycle. We
normally have high unemployment, low real wage growth, low inflation,
and rapid falls in interest rates, which spur on asset
price inflation. And the first sectors that usually signal that
there's a recovery to come are things like the housing sector,
(17:41):
things like credit. Okay, credits kicking up, let's get excited
about economic growth. This time around, we have the opposite.
We have interest rates elevated. We also have elevated real
wage growth, and so the pattern that's emerging at the
start of the recovery is very different. And the kicker
in all of this is to say, I don't think
(18:01):
that this is a one off in the UK's case.
We have been here repeatedly through history and the fiscal
framework that we need to understand in this context is
that the UK goes through cycles of strong credibility in
face of markets and it outperforms, followed by periods of
(18:24):
weakness and impaired credibility that it needs to correct. And
I'll stop because I suspect there's a question in here,
but I want to just go through the history to
help people understand why this is.
Speaker 1 (18:35):
Fiscal matters so much I'd like to do that. I'd
like to do that, So I just want to want
to go back. So we're talking about the reasons that
you've given in your latest piece about why the UK
economy is looking sis luggage, not stagnating. So we've talked
about one of the things on your list, which is
this high household savings and self consumption since twenty twenty two,
(18:56):
which are the result of this wealth shock in twenty
twenty two, which is connection to the one markets, et cetera.
But the other major thing that you pull out is
this idea that our policy making credibility is damaged. And
that's a problem, And this is where you want to talk.
I think about the long term history of our cycle
of credibility effectively exactly right.
Speaker 2 (19:17):
So just the one line to keep in mind here
is I do this and I'm not drinking. I don't
have milk in my coffee because it's apparently it's not bad.
It's not good for you. But we're all warned about
the health these healthy lifestyle choices that we should make now,
and if we don't make them, it gives us inflammation
in our body. This is the same with the economy.
Poor policy choices lead to inflation in the economy. It's
(19:41):
exactly the same thing. When you have persistent inflation, it's
a signal somewhere that you're organizing your economy badly. Historically,
the UK, the data I look at starts in the
late seventies, and just a quick history lesson the late
seventies the early eighties, the u K underperformed the G
(20:02):
seven so advanced major economies excluding the UK of course,
in a major way, and our bond yields rose relative
to other countries. We then got back on track through
the eighties until the late eighties, when we had another
inflationary crisis in the late eighties early nineties and we
underperformed again. We then through the nineties right up until
(20:23):
two thousand and seven, go through a long period of outperformance.
Then we underperformed through the financial crisis. We then outperform
from two thousand and about twenty eleven to two thousand
and eighteen. We then start to underperform again. What's the
consistent theme here? In nineteen eighty one, following the underperformance
(20:44):
of the late seventies and the early eighties, the Conservative government,
recognizing that markets feared another decade of huge inflation in
the UK, issued index link guilts for the first time. Basically,
we will compensate you for any inflation that we create.
Will transfer the cost of bad policy choices from the
(21:05):
people that lend to us in markets to taxpayers, but
de facto to government. We'll guarantee a real rate of
return that established credible commitment to low inflation. The UK
then sees its bond yards come down, the economy outperforms.
This inflation to crisis the late eighties early nineties gives
(21:25):
way to another loss of credibility and rise in bond
yo olds. We join erm to try and stabilize and
reassert credibility. It doesn't work. In September nineteen ninety two,
of course we crash out Black Wednesday. Very famous people,
I think forget that. In October nineteen ninety two we
introduce inflation targeting for the first time. We say we'll
(21:48):
commit to inflation between one and four percent retail prices
excluding mortgages. The banking Land, of course wasn't independent at
that point, but the Conservatives were viewed as credible enough
that it helped to restore confidence bring yields down. Then
into ninety seven when labor Win Gordon Brown makes the
Bank of England operationally independent and reduces the inflation target,
(22:09):
switches to CPI and this once again strengthens the commitment.
He also introduces fiscal rules for the first time, which
at that point we viewed as credible. The UK then
continues to outperform. We then get to global financial crisis,
which reveals the policy mistakes of the past on banking regulation,
on fiscal policy and some other such things. George Osbourne
(22:31):
leading the Coalition government in twenty ten introduces the Fiscal
Sustainability Pact. He legislates to reduce the deficit for five
years in a row. He makes the Office for Budget Responsibility,
which is our independent budget scoring commitment, an independent institution
to check to budget score the government. This works, Bond
(22:51):
yields come down, the UK economy continues to outperform, and
then we start to undo this credibility with a succession
of policy mistakes. We mismanage breaks it. We have the
trust fiasco, We create too much inflation through COVID, and
so the failure. Now we come to present day of
Rachel Reeves and the Chancellor in the government is not
so much that they've and this is true by the
(23:16):
way they chosen their first budget the wrong kinds of
tax increases. It's that she is the first chancellor following
a significant period of damaged credibility and underperformance that has
not tried to introduce some fresh new commitment to credible
money in the UK, to sound money.
Speaker 1 (23:35):
Okay, she's filled around the edges of the old stuff,
but she hasn't introduced a new system. And you think
that that would change things.
Speaker 2 (23:42):
Would change things, or you need such a big policy
change to re establish your commitment to sound money. Now
it begs the question to what extent are we actually
seeing this as a problem. So the UK is a
mid atlantic economy geographically. It's also in its behavior sort
(24:02):
of mid atlantic. It's not quite as sclerotic as the Eurozone,
but it's also not dynamic like the US. It has
faster growth than the Eurozone, but it doesn't quite grow
as quickly as the US. It's small state relative to
the Eurozone, but not small state relative to the US.
It really fits this mid atlantic picture and for that reason,
historically UK ten year bondials are fives or twos or
(24:25):
even bank crepe tends to sit somewhere between the average
of well US and the Eurozone. Today. If I look
at markets, French ten is sort of two and a half.
Excuse me that German ten is two and a half.
The French ten is three and a half. So the
eurobone basically three. US is at four point one, we're
at four point five. We should be around three point five.
(24:47):
The maths there is we have a two percent inflation
target and potential growth probably around one and a half
one point six percent. You can add inflation to potential
growth and roughly get your ten year bondial. So we're
above to one hundred basis points and you can see
the moment when we jump above this G seven range.
It's October twenty twenty two with the List Trust bond crisis.
(25:09):
This is when we dispense the credibility that we had
earned after the GFC period and with the Labor government
winning the election and having a chance to restore credibility
not taking it. And is said, reminding everyone that the
UK is badly managed and we had the additional inflation
thanks to the last budget has just validated market expectations
(25:30):
that the UK is still not an economy which properly
commits itself to sound money. And so this one hundred
basis points extra is the reason why we don't have
the cyclical momentum and we need some renewed commitment to
bring these rates down. And this for me is not
about borrowing, so which is it's actually about inflation?
Speaker 1 (26:13):
Okay, so if we were too I mean, this is
something that a lot of people say that the reason
why UK bond deals are so high is because there's
no expectation of a change in policy that will take
inflation out of the system or that will bring spending down.
But you think it's not really about expense about spending.
Speaker 2 (26:29):
We have lots of evidence where advanced economies with very
low potential growth can run huge deficits for a long time,
so long as inflation is under control, as long as
lenders feel like the money that they give will be
roughly the same in value to the money that they
get back. Japan is a point in case. Japan is
(26:51):
only now facing some fiscal issues because inflation is returned
to its economy. If I compare an and again you
don't need to take my forecast. Just look at the
economic consensus function on a Bloomberg terminal. What you'll see
is the UK has probably over the next three years,
(27:13):
the US will be the fastest going to economy, followed
by Canada because markets tect to pick up in twenty
twenty seven. Then it's the UK and then it's everyone else.
So third fastest in the G seven, second or third
lowest debt to GDP, and second or third lowest deficit,
and we're the only country where the deficit is actually
declining over this period. Even with all the uncertainty over
(27:36):
fiscal policy, markets still expect this, so it doesn't seem
to be a fiscal issue. But if I compare the
UK economy, say, over the last ten years to the
G seven, we've had extra inflation to the tune of
about one hundred basis points. In that sense, markets are
mostly rational. They're pricing in this inflation. And again we
can just we don't need to guess narratives. We can
(27:58):
see the evidence before our eyes. The market liked the
idea of an income tax increase because an income tax
increase would have depressed demand, depressed inflation, and yes, reduced borrowing.
That's important, and it would have happened immediately. It wouldn't
have hinged on the Office Budget Responsibilities forecast relative to
(28:20):
the government's target being correct three years out, which is
when the fiscal targets kick in, and so you'd have
had this immediate recommitment to disinflation by fiscal policy makers.
And we've had this jump in bond yields as the
government's abandoned this plan, And it just reminds us actually
that fiscal credibility is a serious problem in the UK.
(28:44):
We are paying a real price for this, and I
think the challenge for policy makers to understand is just
because we're not facing an immediate crisis now, doesn't mean
that these rates, which are obstructively high for the private
sector to get going, are not a serious, serious problem
and a serious dysfunction in the private sector.
Speaker 1 (29:05):
Okay, And the third thing that you talk about in
this report that we've been discussing is an extension of
that to say that interest rates, obviously they have this
effect on asset prices and make people feel bad, but
also crowding out exactly.
Speaker 2 (29:22):
So, crowding out is kind of a bit of a
technical concept, but it happens in two ways. One quite
simply that interest rates are prohibitively high because of fiscal
policy for interest rate sensitive parts of the economy to
get going. And so, for instance, the government's unwillingness to
address either it's excessive spending excessive borrowing or the inflation
(29:46):
that it's creating as a result of those two policies
is basically on a collision course with its housing markets.
Speaker 1 (29:51):
One step back, one step back. So it is the
fiscal policy that creates the inflation, it's the borrowing on
the spending.
Speaker 2 (29:58):
That's exactly right, that's exactly right. Of course, you can
you can, you can make some adjustments here or there.
But this is this is this is the this is
the problem. In that sense, the real limit on an
advanced economy when it comes to borrow in is inflation. Right,
It's not the overall level of debt. You can carry
huge debts in a low inflation economy, you can carry
very little debt in a high inflation economy. Markets care
about getting their money back in inflation just in terms.
(30:21):
So the interest rate effective, of course is significant, and
we can see that with the weakness that we see
in the housing market. We can see that in the
weakness that we see in other interest rate sensitive sectors
like manufacturing, investment and so on. The second way we
see this effect, and this is where this problem lends
(30:42):
itself to a broader theme which I which I which
I think we just need to get into a little
which is to say that the government is much less
price sensitive when it comes to spending than the private sector,
and so the government, when it spends, strips away scarce
resources for the private sector to use, and so the
(31:05):
crowding out takes place through the interest rate, but also
as spending rises as a share of GDP over time.
What we're doing is We're reallocating more and more scarce
resources away from a private sector which is not as
productive as it used to be in growth terms, but
it's still growing its productivity and towards a public sector
where productivity has been stagnant for more than two decades.
(31:26):
And so we're creating more dysfunction through this rising share
of government spending as a center of GDP, and it
comes through the way the government consumes resources that could
be used by the private sector to do something that
would be much much more productive.
Speaker 1 (32:00):
I've got a lot of problems here. What should happen
on November twenty six at the budget? What choices can
Rachel Reeves make that can at least mitigate some of
the damage or actively improve the state of zulkcare.
Speaker 2 (32:18):
I think identphasize three things here. Let me go one
point on the immediate problems, one point on the long problems,
and then we should discuss capital spending. The first thing
is to say, think of the budget like a traffic light.
There's a green outcome, there's an amber outcome, and there's
a red outcome. The green outcome is the best outcome.
(32:39):
It's where government recognizes that it demands on the economy
are simply too large, and we will cut spending in
order to close the borrowing gap. And by cutting spending,
we'll depress demand and we'll depress inflation and it will
get markets on side. And you could do that through
addressing something like welfare or departmental spending. The advantage with
(33:00):
welfare is if you cut it in the right place,
you can reset incentives for participation in the labor market,
especially among young people, where we know we have a
problem politically. That's going to be very, very difficult YEP.
That's close to a zero probability event. I suspect the
Amber outcome, which is where I think we were for
basically a month, which is where the government realizes, actually
(33:25):
we need to counteract the inflationary narrative that we introduced
a year ago by doing a big policy change that
is clearly disinflationary and create space for market interest rates
to fall and for the Bank of England to be
more aggressive with interest rate cuts, which was the advantage
(33:45):
with the income tax increase on its own, this is
not a good policy. As you mentioned, consumers are skittish
and they're not spending enough anyway, so why hit them
with an income tax increase. However, because this interest rate
problem is such a big deal, you can have this
setting effect. It's kind of the Clinton Rubin approach in
the early nineties. You raised taxes, the Fed cut's interest
(34:05):
rates in the economy kicks on. Markets would have reacted
well to that because you would have had this Bank
of England offset. That's the amber out comen. I call
that amber because it's contingent. It's contingent on the Bank
of England doing something. I fear the government's abandoned this
and yeah, last Friday, and the challenge is that understanding
(34:29):
what quite happened. I suspect the government realized that it
needed to do a lot, convinced itself that it's one
option was the income tax increase, decided we better signal
this to market since we're breaking our manifesto commitment into
households and to businesses who have all factored in this expectation,
and adjusted bondials declined over this period, which validated the
(34:51):
idea that this was actually a good policy. The governments
then received a new forecast from the OBR seen that
with lower bond deals everything looks better. We don't need
to we don't need to do so much taxation and
decided to U turn as opposed to saying, well, perhaps
we cut stamp duty stuty on shares, or cut stamp
duty on housing or something like this. This is unbelievable.
(35:12):
So this Amber outcome is now off the table. We're
now in what I would consider to be the red zone.
But again this traffic light idea, where we have this
horrible patchwork of anti growth tax measures which, even if
on the face of it are not inflationary, if they
land on businesses, businesses may try to pass them on
(35:33):
to final prices. But I fear that government is going
to go after things like pensions and assets. And as
I think I've established with quite a lot of evidence convincingly,
it's the weakness in asset prices and the desire to
offset that through higher saving that is causing the underlying
problem in the economy. So if you go after assets,
what you're doing is you're agitating the fundamental problem that
(35:54):
the economy is facing. So I think this is a real,
real issue, and what we're doing is unfortunately by being
in this red zone is base case for me into
next year would be in this scenario, growth still around
one and a half percent, very little sickly cality. Inflation
will come down mechanically because we just have a disinflationary trend.
The Bank of England, i think, will cut three more times.
(36:16):
We might get ten years down to a little below
four percent, but the income tax increase would have add
two or three more cuts to the Bank of England.
Take benchmark interest rates down by one hundred basis points,
revise your growth forecast up to two percent. We've taken
away this very clear upside risk which the government had
set about. So this is the frustration, and now we're
(36:40):
left with a real danger that the economy just has
this slow motion puncture into next year. Growth dwindles, we
get a bit more inflation than we like because businesses
try to pass this on the Bank of England finds
it hard to cut even three times. The bomb market's
not convinced, thinks we're going to have to come back
for tax increases next year, so bond yield stay l elevated,
(37:01):
and the frustration that the economy is producing for people
leads to impatience in the labor party. That then leads
to the uncertainty that could have erupt around leadership challenges
and all that kind of stuff. So that's now the
downside risk, which has become real. So in one week
we've replaced a very real upside risk with the downside risk.
So in the short run they just need to somehow
(37:21):
pick one or two big policies that close the gap
in a disinflationary way that avoid this. They've called it
a Shmaugus board, but I don't think that's right. I
think it's an anti growth patchwork of taxes.
Speaker 1 (37:35):
I mean, this is the problem. And then every single
one of those new fiddle taxes, because that's what we fiddles, right,
every single one of them will come with a furious
lobby group and so the fight back against every single
one will be much harder than if they had just
come out, as you say, with one big tax across
the board.
Speaker 2 (37:55):
That's right. And I think, just to add another dimension
to this, the government seems to have traded off the
opportunity to reassert credibility now with an income tact increase
in April, and to not just be a passive observer
in this disinflationary narrative into next year, but actually, in
(38:17):
the market's eye, the driver of the disinflationary narrative to
now a budget which will rely on the obr's ever
optimistic forecast being right on borrowing, growth and inflation, and
the market is tired of it's going to happen tomorrow, right.
The amount of foreign investors I've been sort of everywhere
(38:37):
in the last few months, including far away places like
Singapore and Australia. They say, why does the OBR keep
including this fuel duty increase when it's been delayed for
fourteen years, which never happens. This is the kind of
thing that is eroding credibility. So it's it's now no
longer it's going to come tomorrow. Tomorrow never comes. Do
(38:58):
something today. A week ago we thought we were there,
Now we think we're not there. This is a this
is a real policy failure.
Speaker 1 (39:07):
What do you think that the smalls that sense again,
Smagas Board, what do you think the Smagat Board of
tax changes is going to involve.
Speaker 2 (39:18):
I think it's anyone's guess at this point. I hope
that they do a little bit on the spending side,
maybe after the spending round is over, as hume lower
departmental spending. I think they'll probably they should spend a
couple of hundred million to try and reduce tax avoidance
and things like that. The OBR might reward them with
(39:38):
sort of three or four billion. I think they'll freeze
in contact thresholds from twenty twenty eight, which is sort
of sensible, But again it's it's in the future. Then
I think we're probably looking at something on pension contributions.
We're probably looking at the changes to council tax bans,
we might be looking at the bank leve fuel duty
(39:59):
make up. But when you're faced with a complicated economic scenario,
where again I don't want to make the case that
the future is so certain, it's just that uncertainty doesn't
seem abnormally high in the UK, what you need is
a clear narrative income taxes up, interest rates down, economies
actually were sorted, get over it and beyond and beyond,
(40:22):
and then come back in a year with a load
of head we've given up that. Then there are the
two other issues. So let's address capital spending first and
then tackle what is the problem not just for the
UK but for all advanced countries, which is this rising
debt to GDP public debt to GDP as the population
ages that you mentioned before me before we had our
online chat. You were discussing at what point is the
(40:44):
government just put up against the war by bomb markets
to say fix things. I think that's where the problem looks,
so we should touch on that. But just on capital spending,
I'm really taking issue actually with this abstract view that
if only you raise capital spending in the economy, we'll
see more productivity growth. Okay, this is a nice sentence
(41:08):
to include in a policy report, but what this means
in the real world is businesses increase their current spending
in capital goods and energy and commodities. They combine those
factors of production to produce capital stock that can then
be plugged in, receive some energy from the grid, and
(41:29):
make workers more productive. The problem is when you have
a regulatory system which says you can't dig that commodity
up from the UK, we can't use the energy that
we produce in our market. You can't build on that land,
we won't produce those capital goods, so you have to
import all of this stuff. Productivity is just the ratio
of GDP to workers. If when you raise capital investment
(41:53):
you have to import all of this stuff, yes, you'll
get some benefit, but what you really into subtract that
benefit is all the inputs you're sending capital abroad. You
can't have a proper productivity revolution that is driven by
capital expenditure unless you permit yourself to use your own
domestic factors of production. The UK is an economy with
(42:14):
huge factor endowments. It's the reason we had the industrial revolution. First.
This is what people forget. We have this stuff underground.
We just have a lawmaker saying you can't use that mind,
you can't use that energy field, you can't build there.
And now with the employment rights build you can't employ
this person under certain circumstances. This is economic suicide. It
(42:35):
doesn't work. And so we won't transform this ambition to
have higher capital spending into higher productivity unless we radically
deregulate the domestic economy to allow that capital spending to
go towards extracting our own domestic factors of production and
combining them in a productive way. And again, this is
(42:55):
just one of those problems where in the UK we
have concent census around another narrative, and yet governments repeatedly
try to fit their policies with this narrative. We heard
under Osborne, we're going to increase capital spending. We heard
under Boris, we're going to increase capital spending. We now
hear it under Rachel Reeves. And yet the productivity statistics
(43:17):
are just not showing the rise that we want to see,
which means there's something fundamentally going wrong in our understanding
of the economy. It's not that if we just do
cut more capital spending eventually we'll force our way to
higher productivity. The chain of events that we think is true,
the narrative is not wedded in the fact in the
right way. And this practical problem that I mention, you know,
(43:37):
escaping this weird abstraction that economists do is where I
think the root of the problem lies. And it's why
you see the best productivity growth in the economies that
are open to using their own domestic factors of production.
The US is a point in case, but look at
what you see in the Middle East, look at what
you see in parts of the emerging world, where they're
digging up stuff from their own economy, they're combining it,
(43:58):
and they're making their workers more productive. Until we accept
that we have to do this, we won't see a
reacceleration in productivity growth.
Speaker 1 (44:06):
Interesting now you say, as you say, we're having a
conversation before we started recording about all these things, and
we were discussing your view that the UK is not
in crisis mode or not near crisis mode, but is
in a state of serious dysfunction, is what you call it.
And I definitely agree with you that we're in a
state of serious dysfunction, no doubt about that. But look
(44:28):
at what you've just said about about CAPEX and about
you know, increasing capital spending and why we won't use
our own stuff, and what you said earlier about capin
welfare spending and why that simply isn't going to happen.
It slightly feels as though all the solutions are there.
You know, you're very good. You've written a marvelous report.
It's all absolutely true. Can't disagree with you on any
(44:48):
of it. But no one in government is listening, and
there doesn't appear to be any political appetite at all
in the UK to shift on any of the things.
Be it a bit well, there, be it at zero
beard any any of these things. Although this shift on
immigration is kind of interesting. Maybe that's the door opening
to some rational thinking in government, but nonetheless without the
(45:12):
feeling that there is any kind of political appetite for change.
It feels that the point at which the bond market says,
do you know what enough and as you said, puts
so you get up against a wall is significantly closer
than it has been for a long time now, is
that we may move from dysfunction to crisis faster than then.
Speaker 2 (45:32):
Of course I might be front run here by what's
happening in US tech. But my guess is, and this
is this is not the first time I've said this.
I've happily said this three or four times on the
show this year, that the government debt problem that we
have around the advanced world, and this is where the
UK just is ordinary, not in a good way, is
the root of the next crisis for sure. The reason
(45:55):
why I think governments are in the UK and elsewhere
this is a broad point, but let's just us the
UK's point in case. Governments are reluctant to address this.
So so for anyone listening, what is going to happen
in these in our advanced economies is we have made
legal commitments. And by the way, I think this is
the right thing to do. So to be absolutely clear,
(46:19):
rich societies should not be inflicting poverty and health related
indignities on retired people. We can avoid that problem if
we get our act together, no question. So this is
not about saying we're not going to look after you.
But as we see an aging population and the share
of dependence rises, especially at the upper end, our public
(46:46):
debt to GDP ratios are going to rise as far
as the eye can see. In the UK's case, we
have one hundred percent debt to GDP today. The OBR
thinks we'll get to two hundred and fifty percent within
our lifetimes. I just don't think the market's going to
let us get there, by the way, but this is
driven by dramatic increasing health spending, dramatic increasing things like
pensions and welfare. And this is true across the advanced world.
(47:09):
And we're just at the foothills of this debt mountain.
And just as we reached the foothills, the natural buyers
of government debt, things like pension funds, which already saw
this problem far in advance and had to prepare and
money risk for it, have basically decided we've got enough
of this paper we don't need any more, and so
the price that the market is charging us to issue
(47:31):
more debt is too high relative to to again what
the private sector would would prefer to really get going. Okay,
Why why are governments not addressing this? Is as the
central economic problem. First is governments don't distinguish between chronic
(47:51):
problems and crises, and so you'll often see that policy
makers simply taken as given UK is a an economy
with slow potential growth, as if this is just normal,
we should just accept this and we should just manage
around it. So you need to raise taxes. We remember
the New Statesman title early this year. Just raise tax Hey,
(48:11):
that's the solution, accept it, raise tax You're a slow
growth economy. Make sure you can fund the state. Okay.
So there's there's there's a degree of naivety in that view.
The second problem for me is that and of course
in the absence of a crisis, you just kind of
never have your priers on this front challenge. The second challenge,
(48:33):
which for me is more important, is policymakers, I think
overestimate the positive impact which government spending has on GDP
under conditions of normal balance sheet strength in the private sector,
which is roughly what we have now, which is to say,
in the middle of a financial crisis, do you want
to cut government spending? No? When you have a fundamentally
(48:55):
healthy private sector with full of smart people, low levels
of debt, and clear opportunity to raise productivity through things
like AI, should government fear just pulling back a little
bit in not small ways to rebalance fiscal policy. No.
But I think they fear if they could spend in
they'll tank their economies into recession and that will mean
(49:18):
they'll be out of office. I think this gets it
exactly the wrong way around because of the way that
I explained this crowding out effect. So what's going to
happen I suspect is at some point these policy choices
will these bad policy choices which have compounded over time.
It's not just the labor government's previous conservative government too,
(49:40):
and the previous labor government before that will erupt into
another bout of inflation and the bomb market will say
that's enough and governments will be forced. And actually I
quite liked the idea that Andy Halding, in the previous
Chief Economist that the Bank of England came up with
this week's say, you should say we'll raise taxes by
a pound, we also cut spending by a town. This
(50:01):
is a nice handy rule of thumb. You will be
forced to dramatically cient fiscal policy in near term or
say we need a better way to manage these long
term liabilities. The result will be markets I suspect and
governments will fear recessions. The actual consequence will be the
(50:23):
bond market. We'll see much less issuance, much less inflation.
It will reward governments that fix these fiscal problems, drive
down interest rates, and then the private sector will start
to do much better, which is why you see so
many instances where bloated states suddenly decided to austerity and
the private sector comes alive. I mean, Argentine is our
(50:45):
point in case today, Britain, in the eightiers, We've seen it, Canada, Sweden,
There's lots of examples. But we actually have a better
option here in my view, which is to say, we
have not properly managed our public services for the past
fourteen years, and justifiably so, people are uhappy with things
like education and health and welfare. Is there a solution
(51:07):
where we don't have to cut this? Yes, I think
we can address these long term issues. What we need
to do is find clever ways to address our long
term pension commitments, our long term health commitments, which mean
that yes, debt will rise, but instead of getting to
two hundred and fifty percent, maybe it gets to one
hundred and fifty percent and rolls over. And I'm going
(51:28):
to stop. But if you want, I think I have
a solution to this.
Speaker 1 (51:33):
Yeah, you have to stop there, so I can ask
you what are these clever ways? Everyone wants to know
the clever ways where we cannot have to cut spending,
okay and not end up at two hundred.
Speaker 2 (51:45):
And for me, let me kill a lazy narrative here
first to say that you often hear naively that government
debt is less risky than private debt. This is fundamentally
wrong in a properly regulated economy, and roughly speaking in
the UK, basically is now, when a bank issues a loan,
(52:07):
it will have done the due diligence to make sure
that the borrower is using that loan for something good.
And when it comes to big loans generally it's like
are you actually investing? Are you increasing the value of
your house? Right? So, there's there's a there's an income
generating asset that goes with the loan, and so that
the net yield, the net return is positive, which means
(52:30):
on the private sector, yes, you have rising debt over time,
but you tend to have rising assets and you generate
an ever greater positive net wealth position, which is which
which is why we can tolerate ever growing levels of debt.
With the public sector, it's completely different. What we've had
actually across the advanced world is this ratcheting effect where
to avoid recessions in the short run, which would have
(52:53):
had some bad consequences, but also some good consequences. They're
great cleansing events. We have increased debt substantially to fund
current spending just to avoid the recession. The result of
this ratcheting effect is we've had a succession of crisis
where we've just added and added to debt and we
have no assets that are productive on the other side
(53:15):
of it. If we would have raised all of this
debt to GDP to expand energy and infrastructure and minds
and all the rest of it, Okay, I'm not in
favor of making everything statement, that would have been a
very very different result so now we have a situation
where we have no assets to go alongside of all
of this debt. But the debt itself requires an interest
(53:37):
which is now aheadwind. We spend one hundred billion pounds
a year. Okay, so we need to start re evaluating
the way we think about government debt so that we're
generating assets and actually again to an extent, Rachel Reeves
adjusting her fiscal rules to not exclude capital, to exclude
capital spending sort of gets there, and to look at
a net wealth measure. But take the two big costs
(54:00):
that people will impose in retirement on the public. First
is their pension. The second is health costs. With pension,
it's through their entire period out of work. With health costs,
for most people it's sudden increases very late in life
or in one or two instances. What we should do
(54:23):
is recognize there's a difference between government providing pensions in
healthcare and guaranteeing it. And so what I would like
to see in the UK when people enter the workforce
for the first time, and you could probably apply this
to anyone under the age of forte you get a
two thousand pound tax cut in your first year, that
(54:46):
two thousand pounds goes into pick something. Take an ETF
fifty percent global, fifty percent UK. It'll give you anywhere
between eight and ten percent per year. You con pound
that until you retire, and that is your pension pot,
and you will get a big number. By the time
you're seventy you'll be anywhere between three hundred and fifteen
four hundred thousand pounds. You'll be better off than if
(55:07):
you've got your your state pension today in a lump sum.
And that small tax cut generates a huge asset that
takes off the liability side of the government balance sheet
funding your pension either through taxes or borrowing. When you
actually get to that point in the second year, you
get another thousand pound tax cut. It goes into the
same instrument, but it's used as a pot of money
(55:31):
that can finance health costs, and you can spend that
however you like. When the time comes go to the
private sector, you can spend it on the NHS. It
really doesn't matter. But what you do is you de
risk those sudden health costs from the taxpayer. But I
think with both of those things, what you can actually
say is if you don't use these parts, your children
(55:52):
can inherit them, which means on the health side, you're
incentivized to make good lifestyle choices, which is something that
we need to seriously talk about in order to get
fiscal sustainability. But then on the pension side, it will
induce people to contribute more to their private pension so
that there's more that can be inherited down the line.
(56:13):
And so we're addressing some of these fundamental issues. And
I think once the market sees these credible commitments to
longer run sustainability, you then don't need to be up
against the wall every six months, every twelve months to
find ways and to resolve all these very very bitter
and politically tense issues around welfare and the like.
Speaker 1 (56:33):
Yeah. I mean, I love this idea, callum, but I'm
going to add it to the list of things that
simply aren't going to happen.
Speaker 2 (56:39):
Under this government nobody. Eventually, I suspect we will reassert
credibility in these clever ways at some.
Speaker 1 (56:44):
Point this kind of thing will have to happen. But
I mean, that's the other side of the crisis, isn't it,
Because that's that's giving giving money away, that's so we
thought and I did that already it's there, And of
course it's too long term because there are the positive
results of that fit into the five year four cust
And who's gonna do anything that doesn't fit into the
five year four cust that's it. So filing that under
(57:08):
an excellent idea, marvelous tuns great never gonna happen.
Speaker 2 (57:11):
In this budget. No, I suspect in future. That's we
will get to these kinds of places in the end.
Speaker 1 (57:18):
Well, callum, I guess we will pin our hopes not
on this month, but on the future, when hopefully a
government will start reading your reports and acting.
Speaker 2 (57:29):
You're speaking be from Edinburgh. There's a statue of Adam
Smith with his great quote fear not, there's a great
deal of ruin in a nation. If we can get
one or two things right, suddenly this gloomy narrative will
turn positive. And so it's incumbent upon us to just
solve these one or two big issues. And it's amazing
how much then we can tolerate day to day.
Speaker 1 (57:50):
Oh okay, well, fingers crossed, Callum, thanks so much for
joining us today.
Speaker 2 (57:55):
Oh my pleasure, thank you, thanks for listening to.
Speaker 1 (58:04):
This week's Marin Talks Money. If you like our show,
rate review, and subscribe wherever you listen to podcasts, and
keep sending your questions or comments to Mirror Money at
Bloomberg dot net. You can also follow me in John
on Twitter or x I'm at marins w and John
is John Underscores Stepic. This episode was hosted by me
Mary Zumset Web is produced by Someersadi and Moses, and
sound designed by Blake Maples and Aaron Casper especial thanks
(58:26):
of course to Callum Pickering
Host
Merryn Somerset Webb
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