Transcription
Today we're talking about France. Weeks ago, we were discussing U.K. Two months from now, it might be the US again.
The problem is endemic across the advanced world. The long-term public debt trajectory, as a result of ageing populations, is unsustainable. No political party across the advanced world has a serious or credible plan to bring it down, and markets are staring at a factor of two or three or the increase in debt as far as the eye can see. And this is happening at a time when pension funds and the natural buyers have basically gobbled up as much debt as they need. And now we see the economic consequences of that. It's the politics and the challenges associated with fixing short-term budgets. It's the economic consequences, slow growth from crowding out, political uncertainty.
And the reality is, until either the bond market forces a government to make serious steps, let's call it long-term austerity, because that's what it is to fix these budget problems, or someone convinces, through a democratic vote, the electorate that this is the step that needs to be taken, we're not going to escape this. We're now in a repeating cycle of foreboding and worries about fiscal issues.
The good news is we're all going to panic once a government is forced to do austerity, long-run austerity. And the economic consequences, I think, will be almost immediately positive because you'll bring down bond yields, you'll have long-term confidence in the fiscal situation, and businesses and households and banks that have got ample balance sheet capacity around the advanced world will then just start to behave much more normally. I think that's very interesting that you remain glass half full despite always on the rise, you know, 50 years of sort of expanding budgets, tax receipts that don't cover in a lot of, you know, developed countries. And yet the fallout of that could still be positive is interesting.
I mean, I'll pick up on one other thing. I don't often do this, but reading Mario Draghi. Politico has a story out this morning about Draghi. And they, they look at all of the instances where Mario Draghi saying you must listen and European leaders must listen to the big plan that he laid out. I mean, they all signed up to it, at least, you know, in it in terms of ideas. But none of them have really been able to deliver, you know, the central thrust of his plan, which is, in my view, absolutely right, is to recognize that. And let's throw the U.S. in here, because even though the U.S. is, they're the sort of the well-behaved child in class when it comes to regulatory policy. It's in a bad group. Let's be clear. We have overregulated ourselves as we've grown governments. And the result of that is now we prohibit major parts of economic activity simply through the rules that we set ourselves.
And so the way to resolve this long-term structural budget issue, which is to say, yes, we're going to have to spend more on healthcare and welfare, because it is right that we want to avoid inflicting indignities on an ageing population. You need to generate sustainable tax revenue from doing that. So give yourself more economy to tax. If you take the, the artificial rules, certainly the artificial impediments through the rules and regulatory system away, what you'll find is whole chunks of economic activity which today are just not permitted will happen. You'll be able to tax that. Then you'll be able to finance the, the budgets in the longer. And so it has to be both of these, these things.
You can also broaden that conversation out globally. Right. There is a risk that the U.S. is headed into some sort of slowdown if you believe the labor market data showing labor demand softening. You know, a U.S. recession could cause some pain also for Europe, which means, frankly, you don't get that nominal GDP growth that you need to keep those tax receipts, you know, on par with what you're spending.
I think that's completely right. I mean, this is now, well, as we know, it's eased off a little bit over the past week because now we're anticipating Fed cuts towards the end of the year. But the, the global worries over fiscal sustainability, which caused the long end of the curve to move out last, last week, that's the third time this year that that's happened. Just to be clear, like we've had that twice already. We had that, I think it was in February. We had it in April. This is it. This is not going to go away. The question is, and to your point, how does it change? Do you get a government convincing a public, actually, we need to start taking away some of these promises in order to get our economies on track? Or does the bond market force a country to fix its ways?
My view is, unfortunately, the U.K. is the most vulnerable because of the, not because its economic growth is weak. Actually, we've got the second fastest growth in the G7, or the budget looks worse. It doesn't. It looks sort of we're a bit of a middling country in the G7 when it comes to the public finances. But because the nature of the gilt market is it's smaller, it doesn't benefit from the natural buyer that you have in Japan. The exorbitant privilege of the dollar or the hard currency aspect of the euro. And unfortunately, we have had ten years of repeated and highly visible policy mistakes that now get priced in as a premium at the long end of the curve.
I think that we're going to be pleasantly surprised when the government actually bites the bullet and fixes this. I don't think it's 2010 where we should have been genuinely fearful of austerity. I think you're looking at full employment economies with good private sector balance sheets and governments should be actively pursuing fiscal policies which depress inflation and depress interest rates for the good of the private economy.
I'll come back to the Academy in 50 basis points from the Fed, though. Too soon to say. Too soon. You might view too soon and too much priced in then too cuts next year or about. Right. How do you. 150 basis points is priced at the end of I go to I guess I've got 100 basis points more, which I think feels about right. I think the skew is probably towards more rather than less.
The Fed has been faced with a puzzle over summer, which is to say, which, which side of our mandate are we likely to stray further from as a result of the administration's policies? Are we going to stray further away from our employment mandate or our inflation mandate? The market has concluded basically conclusively, the employment side of the mandate is at risk. Now what? More than the inflation side of the mandate? Now what? The Fed typically does is react more aggressively and at a faster pace to downside risk to employment and growth than it is upside risk to inflation, which is why roughly this time last year we got the 50 basis point cut from the Fed when we activated the same rule, this kind of 0.5 increase in the unemployment rate. But it's still not clear that we're at the, the other side of the inflation risk hump. So my guess is the weakness in the U.S. economy for now will encourage the Fed to think about potentially going over successive meetings if the inflation risks really, really dissipate and the economic data start to look really bad. I think it makes sense that we start to ask the question, will the Fed go 50 basis points? But I think there's been too much political pressure on the administration by the administration onto the Fed for the Fed, I think, to just say we'll take the risk on 50 basis points already, because the danger will be that inflation surprises to the upside over the next couple of months and the longer end of the bull market starts to panic again.
Yeah, yeah. No, I mean, it does seem to be that the risk to markets is a bond market blow-up. But we reversed the last one so quickly that my mind goes to the fact that, you know, you have in markets. Tell us one thing. You've got equity markets at all-time highs, high-yield credit spreads really tight. Even homebuilders outperforming the Nasdaq in the last few months. That is not something that was telling us the cycle is turning. But then you have this labor market data which is showing some signs that demand is softening. I just how do you pin these two together to create a near narrative, how the Fed should handle those two things?
The Fed is always setting is always facing a set of trade-offs and the U.S. economy is highly cyclical and the momentum in the upward part of the cycle over the past few years has by and large not been driven by robust private sector growth. Really, the growth has come from an expansion in public spending through the Biden administration, through three big fiscal plans. I mean, not actually, if you strip away government consumption from the past two and a half years where the room rate of the U.S. economy has been 3% annualized, you have a sub-2% growth economy. So what you're now facing actually is weakness in the private sector as a lot of these fiscal things wear off. So the arithmetic for the economy is for things to slow down. The danger is that consumers and businesses anticipate a slowdown and U.S. households that have not been saving all that much anyway start to then do some precautionary saving and businesses that have some good profits for quarter two start to retain more earnings. And then you see this cycle momentum really turn sharply to the to the downside. I don't think that's my base case. I think the base case is the U.S. is going to be a sort of sort of one and a half, 2% growth economy for the next few years, which is not million miles away from its potential.
Really briefly, I do want to ask you about Reform UK. The whole of Europe in, look at Norway, you look at the UK, we're being affected by right-wing U.S. policies in. But there's something novel surely about Reform UK riding high in the polls with very few MPs talking about actually killing certain projects if they're brought forward by the Labour Government. That seems quite a new place and unstable and difficult for markets and businesses.
Now, the next political cycle in the U.K. will mark a very significant lurch in my view towards, let's call them free market economic policies. That's opening energy markets, deregulating, shrinking the size of the state. This is not so dissimilar to what happened both in the U.S. and the U.K. in the early eighties. What we had in the U.K. is a succession of governments all in the same variety, starting with Blair right up until Starmer. There's not that much difference actually between the politics of Boris Johnson or David Cameron or Starmer. It's just that for best part of 14 years, it was very easy to say, Well, this is the Conservative Party that are not of sufficient quality to run the country. Now that Starmer has had to try and people don't like it. Notice that a good majority in the U.K. now favor parties right of center. It suggests that the gravity of politics has moved against Starmer. That's probably the bigger story actually, than his own failures.
Yeah, very interesting. Thank you so much for being with us.