Should the UK issue perpetual bonds?
I recently came across this interesting article from George Soros, suggesting that the UK DMO should issue perpetual bonds to help it get through its current bind.
Soros has written about this topic a few times already over the past few years, suggesting the EU as a whole (and France as well) should issue perps, to take advantage of super low rates and help finance the big spending commitments that were made to help mitigate the pandemic.
An interesting concept
It's an interesting concept, and one that I think should be taken seriously by the DMO. The UK actually had a few perps outstanding that were initially issued in the 18th and 19th century and only recently retired in 2015.
It’s true that given recent volatility, UK interest rates are higher and that extra interest would cost the government money – but they are still very low in historical terms. More importantly, the yield curve is an interesting shape, looking a bit like a bell curve:
1y – 3.24%
10y – 3.64%
20y – 3.84%
30y – 3.61%
50y – 3.26%
This is because there is a real shortage of issuance in the very long end of the curve, yet there is huge demand from the UK’s very large pension sector. Pension funds entered a doom-loop of selling assets to raise cash last month, but the assets they were selling were in the belly of the curve. In the ultra-long end, there is still a huge supply-demand mismatch, which is keeping rates anchored.
A pyrrhic victory
It is right that the government is focused on its budget and on ensuring that difficult choices are made with regards to taxes and spending.
But, as many commentators have pointed out, Liz Truss’ diagnosis wasn’t wrong. The fundamental long-term issue facing the UK is growth. Sunak needs to be careful in wielding the knife on spending too carelessly, lest he plunge the country into a Greece-style depression.
There may be pockets of inefficiency here and there, but broadly, the UK needs more investment, not less.
Mouths to feed
Sunak himself has previously said that borrowing was justified if for investment. And he should heed his own advice.
Voices clamouring for investment are manifold: health, education, and energy are three of the big ones and to be honest, each one could justify a campaign on its own:
Nearly 7 million on the NHS waiting list has put a record number of people on long term sickness and out of the labor force, dragging down productivity;
The Brexit driven skills gap is getting wider;
The twin objectives of energy independence and net zero will require a lot more money than is currently earmarked.
There is no way these big priorities can be paid for by small increases in taxes here or there.
A good use case
We need to retain some perspective here. The pandemic was a once-in-a-hundred year event and the energy transition is a once-in-two-hundred year expenditure. These are exactly the types of investments that perpetuals should be issued for.
Perpetuals benefit the issuer, as they remove worry about refinancing risk. And they benefit the investor as they remove the worry about how to reinvest the funds after maturity. For long term investors like pension funds, they are the perfect asset.
Soros suggests the government includes a call option, allowing them to redeem in case the interest rate environment goes down. The government will have to pay a higher coupon for the privilege of the call option, but it could be worth it - that higher coupon may help turbo-charge demand. Even at prevailing interest rates (3-4%), the government could mobilise £100bn of capital and only have to pay £3-4bn annually.
The most important thing
Of course, the key is that the capital is actually invested and not spent. The distinction isn’t always obvious. Perhaps they should be specifically earmarked for certain uses in order to prevent subsequent governments from squandering it on pet projects and bridges to nowhere?
Ultimately, the principle remains – the UK needs investment. And while it should be cautious with its finances, the right kind of targeted borrowing (such as issuing perps) could be the way to fund that investment.
