The magic money tree: investors may not need to be too anxious

There is a theory that money does not grow on trees. Despite this, the UK’s main political parties, some more than others, plan to go money picking from the local forest. Is this viable, will it crash the economy, should investors run for the hills, or indeed, find safe refuge amongst the trees?

Article updated: 22 November 2019 3:00pm Author: Michael Baxter

Pantheon Macroeconomics says that based on their plans, “we expect borrowing to rise to 2.8 per cent under the Tories and 4.0 per cent under Labour in 2020/21.”

Read the press, especially the more traditionally Conservative supporting press, you would have thought that the Labour government’s policies will bring forth the four horsemen of the apocalypse.

I don’t wish to get drawn on ideology, you may think Labour’s plans to tax the rich will crush the economy, you may or may not be right, but that has more to do with beliefs than facts.

Labour’s plans to nationalise certain companies may create inefficiency, they may destroy the value of shares held by investors, but for the wider economy, the facts are not so clear. Yes, nationalising certain industries will cost money, but it won’t necessarily create a net deficit. Sure, burrowing will rise, but so will income. Of course, once nationalised, the respective state owned companies may become less efficient, yielding less income for the government, but the act of nationalising itself won’t necessarily create an unsustainable position. (See an analogy here with private equity — it borrows to buy companies, but usually this is extremely profitable.)

But what about borrowing plans? Are they sustainable?

The lesson from New Zealand a few years ago is relevant. In 2017, its Labour Party changed leaders during the course of the election, overturned a big deficit (according to opinion polls), to form a coalition government. The party had big plans to implement a left wing agenda, analogous to the UK’s Labour Party’s manifesto.

In the immediate aftermath of the election, business confidence and investment intensions fell sharply, and house prices were hit. However, the coalition junior partners stopped the more extreme policies.

The economy has since gone on to do quite well, and although the economy has slowed recently, this is probably due to the wider global slowdown.

“New Zealand equities initially fell relative to equities in the US and Australia, but soon recovered,” said Paul Dales, Chief UK Economist at Capital Economics.

So what about the UK. What would be the impact of a Labour victory, albeit, an unlikely victory?

In particular, what about gilts? Will a Labour victory push up on gilt yields, drastically increasing the cost of government spending?

Andrew Wishart, UK Economist, at Capital Economics said: “There is little sign that gilt investors are concerned about a big fiscal stimulus in general.”

Bear in mind that either an outright Labour victory or Labour led coalition reduces the odds of a hard Brexit, or indeed of any Brexit.

Mr Wishart said: “Gilt yields would not rise much relative to expected short rates because there is little risk of debt sustainability becoming a serious concern. Low interest rates mean governments can service much larger debt piles than before. Despite the rise in the debt ratio from 34 per cent of GDP in 2007 to eighty per cent, interest payments will cost the government just 2.2 per cent of GDP this year.”

In any case, suggests Capital Economics, Labour’s policies point to a rise in debt to around 100 per cent of GDP, and investors are unlikely to be concerned unless debt rises to over 120 per cent of GDP.

“As long as investors feel gilts are safe, any rise in yields would probably be limited by the global search for yield. If Labour won the election, we think the spread of gilt yields over the policy rate would rise by only 25-50 basis points,” suggested Mr Wishart.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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