Government debt and your portfolio – should you worry?
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One of the results of the 2020 pandemic and global lockdown is that national governments have been increasing their debt at a very high rate. Is this level of debt sustainable or spiralling out of control? In either case, what are the implications for an investor’s portfolio here in the UK? In this article, our Grantham-based financial advisers here at Castlegate offer some thoughts on these important questions. We hope you find this content helpful, and if you would like to discuss your own financial plan with us please get in touch to arrange a no-obligation financial consultation, at our expense:
Public debt in 2020
So how big is the global debt market in 2020 compared to recent years? In 2009, global debt stood at around $80tn – with the US comprising about 39% of this figure, the EU27 about 30% and the UK 6%. By 2018, however, this total worldwide debt had risen to $102.8bn with the UK’s liability (6%) standing roughly the same, the EU27 down 9% and emerging markets up from 5% to 15%. To put this in perspective, the global equity markets in 2018 stood at around $75tn. This is interesting since much of the media commentary focuses on the equity markets, which were nearly $26tn smaller than bond markets in 2018.
So where do things stand now in the wake of the 2020 pandemic and lockdowns? Due to the crisis, many governments have had to intervene in their economies to try and support workers, businesses and markets. Here in the UK, for instance, the Chancellor – since his March 2020 budget – allowed businesses to defer their taxes, provided wage subsidies and provided sectoral support. All of this has cut revenue and raised governments’ expenditures, with the generosity of such measures varying across countries. According to the IMF, for instance, the most generous countries include Germany, Italy, Japan and the United Kingdom, which have implemented measures totalling to between 18%-35% of the GDP. This, of course, has led to a huge rise in public debt in such countries. UK public debt, for instance, stood at 84.0% of GDP in 2019, yet so far in 2020, it stands at 100.9%.
Can this level of debt be sustained in the long term, and how does the answer affect the economy and, consequently, investors’ portfolios? One important factor here is GDP growth. In short, if GDP growth outstrips the growth of public debt, then the latter gradually falls relative to the size of the economy. As such, the key question here is: will the UK and other countries achieve this kind of GDP growth in the coming years, to shrink the debt from the pandemic?
One positive aspect of the current economic climate is that interest rates are very low, which allows the UK government to borrow large sums of money without leading to high debt servicing costs. Yet, ultimately, how you regard the UK public debt largely depends on your view of economics. One school of thought, Modern Monetary Theory (MMT), for instance, argues that the government can never became insolvent because it can create money. The money that the state creates, moreover, can only be constrained by inflation – which can be managed through taxation and by cutting government expenditure. Whilst this approach does not work in less advanced economies (think Zimbabwe), it can be a useful way to look at UK, U.S. and other public debt caused by the global pandemic.
Implications for investors
Where does this leave an individual in Grantham, say, who wants to know from their financial adviser about how all of this affects their investments? Much of the answer comes back to the central point above about sustainability. If the UK and other economies are able to “grow their way out” of their high debt-to-GDP ratio, then there should be little cause for concern at this stage. In advanced economies such as the U.S. and many European nations, many forecasts such as the OBR, IFS and the CBO give reasons to be tentatively optimistic about an economic recovery up until 2024. The picture in some developing markets, however, is perhaps less rosy.
In many non-investment grade “frontier” and emerging economies, how the recovery and public debt transpire will depend heavily on government policy and resiliency. Those which depend heavily on tourism and commodity exports may particularly struggle, and Moody’s Investment Service has highlighted Latin America as a region with low growth forecasts. In many of these countries, growing out of their debt could be much harder. In the worst-case scenario, it could lead to a sovereign default. As such, if you are considering an increase in your emerging market investments in 2020, we recommend that you consult your financial adviser first to ensure that you are managing the risks appropriately.
Conclusion & invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense: