Allocating capital post-QE

[TheMotorcycleBoy]

Hi,

What are your asset allocation plans when the "free money" eventually runs out, interest rates climb and trigger large scale loan defaults?

Thanks

I think you've pointed out a major reason why interest rates will not climb significantly for some time. There is still a mountain of debt out there which will continue to limit further lending which, in turn, is a key driver of inflation.

So high existing debt limits further issuance of debt which limits increases in money supply which limits inflation which limits the need for interest rate rises.

Hi BoE,

I think I understand what you are saying here. But I'm puzzled by this statement of yours: high existing debt limits further issuance of debt since firstly:

1. Do you mean household or corporate debt? And does that distinction matter in the context under discussion?
2. And given the above question, I was under the impression that corporate debt was continuing to rise (I may be wrong though). Since I believe that many of LBOs and stock buybacks are financed by debt possibly encouraged by the prevailing low rates of interest.

thanks Matt

[Bubblesofearth]

Hi BoE,

I think I understand what you are saying here. But I'm puzzled by this statement of yours: high existing debt limits further issuance of debt since firstly:

1. Do you mean household or corporate debt? And does that distinction matter in the context under discussion?
2. And given the above question, I was under the impression that corporate debt was continuing to rise (I may be wrong though). Since I believe that many of LBOs and stock buybacks are financed by debt possibly encouraged by the prevailing low rates of interest.

thanks Matt

Household debt mainly. There is a limit to how much debt can be assumed before repayments take up so much of ones income that further indebtedness becomes impossible. Reducing interest rates increases this limit but rates are so low now that further decreases will have little affect as capital as well as interest needs to eventually be repaid.

Corporate debt can increase but corporations will only do this if they believe consumption rises will make it worth the investment. If household debt levels are maxed out then significant increases in consumption will be hard. So why should corporations increase their debt levels?

BoE

[dealtn]

Household debt mainly. There is a limit to how much debt can be assumed before repayments take up so much of ones income that further indebtedness becomes impossible. Reducing interest rates increases this limit but rates are so low now that further decreases will have little affect as capital as well as interest needs to eventually be repaid.

UK Household Debt as a ratio of GDP has barely moved over the last 5 years, and noticeably lower than at its peak in about 2010. I don't think we are anywhere near levels where the issues that concern you will be kicking in.

Debt may have risen marginally but wages are rising too. Only this week was it confirmed that the average weekly wage, inflation adjusted, is above that of the peak before the "Financial Crisis".

[TheMotorcycleBoy]

Hi BoE,

I think I understand what you are saying here. But I'm puzzled by this statement of yours: high existing debt limits further issuance of debt since firstly:

1. Do you mean household or corporate debt? And does that distinction matter in the context under discussion?
2. And given the above question, I was under the impression that corporate debt was continuing to rise (I may be wrong though). Since I believe that many of LBOs and stock buybacks are financed by debt possibly encouraged by the prevailing low rates of interest.

thanks Matt

Household debt mainly. There is a limit to how much debt can be assumed before repayments take up so much of ones income that further indebtedness becomes impossible. Reducing interest rates increases this limit but rates are so low now that further decreases will have little affect as capital as well as interest needs to eventually be repaid.

Yes that's what I thought you meant.

Corporate debt can increase but corporations will only do this if they believe consumption rises will make it worth the investment. If household debt levels are maxed out then significant increases in consumption will be hard.

Agree.

So why should corporations increase their debt levels?

I'm no expert. But presumably for the 2 reasons which I mentioned in that post to which your reply was aimed: to finance acquisitions and stock buybacks. Additionally, I assume, that using creative accounting debt can be used to maintain dividend levels (or even grow them), for short periods of time.

Matt

[odysseus2000]

motorcycleboy
I'm no expert. But presumably for the 2 reasons which I mentioned in that post to which your reply was aimed: to finance acquisitions and stock buybacks. Additionally, I assume, that using creative accounting debt can be used to maintain dividend levels (or even grow them), for short periods of time.

A lot of business grow organically & fund this growth by internal cash flow and/or borrowing. If a business can borrow at x & boost their income by nx, where n is > 1, then everyone is happy as although debt has increased it has lead to more profits & the lender will eventually get their dosh back plus the interest they have charged. A system were debt is hard to get limits growth & limits bank profits, so that the overall result of having relatively easy access to debt is positive if everyone behaves, but of course bankers have a recurring habit of being stupid so that the economy is troubled by periodic financial crisis.

Regards,

[Bubblesofearth]

UK Household Debt as a ratio of GDP has barely moved over the last 5 years, and noticeably lower than at its peak in about 2010. I don't think we are anywhere near levels where the issues that concern you will be kicking in.

Debt may have risen marginally but wages are rising too. Only this week was it confirmed that the average weekly wage, inflation adjusted, is above that of the peak before the "Financial Crisis".

If you look over a longer period of time you can see the debt explosion of the 80's and 90's took household debt from around 60% of GDP to a peak of around 200%. Yes, we've come off that peak and there is scope for further debt assumption, but not the levels that would IMO trigger big rises in inflation and a need for interest rate rises.

Relatively low levels of increasing debt, and therefore money issuance, can be swallowed, in inflationary terms, by continued reductions in the cost of manufacture.

BoE

[dealtn]

If you look over a longer period of time you can see the debt explosion of the 80's and 90's took household debt from around 60% of GDP to a peak of around 200%.

Not even close

https://tradingeconomics.com/united-kin ... ebt-to-gdp

[GoSeigen]

If asset prices are over-inflated then have a large cash and government bond allocation. It's that simple.

Er, Government Bonds are one of the most over-inflated assets though!

Doesn't matter. They will still outperform the other over-inflated stuff -- and you have cash if the gilts fall too (which they probably will not).

EDIT: And who's to say that their value will not have changed before this hypothetical occurrence?

GS

[dealtn]

If asset prices are over-inflated then have a large cash and government bond allocation. It's that simple.

Er, Government Bonds are one of the most over-inflated assets though!

Doesn't matter. They will still outperform the other over-inflated stuff -- and you have cash if the gilts fall too (which they probably will not).

Gilts are priced above 100, and redeem at 100. Not sure why you think "they will probably not" fall.

[GoSeigen]

Er, Government Bonds are one of the most over-inflated assets though!

Doesn't matter. They will still outperform the other over-inflated stuff -- and you have cash if the gilts fall too (which they probably will not).

Gilts are priced above 100, and redeem at 100. Not sure why you think "they will probably not" fall.

I don't know why you think they will!

Look at this chart of TR55:

http://www.fixedincomeinvestor.co.uk/x/ ... &groupid=3

TR55 has been priced above 100 for nine years and was due to redeem at 100 that entire time. It's price did not fall: it rose 100%.

So I'm afraid there is something vital missing from your logic if you think I have to justify why gilts priced over 100 might not fall.


GS

[dealtn]

Doesn't matter. They will still outperform the other over-inflated stuff -- and you have cash if the gilts fall too (which they probably will not).

Gilts are priced above 100, and redeem at 100. Not sure why you think "they will probably not" fall.

I don't know why you think they will!

Look at this chart of TR55:

http://www.fixedincomeinvestor.co.uk/x/ ... &groupid=3

TR55 has been priced above 100 for nine years and was due to redeem at 100 that entire time. It's price did not fall: it rose 100%.

So I'm afraid there is something vital missing from your logic if you think I have to justify why gilts priced over 100 might not fall.


GS

So how will they redeem at 100, if they are currently at nearly 200, and yet not fall? There is nothing missing in my logic, vital or otherwise, thank you

[Bubblesofearth]

Not even close

https://tradingeconomics.com/united-kin ... ebt-to-gdp

Same trend and % increase over the period, just different absolute numbers which seems to be site dependent;

https://neweconomics.opendemocracy.net/ ... -about-it/

BoE

[dealtn]

Not even close

https://tradingeconomics.com/united-kin ... ebt-to-gdp

Same trend and % increase over the period, just different absolute numbers which seems to be site dependent;

https://neweconomics.opendemocracy.net/ ... -about-it/

BoE

Nope. Not site dependent, they are remarkably similar. But you said "Household Debt", which is the blue line on the final chart. If you meant "Private Debt", which includes "Corporate Debt", then you get the kind of numbers you are talking about.

[GoSeigen]

Gilts are priced above 100, and redeem at 100. Not sure why you think "they will probably not" fall.

I don't know why you think they will!

Look at this chart of TR55:

http://www.fixedincomeinvestor.co.uk/x/ ... &groupid=3

TR55 has been priced above 100 for nine years and was due to redeem at 100 that entire time. It's price did not fall: it rose 100%.

So I'm afraid there is something vital missing from your logic if you think I have to justify why gilts priced over 100 might not fall.


GS

So how will they redeem at 100, if they are currently at nearly 200, and yet not fall? There is nothing missing in my logic, vital or otherwise, thank you

You asked me to justify how they could not fall. I showed that gilts can easily rise even if they are priced over 100. Don't see what I have said that is so wrong...

GS

[Bubblesofearth]

Nope. Not site dependent, they are remarkably similar. But you said "Household Debt", which is the blue line on the final chart. If you meant "Private Debt", which includes "Corporate Debt", then you get the kind of numbers you are talking about.

My bad I was reading private debt as household debt, should have checked more carefully.

However, my main argument stands, i.e that historically high debt levels will IMO cap inflationary, and therefore interest rate, rises for some time to come. So when you say;

I don't think we are anywhere near levels where the issues that concern you will be kicking in.

if you are talking about 'concerns' of low interest rates and inflation then I disagree.

BoE

[GoSeigen]

I don't know why you think they will!

Look at this chart of TR55:

http://www.fixedincomeinvestor.co.uk/x/ ... &groupid=3

TR55 has been priced above 100 for nine years and was due to redeem at 100 that entire time. It's price did not fall: it rose 100%.

So I'm afraid there is something vital missing from your logic if you think I have to justify why gilts priced over 100 might not fall.


GS

So how will they redeem at 100, if they are currently at nearly 200, and yet not fall? There is nothing missing in my logic, vital or otherwise, thank you

You asked me to justify how they could not fall. I showed that gilts can easily rise even if they are priced over 100. Don't see what I have said that is so wrong...

GS

Markets down 10% since this discussion. Government bonds, "the most over-inflated assets", are up.

Just sayin'...

GS