NIESR International perspective on financing
Swapan Pradhan of the BIS and I begin by looking at bonds as an asset. The striking fact is that over the past 20 years there has been an explosion in global investor demand for bonds denominated in the main currencies – dollars, euros and sterling.
Strong income growth in Asia and the need to prepare for longer retirement periods everywhere led to what Bernanke called a Global Saving Glut. Savings in excess of domestic investment opportunities sought a home in foreign financial assets, especially bonds denominated in the major currencies. To protect themselves against currency risks, investors like portfolios with several currencies. As they move between currencies as returns change, major bond markets move closely together. Global demand dominates domestic demand. Hence it makes sense to talk of a world long-term interest rate. Our measure of this is based on government bond yields which provide the benchmark against which other debt is priced.
The world long-term interest rate has been on a 20-year trend decline that nobody foresaw. It went from about 5% in the early 2000s to a little over 1% currently. Even if investors apparently expect short-term rates to rise above 2%, they still prefer to hold bonds.
This clear trend shows as a first approximation that investor demand for international bonds has been much stronger than the willingness of borrowers – at given market rates – to issue new debt.
There was a big increase in government borrowing in the United States and other advanced economies last year, and the prospect of more to come this year. But this has led to only a small uptick in this world rate – to about 1.2% last month (March). By all accounts, then, investor demand for safe assets in the form of government bonds in dollars, euros or sterling remains strong.
Sterling-denominated bonds – all issuers not just the British government – account for about 6% of total international bonds. By mid-2020, that amounted to $5.2 trillion. This is about 190% of UK GDP. In 2000, the equivalent was just 90% of UK GDP. So the rise in the stock of sterling bond assets globally over the past twenty years is equivalent to about 100% of UK GDP.
This provides one metric for measuring the change in “fiscal space” – from the point of view of foreign investor demand. A bigger proportionate rise in government debt would reduce the share for other borrowers. UK government debt is up by somewhat less than aggregate international bonds in sterling -- it rose by 90% of UK GDP. So the UK has not used up all its fiscal space (to repeat, by this metric) – despite the severity of the COVID shock. But it has used up a lot of it and more than the United States … but that was before Biden!
Two aspects of UK debt make government bonds especially attractive to foreign investors.
The first is its sizable inflation-linked share. Greater uncertainty about inflation over the past 12 months has increased the demand for inflation-linked debt. Any asset manager running an international portfolio of inflation-linked debt will have to hold a sizable chunk of UK debt paper.
The second is the unusually long average remaining maturity of UK debt – 15 years. Therefore the UK can be quite aggressive in issuing short-dated debt if it wants to prevent a sharp rise in bond yields. Even if decided to stop issuing long-term bonds for one whole year, the average remaining maturity would still be 14 years. The average maturity of US Federal debt is 6 years. It has the potential flexibility to see it through bond market squalls in the years ahead.
To conclude. The bottom line is that the financing of a sizable increase in British government debt looks a lot easier from an international perspective than it sometimes does from a purely domestic perspective.
Philip Turner is a visitor at the National Institute of Economic and Social Research and one of the authors of the occasional paper "Designing a New Fiscal Framework: Understanding and Confronting Uncertainty".