PIMCO on British National Solvency
PIMCO is out with its secular outlook for the UK. PIMCO Portfolio Manager and EVP Michael Amey comments on growth and inflation and their effect on UK assets in the new normal of deleveraging, greater regulation and de-globalisation. One comment he made on default risk was quite informative:
Q: PIMCO has identified sovereign risk as a key theme for 2010. How significant is this risk for the UK relative to the eurozone?
Amey: Sovereign risk is a key risk for the UK but in a slightly different way to the economies of continental Europe. The UK government deficit, which is currently running at around 11% of GDP, is one of the highest both on record and within the developed world. That creates a potential risk as regards to the ability of the government to finance its debt. However, unlike countries within the eurozone, the UK has the advantage of an independent floating currency, making it highly unlikely it will suffer the problems currently besetting parts of the eurozone. With its own currency, the UK will always have the ability to repay its debts, but it may devalue the debt in real terms when viewed in non- GBP terms. Therefore, UK sovereign debt risk will continue to be an issue as long as UK debt levels remain high, which in turn will put pressure on the currency and the inflation rate, and potentially erode the longer-term value of government debt. [underlining added]
The UK government is a sovereign with substantially all of its debts in a currency it creates. It cannot face an involuntary solvency crisis any more than Japan or the United States. This is quite a bit different than Spain, Greece or Portugal for example where national solvency is an issue in the medium-term.
Notice how low Japanese, US and UK interest rates are despite enormous budget deficits in this chart from the FT.
When you hear pundits talking about national insolvency for the UK or the US, it’s absolute rubbish. As Amey says, the risks are inflation and currency losses not losses in principal.
The full Q&A is a good read if you have British-based investments and is available via the link below.
Source: Mike Amey Discusses PIMCO’s Secular Outlook for the UK, PIMCO
Update: Note that Amey’s colleague Andrew Balls says that these differences between the Eurozone and sovereign debtors like the UK or US mean PIMCO would not favour Bunds over Treasuries.
We will look both within and beyond Europe for higher-quality securities where we think we can achieve similar or superior risk-adjusted returns. We remain positive on core duration and German bunds. But given the potential for eurozone governments or the ECB to be drawn deeper and deeper into providing support, we do not see German bunds as offering significant advantages over the secular horizon compared with U.S. Treasuries.
See my post "Russia, sovereign debt defaults, and fiat currency" for more on national solvency.