Andrew Miller: An elephant is leaving the room . . .

The idea our children will be collectively shackled by our debts is as misleading as the headlines suggesting the average person on Earth owes X thousand dollars

Money
Money

The idea our children will be collectively shackled by our debts is as misleading as the headlines suggesting the average person on Earth owes X thousand dollars.

They won’t be shackled because they can’t repay debt to a generation that won’t be here.

This is not to say that debt doesn’t matter: for individual consumers and companies, and for small countries even, it can be a life-changing burden.

Its aggregate importance, however, is still overstated – usually because pundits forget that for every borrower there is a lender. In aggregate, all debt is matched by a corresponding asset on somebody else’s balance sheet, leaving consumers not in hock, but the ultimate owners of the economy. For this reason, we have been sceptical of the need for a “great deleveraging”.

The crisis was primarily a financial-sector event – although it certainly had economic consequences – and the underlying condition of collective consumer balance sheets has not been weakness, but resilience: the economy is worth owning.

Keep this in mind as the US budget deficit fades.

This week, Moody’s lifted its outlook for US sovereign creditworthiness to neutral from negative – S&P did something similar a few weeks back, but Moody’s has retained its AAA rating throughout, in contrast to S&P’s 2011 downgrade to AA+.

It cited a faster-than-expected decline in the deficit (which you read about here first) from 10% of GDP in 2009 to a prospective 4% this year, and 2% in 2015. Because we thought the earlier concern was overstated, it’s nice to see the agencies coming around to our view.

And it does loosen a potential constraint on medium-term growth, because it reduces the risk of politicians feeling the need to tighten fiscal policy more aggressively.

But it is not a reason to turn more positive about US or UK government bonds.

The main driver of government bonds is not creditworthiness, or central bank buying, but the business cycle.

If the economy is growing and risk appetite is reviving, bond yields are likely to rise – particularly when, as now, they are starting from low levels.

The 10-year Treasury note and 10-year gilt yield at 2.5% and 2.3%, respectively, are both still way below the likely trends in nominal GDP, even after rising so sharply since April.

Tactically, we think investment grade and emerging market bonds are most vulnerable, but strategically, we’d advise investors with large holdings in government bonds to use rallies as an opportunity to trim positions.

:: Andrew Miller is a director of Barclays Wealth and Investment Management in Newcastle

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