Live From Fringe: What Adam Smith Would Say of Bond Market Turmoil

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2:19Welcome to Meryn Talks Money, the podcast in which people who know the markets explain the markets. I'm Meryn Somerset Webb. It is that time of year again, and we are bringing you something very special. Over the next few days, you are going to hear recordings of the conversations I had at Pamir House for the Edinburgh Fringe Festival. The Fringe is a three-week arts and culture festival that began in 1947 and takes place in Edinburgh in Scotland every August. And for the last few years, I have been hosting conversations about markets, economics and investing from one of the most special locations in Edinburgh as part of this festival.

2:53I do it from Pamir House, which is the last home of Adam Smith, philosopher and father of modern economics. It's where he completed the last editions of his bestsellers, The Theory of Moral Sentiments and The Wealth of Nations. In the previous show, you'll already know that this episode is the second of three conversations. I spoke with Richard Wilson, the CEO of Interactive Investor, one of the UK's largest retail investment platforms, Anna MacDonald, Investment Strategy Director at Hargroves Lansdowne, and Professor Russell Napier, financial historian, author and keeper of the Library of Mistakes.

3:25Each one of our panellists selected their favourite Adam Smith quote, and of course, we discussed it. Along the way, we chatted about the global bond market, second-order consequences of economic policy, the similarities between the invention of the steam engine and the emergence of AI, and of course, the fiscal constraints that bind the UK government. Enjoy the show.

3:49Now, last year was a great year for this show because we were talking about the 300th year since Adam Smith's birth. And, you know, we were talking about him and his life and the salons he had here and all that kind of thing. It gave a great energy to the whole thing. But this year is the 250th anniversary of the publication of The Wealth of Nations. Now, when he published that, he published it into the beginning of the greatest industrial revolution the world had seen at the point and has seen until quite recently. It was the same year that James Watt unveiled his steam engine. So that was the beginning of something absolutely extraordinary.

4:22When we look at this year, I'm going to talk about this a lot today, I think. we're at the beginning of another extraordinary industrial revolution, which will be probably more life-changing than that one was, the beginning of the AI revolution, the beginning of us all feeling the AI revolution. So we're going to talk, I think, today about the way that will change the way we live, change the way we feel. And I think we'll also talk a little bit about moral sentiments and Adam Smith's view of humanity and what it is to be human, because that is another thing that we're going to need to confront over the next four or five years, if AI I can imitate everything about us.

4:57How can it be human, but also not human? What is the struggle that makes us feel other people's loss, pain and joy, which Adam Smith, as the only person in the room who has read both books will know, wrote a lot about. So, and the way we do this is we have three guests. And you all know this. You've all been before. Who hasn't been before? And I'll speak directly to you. Okay. Those of you who haven't been before, the way it works is I ask, each of my guests for their favorite Adam Smith quote. And amazingly, they all have a favorite Adam Smith quote. And amazingly, it's not the same one every year.

5:34And then... Miracles, miracles. And then we talk about that quote. We talk about why they chose it. It's relevant to them. It's relevant today. We'll all chit-chat about that. There will definitely be investment advice. Right, Richard? Absolutely. Regulated advice. Okay, right, Anna? Definitely investment advice. Bad at that. Anyway, on to introducing the panel. You thought I'd forgotten them. I haven't. Far corner, there is Anna McDonald, who is the Investment Strategy Director at Hargroo's Lanzar, and she's been on the podcast a few times. Who's here to Anna on the pod and already knows she's brilliant?

6:09Let's go.

6:13Excellent. Thank you. Next to Anna, Russell Napier, the keeper of the Library of Mistakes. Has anyone been to the Library of Mistakes? So cool. Okay, if you haven't been to the Library of Mistakes, look it up and go. It's absolutely brilliant. And it's all because of Russell that it existed all. Fantastic. He's also our favorite investment strategist and financial historian. And you all heard Russell on the podcast before, right? Yes. And he's brilliant, right? Yes. Finally, Richard Wilson, CEO of Interactive Investor, who has also been on the pod several times. So we are going to start, Russell, I think we'll start with you and your favorite quote this year.

6:50Yeah, when you said you've written lots of books, I nodded just for accuracy too. And also, to be clear, I've only written the introduction to one, right? We did have one wonderful show when everyone had written a book and someone said they'd written a book. And I said, oh, I wrote the introduction to that. And he said, yes, you did. And then we moved on to the next guest and he talked about his book. And it turned out I'd written the introduction to all three books. Writing introductions is much easier than writing books. I'll let you know if anybody ever asked me to write an introduction. So we'll begin with the men of system.

7:24I think it'll be obvious when I read this why it's topical, but I'm going to talk about it anyway. But it's a rather long one. The man of system, on the contrary, this is from the theory of moral sentiments, by the way, which four of you will know. The man of system, on the contrary, is apt to be very wise in his own conceit and is often so enamored with the supposed beauty of his own ideal plan of government then he cannot suffer the smallest deviation from any part of it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chessboard.

7:58He does not consider that in the great chessboard of human society, every single piece as a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. and why have you chosen that one Russell I think we're probably all guessing but I think you can all guess the man of so I wake up every I thought when I woke up every morning I was perfectly normal because when I wake up every morning I have no intention whatsoever of telling anybody else what to do it wouldn't even occur to me that this would be my role in life to say that somebody else should do something but it turns out that that is the main qualification to be elected to public office is to wake up every morning and have a view that you should be telling other people what to do.

8:42Now, the reason that that is on the rise is lots of the variables, we can call them economic variables, market variables, are kind of chaotic, or they are signaling things that the men of system, and of course we now have to say women of system, Smith didn't, but we do, that they don't like, those outcomes they don't like, so they want to change those variables. And topically, last week, the US Secretary of the Treasury, Scott Besant, decided that he would intervene to begin to determine the price of selected US government bonds, which is the biggest financial market in the world. This is even more bizarre because he's a former hedge fund manager, sworn enemy of the men of system.

9:24And here he is enfranchised with power, willing, able, and desperate to exercise it. He also decided that he would intervene in the foreign exchange market between the dollar and the end of the second biggest currency pair in the world. So this man of system converted from a hedge fund manager is decided to do something. And I think the problem with the men of system, in my experience, and I've met a few, but also in history is that their mantra, their motto is, if at first you don't succeed, try, try again. So for the people in his room who don't know what Scott Bessant has done, it's worth having a look at, they'll be back.

10:04The men of system are on the rise. But there also, I mean, the catchphrase is as much try, try again as something must be done. You know, we called on the podcast, something must be done ism, something isn't quite right. It must be fixed. Vladimir Ilyich Lennon. So there is a comparison here. There you go. So we talked yesterday in the show, we talked about price fixing. We talked about this idea that you can fix the price of food, which I think Scotland might have finally abandoned this idea. But it came up before the election that we could, we could have supermarkets in which we could fix the price of food.

10:34And of course, this is happening in New York. And the idea of fixing the price of energy, fixing the price of labor, fixing the price of things, the rent controls being the absolute classic from the man of system, rents are too high. So we will make them low regardless of what the market wants or doesn't want. Yeah. So it's not as if this is new. It's all been done before and it always fails. So that's the problem with the man of system, the man of system or the people of system. Let's use people of system. It doesn't matter that it failed before. It's really not relevant to them that this is proven not to work because it signifies and signals to the electorate that they care.

11:09And they never think of the second order effects. They don't care about the second order effects. They just want to send a signal to the electorate that they really care. And in the long run, you fix all the prices and you end up in 1976 Britain, which is bankrupt. But we have a very good jet that moves very rich people across the Atlantic very quickly. So we did get something out of it. Isn't there a problem really with what Scott Beston is trying to fix is something that can't be fixed by basically borrowing at the short end of government debt and buying back long end government debt. So it's actually about the deficit itself and this extraordinary, and actually it seems bipartisan way of thinking about the level of US government borrowing.

11:59It doesn't seem that the Democrats, if they get in, are going to change anything particular. And we're running at 7%, 8 % of GDP deficit, which is not seen outside big wars and big recessions. So we agree that that fails. The problem is what does he do next? And when that fails, what does he do next? And that's the problem with the manor system. They keep coming back. But the underlying issue is that level of debt. And all this is fiddling around the edges. Yeah. The solution is to do something about the debt, but that is not politically possible. Yes. The Americans will justify and are justifying this on an existential risk to the state in China.

12:34So there will be lots of rhetoric around we have to do this or China is going to rule the world. And that's how you justify massive deficits. That's how you justify massive government debt. There is an existential geopolitical threat. It's not that overt yet, but it's going to get more and more overt. So all of these interventions, because the most intervention in bond marks you ever see are during warfare, will be China is a threat, therefore we have to do this. Richard, I know you wanted to say something. I was curious that both the Chairman of the Fed and the Trash Secretary were both portugies of the same hedge fund manager who came out the other day and said there was a drastic mistake.

13:16and also that you now have the Treasury operating directly in competition with the Fed. So that just reads through the marketer's questionable confidence in the sustainability of the position, which is going to be fascinating. I have a problem with Stanley Druckenmiller. This is going to win me lots of... This is a safe space, Russell. He's hampered by being an economist and not a political economist. So his economic analysis is 100 % correct, and I agree with every word of it. But the only way you can work out what's happening in the world today is through the prism of political economy. And if these guys need to fix prices, they will fix them, full stop.

13:59And Stanley, I've just written this morning that, you know, the next book will be called Stanley in Wonderland. Stanley has lived in a world, this is not a criticism, you know, he is a genius, but he's lived in a world that rewarded that form of intelligence and analysis. And that world's gone. It's fascinating. In fact, the best in things, listen, the price is just wrong, so I'm going to fix it. Fix the price. That ends in the same place. There's a question of when. At least 76 was hot here as well and dry. Yeah. I remember the queen in, I think it's Alice in Wonderland, not through the working glass, said sometimes it's necessary to believe six impossible things before breakfast.

14:39Stanley will have to believe all six of them. Russell, how does it end? Like a political economist. How does it end? What's the investment takeaway here? Well, the investment takeaway is don't own bonds unless they force you to own bonds. The history, we've done all this before. Gold does well. There are selected equities that can do well, particularly value equities, cheap equities. And the number one rule of a financial repression is if you don't have to be there, don't be there. If you can invest in a country that isn't going to run a financial repression, this was the lesson in the post-World War II period.

15:10Switzerland. Be very clear for the members of the audience who are not financial experts, why do we not own bonds right now? The reducing debt to GDP ratio, total government and private, is the number one reason you run this system. That's what Besson's ultimately started tinkering with. So your real returns will be poor. I want to give you, can I give you one example? Yes, please give us one example. You don't have to shut up. January 2021, the government of France comes and they sell a bond. They're borrowing money until 2072. The coupon on that is 0.5%. They sell it slightly below par. The yield is 0.52%.

15:50The great savings institutions of Europe buy this bond. 2021. You've now lost 76 % in nominal terms buying the risk-free asset. And French inflation's up 18%. So that's how it works. French debt to GDP has come. Well, it's actually going up despite this. So that's why you don't buy bonds. You might say, well, surely there could be nothing more damaging than what's happened already. Well, perhaps, but you can still lose money in real terms. That's true. But you are choosing an example, which is a very low coupon, long duration bond. And for some clients, actually, it can be quite advantageous from a capital gains perspective to buy a bond that might be maturing in two, three, four years time, locking in a decent yield.

16:35And if you buy a low coupon you will get that gain completely CGT free. So there's my tip. Okay, good tip. Thank you, Anna. Would that be okay? Russell, you'd be happy with people buying very short-term bonds? You can get to that 5.75 or so, and it's unlikely inflation is going to hit that over the next... I have explained to the Treasury that most wealthy people in this country aren't paying tax anymore. Because of this, because of selling their sovereigns, their forests, their ices, you know, there's a huge section of the population who really just don't have to pay tax anymore. They are elderly or older.

17:09I don't think the Treasury's worked out yet how many people can really avoid paying tax. I mean, perfectly legally through the various methods, one of those methods and all the other ones. Well, I was just going to go back on the tax giveaway. For those who are not familiar, this quirk that you don't pay capital gains tax on the discount on gilts is only available to retail investors and has driven a massive reallocation of assets into these short-dated gilts. And the tax giveaways around three billion pounds a year just to wealthy people, just to take money out of equities and stick them in gilts.

17:46So I think it was a mistake. I don't know where it came from in history. Someone one day would be able to say who made up the silly rule. But when interest rates went to zero, you had all these gilts being issued at almost zero coupon. So all the values in the discount. and everyone who's got any money is buying them. Anybody here got any low-coupon gilts? Of course he did. There we go. Charlie. There you go. Tax the rich, I say. Sorry, index link. So does Adam Smith, actually. I haven't looked at the index linkers recently. I don't think, Russell, you're not a fan, is where I remember. I mean, it's not, it's okay.

18:22They will fiddle with the definition of inflation. I think that's happened already. That's your risk and gold is better. So, you know, sometimes it's just this is okay, but it's just not the best way to do this. There are other ways to do it, forestry, et cetera, et cetera. There'll be one message you can all take away from this show by the end, which is that gold is always better. That'll basically be it. Right, we are going to, we'll come back to some of these themes, but let's move on to another quote. Richard. Right. I'll put my glasses on, bear with me. I tried to read it earlier. We all thought for a lovely moment earlier, we thought Richard was reading a quote without his glasses, but it turned out he just couldn't find them.

18:57So this says here, this was for the Wealth of Nations, and it says, The greatest improvement in the productive powers of labor and the greater part of the skill, dexterity, and judgment with which it is anywhere directed or applied seem to have been the effects of the division of labor. The reason why that struck me as my most recent favorite was that I think Adam Smith passed, what, in 1790? and you mentioned the steam engine was revealed was it 1770 or thereabouts it was part of the the mechanization process the first wave of the industrial revolution um there was a big recession in the 1830s and then there was another great expansion as you went through the mechanization and then the mass production assembly lines etc so a lot of the a lot of the division of labor outcomes came post Adam Smith.

19:53But here we are today, and we're looking at certainly, I'm looking at this in the businesses that I'm involved in. In the world of AI, you say, what does that mean? Because the mechanics of labor and actually doing and making stuff doesn't actually require people. So all the things that we learned in terms of organizational traditional structures, career pathing, scale, or back office, front office, is all, in my mind, going to be dissembled. And you won't have these, because the labor is infinitely scalable. You're really, the question of labor is how much of that's the price of a token versus the price of wages.

20:34So I think we're entering into an extraordinary period where some business models will just collapse. The notion of business process outsourcing and the growth of these businesses in India where you basically swapped massive clerical work for the scaling of cheaper labor, that's all redundant. So I think we're going to face all sorts of heart-searching questions the next couple of three years as this starts to land. Well, there's, I think, the division of labor or division of thinking with the question of how we organize our own time and what creates value because we'll still be employed. but I suspect I'll retire never because I don't think the notion of retirement is going to survive either.

21:18You think AI can't do your job? Clearly not, Maren. It can do large parts of it. I mean, some of the stuff that I do with the various engines to articulate business plans and strategies, they're just better than me. I mean, the stuff it produces is scarily good. Yeah. Do you think, though, if we're all using a few engines that everything becomes very homogeneous and very undistinct. I've been hearing about using what are called small language models and training it very much internally so that you don't let your business knowledge out. Which we do, because that's the premium of actually the value of your own data.

22:04I mean, what I think we'll find, some things will be commoditized quite quickly, but the scale and speed of what we do and the speed of getting things done will just accelerate. And so the cognitive load or the intellectual challenge is going to be this all becoming compressed where things would take three years and you could do five of them. Now you can do 50 of them and it takes you six months. And that intellectually is sort of three degrees further up the evolution than we are. It's going to be a big challenge, I think. Last year, when we were talking about this on the show, you explained the movement of AI through your company in terms of your customer services division and how much of the workforce can be replaced by AI and how that was working.

22:51How's that developing? I mean, what it's producing, and we're still in reality, people talk a lot, but the actual deployment and meshing through the systems is a longer process. So we haven't reached critical mass in many areas yet. But what's happening is that you have a take a simple process where your average complaints handler can manage about 1.2 complaints a day. With some very basic tooling, they can do complaint handling in 40 minutes. So in terms of seven times more productive work and three times faster in terms of discovery, you apply that across lots of areas. The acceleration is huge.

23:40There's also a big thing about what problem you're solving. People talk a lot about the large language models and the hyperscalers. And those have basically got super LLM sitting on neural networks. And that's all about the question of reasoning, which is kind of the higher end of AI. But most of the stuff that we do is deterministic. There's a set of rules. And you apply those rules and you get an outcome. Some are very complex rules, but they're still deterministic. So a lot of the work we're still doing in terms of delivery and speed will be the very basic use of some high-powered tools. But it's not the large-like ones.

24:17Those can all be done, as Anna said, on SLMs with the data centers and contained internally so that you have the element of privacy. It's one of the big dangers of LLMs. You let your employees spend too much time prompting LLMs. You're giving away quite a lot of data at the same time. And there's a rising awareness. We don't allow that. Our job one is no leakage. So we have a very clear separation between inside and outside because once you've leaked, you're not getting it back. Okay. Go back to employment and AI. the employment optimists will point to Jevron's paradox and say that every time this has happened in the past, there's been a big technological leap.

24:51It's been absolutely fine because endless new jobs are being created, and we see more and more employment. But from what you're saying, I suspect that you feel that in an environment like this, sure, more roles may be created, more things to be done may be created, but if those can be done by a mixture of AI and robotics, Jevron's paradox doesn't hold for humans. Well, it may hold. But if you look at the example of the steam engine, that caused mass unemployment and the collapse of the textile sector between 17 and 1800 and then generated kind of huge employment and wealth in the UK one because of access to cheap coal and so on.

25:35And so that could be the case. But if it's true that it takes you 30 years to kind of turn that circle, that's not a great story in terms of social fabric. And that's the question is what's the impact as you go through that journey? And that leaves a horrible, horrible gap for the man of system to step into, doesn't it, Russell? The man of system who looks at this and goes, well, this is awful. Lots of people are unemployed. This isn't working as I want it to work. Therefore, I will fix it. And what will they do? Absolutely. It's a big problem to fix. So I don't think they can succeed in fixing, but it won't stop them trying.

26:11So the fundamental thing about men of system is not what they do. It's the unintended consequences of what they do. I'd love to sit here and tell you what they're all going to be, Maren, but I think we just have to wait and see. But there will be unintended consequences. I think the one thing that my opinion that they will never do, I will never do, is sales. So if you have children, teach them to be good communicators and salespeople. And the real singularity is when a robot is as successful as selling you an investment product as a human being. I think that one's quite a long way away, but we have experts on that here.

26:43Well, interestingly, I was just writing today about whether AI can provide investment advice or not and how you should use it. And I don't know if you saw the FCA had a little report out yesterday saying how shocked they were. Shocked, I tell you, that people trust AI for financial advice more than they trust journalists. I don't know how that could have happened, but it's happened. And it's interesting because the FCA are very upset about this. It's not what they want, but the FCA is also very upset about the advice gap. They constantly complain that not enough people get enough financial advice.

27:17And it feels to me that AI is the perfect solution to that because the problem from the FCA's point of view is that they feel that everyone should have some kind of unique advice. Everyone's circumstances are unique. Everyone is different. Everyone needs different financial advice. And I think that's absolutely nonsense. Almost everyone needs basically the same financial advice. And if a reasonable LLM can tell you roughly what you should do with your money, and I experimented a lot this morning typing into all sorts of different models, you know, what do I do if I have no money and I get given£100 ,000?

27:47The answers were excellent, absolutely excellent. It only gets difficult when you start asking the models to optimize your taxes and deal with, you know, that kind of thing. Of course, you wouldn't worry about that because like everyone else, you don't pay any tax. So not a problem. Didn't quite say that. But it's only when you get very precise and arithmetic that it turns into a problem. Well, financial advice and sales are different things. Financial advice is advice and sales is getting someone to sign the contract. Fair. I think human beings will be good at that for a very long period of time to come.

28:16Well, whatever form of selling it is, financial advice being set. Although people are already developing strong relationships with their bots and LLMs can imitate empathy very effectively. Obviously, it's not real empathy because as previously discussed, you have to live the struggle to feel genuine empathy. But you can imitate empathy pretty easily. And if you can imitate empathy, can you sell? Well, that is the singularity. When machines can sell better than human beings, then that's the singularity. It all depends. In our world, I think about 40 % of our customers come from trusted referrals, your trusted friend.

28:52And the question is, who's that trusted friend? Is it the bloke in the pub or the lady in the pub or is it an engine? I mean, my money says that the engines will win. And pretty soon. It's interesting. Did you have a look through the sources which they were referring to when they gave? Because it's quite a broad spread. And it's very different from what we've been discovering is it's very different from what you would expect if you were, I don't know, if you were a financial advisor where you might go to sort of look for in press and trade press, for example. The LLMs use a very strange group of publications.

29:35They do, but they pick up a lot. Some are great and some are just forbidden. I mean, they can't access, this is money, but they can access Bloomberg. A lot of it is Vanguard and that kind of thing. So it starts with, you know, have a financial cushion, put aside six months worth of living money, followed by use your allowances, followed by use your ICER allowance, use your CIPR allowance, followed by and here's how you should invest. And that's where it runs into trouble, right? Because every single one I looked at told you that you should then the bit that it agrees you should invest should be 60 or 70 % invested in an MSCI World ETF.

30:08and I'm pretty sure, and I don't approve of that, I think a terrible idea at the moment because it leaves you 70 % in the US with a really, really heavy allocation to techs. You've become a tech momentum investor by mistake, which I'm pretty sure. Would you go for that, Russell, at the moment? I agree. You agree with me or you agree with my models? Do you agree with me? Perfect, that's what I want. Anna? I actually do think that you can have quite a broad investment by investing in index funds. But not in an MSC World ETF. Would you be 70 % in the US right now? Would you be the top 30 % of that index is all US tech?

30:47But it is the truth today, isn't it? It is the truth. I think US tech, if you think about those individual tech companies, they're all pretty different. They're all doing pretty different things. They're exposed to, some are very advertising exposed. NVIDIA just blew the lights out. It was expected to have 70 % revenue growth. Sorry, 45 % revenue growth this week. It came out at 70 and it said it could have hit 100 if it had sufficient capacity. But no one really believed it, did they? Because their price went up 7 % or so. 9%. 9%. All right, 9%. 9 % for doubling, doubling. I mean, that looks to me like people going, yeah, don't know about that.

31:32Yeah, but you've got the other side, the argument, which is let's suppose now you say, I'm going to break that model. I'm going to intervene and overweight in Britain. And now you've got your fund is now underperforming the MSCI index materially. And you're explaining to your customer that you did the right thing because that U.S. thing just it can't be right, even if it's true. And don't worry, one day you'll catch up. That's a difficult. We can split the world into two, value and growth. I think probably most people in the audience know how that split is done in the equity market. So two buckets, cheap shares, and then the growth shares.

32:12This year to date, the MSCI World Growth Index is up 9%. The World Value Index is up 16%. That's the capital return. And I think you probably get about 2 % extra from a dividend yield. So you probably doubled the return not being in growth stocks this year. This year. This year. Absolutely. Pick your time slice. Ten years back, not quite the same. So, you know, the idea that you have to be in growth to do well has been true for a very long period of time. I was thinking about this. I started the industry in 89. I was told that at a well-known Edinburgh investment company, I was told there was only two things you could prove statistically about markets and everything else was up for question.

32:55Number one, small cap always beat big cap. And number two, value always beats growth. Of course, completely wrong. now for what seven eight years yeah but what happens if it's right long term long term long term and you believe it is don't you there is a little bit of evidence showing up that mid-camps value is outperforming growth and statistically and i think the data is back to 1926 that fama and french database growth beats value beats growth and small cap beat large cap and hasn't been true for seven years seven lean years seven fat years back to your point on the the advisors though the route is that they i mean i worked for banks for about 50 years of my life and until it's last 25 years ago the branch manager was sacrosanct it was all about making his his or her life easier better meetings much better kind of better presentation to customers that's all just disappeared you can't afford to have all these empowered branch but it's too much money financial advice the cost of advice and you get the full stack between platform product and advice is running at 150 basis points 1.5 percent which is just nonsensical and will probably drop for me down to what 20 points over the next 5-10 years you're not paying a bunch of people to go and buy themselves boats on that money so the whole model is going to change it just is

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35:01Anna your quote Tax which each individual is bound to pay ought to be certain it's a very short one and I thought this was quite apt for what's going to be quite an interesting couple of months ahead of the next budget and we we know that we might have a new prime minister, but we have a lot of the same old fiscal constraints. We've discussed the US ones, but I think the UK ones are, we're not getting the, the UK ones are just as important. Our interest costs are now about the third or fourth biggest line item in terms of what we have, how much it's costing the government to finance our debt. And we have a huge and growing non-productive spend.

35:57That sounds terrible, but if you think about things for the state pensions, incredibly expensive, benefits bills are going up. NHS is hugely expensive too. So the Chancellor, Healy, he faces a really tricky budget. And I think the mood music that I'm hearing is that you don't want to try and scare the horses too much. And he's really keeping his defence sort of security's seal around the Treasury. We're not finding out that much really about what his plans might be. But I think that what we do know is that having isolated about two thirds of the tax take and said, we're not touching that, that's income tax, national insurance for employees and VAT.

36:53By doing that, we know that they have to start looking around the edges, those sort of slightly more esoteric taxes or the ones that people don't consider the second order effects of. and this we have seen therefore in the last this is the third year where we've had actually pretty good first half growth we were leading g7 economy in the first half and it peters away in the second half and I think that's a lot to do with businesses and households delaying spending decisions and being just generally lacking in confidence and I think that so yeah so we've got the October budget coming up that is going to be quite a significant moment.

37:35But I think the less pitch rolling, the better. The less sort of suggestions around what might happen to your pension. But what is left to tax? What is left to tax? Where could you possibly find the amount of money that is required? Well, the last few years, a couple of years, we saw on the platform a lot of people worried about what was going to happen to tax-free cash in their pensions. And a lot of people took money out for something that never happened. And that was unfortunate because then you're outside of that wrapper, that tax-efficient wrapper, as we call it. So we hope that there will be no increases to CGT.

38:22I mean, I think that is quite well versed in the Treasury, that sort of why can't I increase CGT, but almost every study shows that that would have a deleterious effect. It's already a wealth tax, right? It's already a wealth tax because it's not indexed to inflation. So when you pay it, you're paying it on your nominal gains, not on your real gains. So you're already in an awful lot of cases losing wealth. Yeah, there could be some kind of reformation. You know, they could change it. They could reform it. We would love property taxes to be simpler and to remove all those transaction charges. We'd like stamp duty to be removed.

39:00There's so many things that could be done that actually would in the long run be beneficial, but in the short run they would cause disruption, delays, and even more stagnation perhaps in assets. So it is incredibly difficult to know, but I don't know, and I'd love to hear other people's views, whether the Prime Minister or the Chancellor are actually, would be brave enough to go back and change what was set out in the manifesto. And so all they're left with is cut spending. Which is politically impossible. Which seems to be politically impossible unless they can actually get their MPs, if the Prime Minister and Chancellor can get their MPs behind them.

39:47It brings us to financial oppression, presumably. That's one of them. I mean, Colbert, who was an economic advisor to Louis XIV, said the secret of taxation, it's like a goose, it's to extract the maximum amount of feathers with the least amount of hissing. And the rhetoric, you have to pay attention to the rhetoric. The rhetoric is now clear. There are two types of income in the world. There's earned income and there's unearned income. So it's unearned income. I mean, there's financial repression, but it's unearned income. So one of the things being floated now is all those horrible pensioners who get too much out of their pension fund will have to pay national insurance because that is unearned income.

40:23So when you draw that line ideologically, it isn't difficult to come after unearned income as if it's some sort of evil because it isn't earned. But of course, to have the bloody income in the first place, you had to earn it, you had to pay the tax on it, you had to save it and not spend it. So I think you're going to see more of this, but these people are in receipt of unearned income. And that's exactly what the last Chancellor Healy was very big on. This Chancellor Healy, I suspect, will be paying more attention to that. Yeah, and it's an interesting thought when you project what you were talking about, Richard, on AI and jobs.

40:56If you're not going to have the same level of income tax and the same level of national insurance being paid because you've got fewer people working, you are going to have to find other ways to raise revenue. And what if, here's the interesting bit for you, Richard, with them hanging on to US stock market, right? Stock markets, we like to think they're about valuations, but in the short term, at least they're all about flows, right? The amount of money flowing into a market tells you what's going to happen to it. And if you look at the US market, one of the things that has been happening there is the flows come from people's 401ks, from their retirement funds.

41:29That money goes into the retirement fund, flows out immediately, usually into a S &P 500 track or whatever. Money flows out, market goes up. Now, if we follow your line of thinking, which is that a lot of, in particular, higher income jobs are going to be done by a combination of AI, robotics, etc., then that flow stops just like that. It begins to dribble away. You have a flow out, not a flow in. So the arrival of AI on the scale that you're talking about leads automatically to market collapse in the US. This is fun, isn't it? This is that's that's the optimistic view The end of days, but there's also a view that says that in fact what you will happen is that there will be a much greater polarization of wealth which has its own We're already seeing some of the effects today of the kind of a scaled Enterprises grabbing big chunks of the world market and concentration of but was it the top?

42:29seven wealthiest people have more wealth than the entire southern hemisphere, I think, is the stat. So that's, you don't like that stat, take that one away. Well, I think it's an irrelevant stat, actually. No, but the point is, but if you've got a small number of enterprises that are consuming or attracting most of the profits in the world and the value of labor is dropping, what you have there is you have a small number of people with a great amount of wealth, The question is how much do you tax them? Let's look at the data. You mentioned it earlier, actually, when we were talking. We've just released, National Bureau of Economic Research just released, American corporate profits as a percentage of GDP.

43:08It's at an all-time high. Yep. Now, that data also, I think, is 1926. I used to say this is the most mean reverting series in the whole of economic history. I know. I've written a column about how it's going to mean revert every year for 20 years. And we could prove that by running an Audi-Dickey-Fuller test against it, which worked perfectly until 20 years ago, until you started writing about it. and then I used to say well it always mean reverts in a free society but clearly if you're not in a free society it doesn't have to mean revert at all labor doesn't get to fight back creditors don't get to fight back the taxman doesn't fight back so there are two conclusions on America either it's not a free society or it will mean revert so in terms of raising taxation the corporate has to be one source of this but more importantly wearing my Adam Smith hat greater competition and destroying the oligopolies has to be the other way to bring down.

44:01And you think oligopolies, you think of Google. I don't think of Google. I think of beer. How the hell can you have a global beer oligopoly? But that's what we've got. Four providers of beer globally, right? Four providers, but 70, I can't remember the number. Four providers, 70%. And my brewery is the fifth one. But Smith, you know, Smith was sitting here, he'd say, this is ridiculous. It is ridiculous that A, the joint stock company dominates the world, and B, that they have such a huge market share. So you don't have to be in favour of sort of more taxation if you can just be in favour of not having the world run by oligopolies.

44:36And as you said, Richard, the technology is going to make that worse. So at some stage, even in the United States of America, there will be a political movement potentially of the right to end this. The American president who took the most actions under the Federal Trade Commission to break up big business was Eisenhower, that well-known left-wing activist. So you can be on the right of politics and be completely against big business. And if you want to know how that works, just watch It's a Wonderful Life. You know, it's in favour of small bankers, not big banks. Right, we have to have questions.

45:09We have to have questions. We said there'd be questions, and if we didn't have them, we'd be lying. Now, I do want to see, at the back, the person who has read both The Wealth of Nations and Moral Sentiment, do you have a question? You don't have to. But if you did have a question, we would take it first. I do. You do. Excellent. Wait for the microphone. There we go. Excellent. So you talked about the structure of US government debt, but you didn't touch so much on the UK's plans. I think the Treasury plans to issue more short-term debt and less long-term in moving towards the US direction. What impact do you see coming from that?

45:49Well, the good news is this is where we start. So we have one of the longer termed out debts in the world. So it's not a great thing to do. But at least we have this huge advantage over just about everybody else in the developed world because we have long term debt. So not good if you keep at it for a long time. But it'd be even worse if you were starting already with lots of short term government debt and little long term. You might know the numbers for the average maturity across the developed world. I'm not sure. We are at the long end. But it has been reducing quite sharply. I mean, there's less demand for longer dated bond.

46:22The natural buyers of those assets are not just sceptical about the pension funds. They were the pension funds. This is a good time to ask a question I haven't asked yet. Who has a defined benefit pension? Lots of you look the right kind of age for this. The ones where the money just keeps pouring in every month. Same amount. Congratulations. Congratulations to all of you. That's marvellous. How many of you have a defined benefit pension that comes from some kind of public sector work?

46:50Yes, well, that's expensive for the rest of us, isn't it? But that's why we need all this debt. What the effects of this will be is that actually you will, as Prime Minister Burnham said, you are more in hock to the bond markets when you're more reliant on short term debt, which makes it just even more critical and that you have spending under control and that you have a plan. and so we can hope for that. Yeah, so the answer is yes, that's true and it's not necessarily a good thing. Other questions? Well, we can go to the stats. So the UK government data GDP is 88%, ridiculously high. France is 116%.

47:33And we're heading, as Anna said, towards 7%. Italy is 132 % and Japan, I think, is 160%. So we've got a horrible number but not as horrible as some people. I think one shouldn't underestimate how much the Trump administration has punished hedge funds going short and long. So I think they've put quite a bit of effort into making sure that they don't offer one-way bets to people. So people going along the oil market or the gas market or whatever have been horribly burnt by Trump coming out with statements. So it's perfectly possible that what Besson's been doing is making sure people don't think that the bond market in the States is a one-way bet.

48:13So I'll just give you that as an alternative way of thinking about it. Anyway, Reinhart and Rogoff wrote a great book called This Time is Different. And if you look at the kind of assets to income ratios, we are back in bubble territory that looks like the dot-com boom in 2008 and all sorts of other booms. We've kind of talked about it, but I guess I'm interested to know whether or not anybody can make a bull case for the AI profits are going to keep on going up and this time really is different or whether or not Reinhart and Rogoff are going to be right. Yeah. Well, I think Russell can make you the bad case.

48:51You might be able to make a bull case. I sold everything myself, so I'm a very modest bull.

49:01I think the risks are not on the upside. The leverage in the system and the multiples are – And the absolute numbers are absolutely huge. So back to all the metrics compared to the dot-com boom, you look at the math there and you say, okay, well, the market can go along much further than we can think, but if history is any precedent, you've got a hyper bubble on your hands. I would agree with that. And I would also pick up what Anna was saying about SLMs, but the big build-out of the data center has been based on the idea that LLMs are the answer. But once you get to the point, holding a lot of this, once you get to that point where in fact you find that SLMs can do around 85 % of what an LLM can do for you at about 50 % of the cost and hanging onto your data privacy, once that becomes more thought about, you may see the beginning of the end.

49:56I don't know, Russell? Can I refer to the pit of uncertain use? Absolutely. Because I only get to do it every five years. Go on, do it. So one of the most beautiful places in the world is in the middle of Strangford Lock. You reach it by a bridge and it's an old monastic site. it's in ruins but each thing is labeled so where's this it's in strangford lock you must know where that is county down county down that's no i'm from scottish sorry and uh so each thing is so the chapel is labeled and the refectory is labeled there's a bloody big hole at the back and it says pit of uncertain use this this is important because that's what the stock market has been for a long period of time it's not raising capital it's been pouring capital back to investors for a generation.

50:37At one stage, that cash flow yield was about 8%. Now it doesn't. This is to your point. Now it doesn't. So now we have a competition. We have a competition from a corporate sector that needs capital for the first time because, frankly, all of that capital-heavy, intensive stuff was done in China and the government. And the two of them are now in a battle. This is where Besant's intervention is important. They're now in a battle for capital. The government wins. I think that plays a role in this cycle that we're in. But the definitive book on this is Sandy Nairn's Engines That Move Markets of this parish.

51:10Read that book and you'll get a pretty good idea of how these things come and go. So I think there were three railway booms. I'm sure there'll be at least three AI booms. Timing those is going to be pretty tricky. Anna, bull case? Go on, bull case. Well, I mean, I talked about NVIDIA earlier and it might surprise you that something growing that fast is actually only on 18 times forward earnings. So that's not hugely expensive for something that grows that quickly. I think, actually, that you do need to have diversification. I do think you genuinely need to have holdings in stocks that are real assets.

51:54And actually, that's why the FTSE has done pretty well this year. You know, it's got its pharmaceuticals, it's got banks, it's got mining stocks, it's got oil companies. those kind of things. So you can actually diversify your exposure away quite successfully. But the key mistake, it's so tempting to try and time markets. But if you miss the best days, and two thirds of the best days that, you know, we're talking, you know, several percentage increases, two thirds of those best days come within three weeks of the worst days. So it is very easy to sort of just think oh that's looking a bit toppy I'll take some profits there you'd be surprised how very very difficult it is and I tell you when the market is falling several percentage points over a few few months it's never feels like you want to go back in and buy um so I think that you just I would personally um and this is what I do is I have some pretty low cost investment tracker funds.

53:02I have some really interesting active funds that I really like and I follow. And I think that the way to sort of maybe navigate some of the, particularly in technology or in some very specialized sectors is to go with people who I wouldn't, you know, I think you don't want to be, you don't want a generalist fund manager looking after your tech exposure or your biotech or some financials even, I think, or insurance companies, maybe, I think you really want very, very specialist funds for those. So I think there are plenty of opportunities. And, and I wouldn't I think diversification is key. And yes, some parts of the market are quite expensive.

53:43Yes, equity insurance is high. Yes, that mega caps have gone through an awful lot of that cash flow that they were they were they were generating. But you don't have to own those stocks, you can own other stocks too. Thank you so much to our panel today. You are wonderful. And thank you. You've been a wonderful audience.

54:13Thanks for listening to this week's Merrin Talks Money. If you like our show, rate, review and subscribe wherever you listen to your podcasts. And keep sending questions or comments to merrimoney at Bloomberg.net. You can also follow me and John on Twitter or X. I'm at MerrinSW and John is John underscore Stepik. This episode was hosted by me, Merrin Somerset Webb. It was produced by Sam Asadi and Moses Ander. Sound design by Blake Maples. And special thanks, of course, to Richard Wilson, Anna McDonald, Russell Napier, Blair Barrows, and Alan Lloyds, and everyone at Panmier House.

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