311. Why is the US debt crisis a big problem for Burnham?

0:00Steph McGovern:Are we at risk of a global financial crisis? What's driving it and why is it worse for Andy Burnham? It's been a wild time on the bond market, so we're going to talk about why, three big reasons to do with inflation, the state of borrowing by governments and also the big tech firms turning to the debt markets to fund the AI build-out. So what does it all mean?

0:20Robert Peston:We're going to break this down into two parts. We're going to look at the growing fears that we are heading for a genuine financial crash globally. And then we're also going to look at what this rise in interest rates for the British government, the headaches that it's caused for Andy Burnham and his new Chancellor, John Healy, for the first budget of their time in office.

0:43Steph McGovern:This episode is brought to you by Octopus Energy. Greg Jackson, the CEO, is with us now. So, Greg, I've got a question for you. Is it true that by 2040 in China there will be no petrol stations because everyone will be driving electric cars.

1:00Robert Peston:Yeah, crazy as it seems, the Chinese state oil company, the one in charge of its petrol stations, is planning on having none by 2040. If you visit China today, what's really striking is the roads are quiet. I mean, all of the two-wheeled vehicles that used to pump out pollution and noise are now electric. Pretty much all the taxis, buses. Increasingly, more than half the private cars that are sold are now electric. And even this year, so far, 25 % of their trucks are electric. So that electrification means that they're going to be less affected by global oil shocks and they won't have any petrol stations.

1:39Steph McGovern:Greg, thank you very much. Now on with today's episode.

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2:14Steph McGovern:This episode is brought to you by Google Chrome. You think you know a browser, but Gemini and Chrome, that's new. It can help you with practically anything on the web, like restoring a vintage motorcycle from a 50-page restoration block, or finally break down that long article you've had open for weeks. Gemini and Chrome is here for it. Ready to make anything online make sense? There's no place like Chrome. Check responses set up required, compatibility and availability varies 18+.

2:50Steph McGovern:I think we should start with inflation, first of all, because that is a big concern for lots of countries. It's been driven, of course, by the Iranian war. It's been six months now since the US attacked Iran. And of course, one of the big impacts of that has been oil energy prices. You know, despite the ceasefires we've had and the various interventions by Trump to get ships through that Strait of Hormuz, we're still not back to the 20 million barrels of oil that we're getting through there. every day. And just to put that in context to remind you all, we as a world use about 100 million barrels of oil every day.

3:27Steph McGovern:So this is a significant amount that comes through the Strait of Hormuz. You know, recently we had the ceasefires. We've had this kind of heavy armoury around ships going through to try and get them through. You know, Trump has been trying to push to get more ships through. And it's got to about 17 million barrels a day coming through. But again, that is under threat. It's not back to 20 and it's under threat because the tensions have risen. So inflation is a big worry, isn't it? And that's then leading to lots of people wondering what are the central banks going to do about rates, Robert?

4:01Robert Peston:That's exactly right. So, you know, we've already seen in the last few days an upward move to petroleum, what they call gas prices in America. And And particularly, you know, in America, it's hugely politically problematic for any president to be in charge when the cost of filling up your car goes up. It's one of the reasons I think Iran is playing hardball at the moment. I think they want to embarrass President Trump in the forthcoming elections for Congress. I think it's very, very unlikely we'll see stability between Iran and the American president before the midterms, because why would Iran do Trump and the Republicans any favors over that period?

4:49Robert Peston:And then in Europe, we've also seen the price of natural gas, actual gas as opposed to petroleum rising as a result of the tensions, the increased flare up of hostilities between America and Iran. All of this stuff feeds through to the cost of living. All of it feeds through to pressure on inflation. And for poor old Donald Trump, there's a sort of added humiliation, which is he thought he had appointed someone as the new head of the US Central Bank, the Federal Reserve in the shape of Kevin Walsh, who would cut interest rates. Kevin Walsh has decided to be his own person. And, you know, over the summer in in the great gathering of central bankers at Jackson Hole and in his public utterances, Kevin Walsh has basically been signaling that he is worried about inflationary pressures.

5:53Robert Peston:and markets now think the next move in interest rates by the US Fed will be upwards. So I'm slightly anxious about Kevin Walsh because the American President Donald Trump, it doesn't take kindly to people that he's appointed to jobs. They're not doing what he wants. So anyway, that's probably a story for another time. But at the moment, some would say Kevin Walsh is being quite courageous in basically speaking as far as he can as an independent analyst, as an independent economist. And as I say, there are all sorts of reasons to assume across the world that interest rates are going up. When you get into that climate of concerns about interest rates going up, what happens?

6:33Robert Peston:The price of government debt falls and that rise in interest rates becomes a self-fulfilling reality because, you know, the effective interest rate on U.S. government debt treasuries, That has been rising, particularly at what's called the long end of the spectrum, if they're borrowing for 10 and 30 years. And of course, it's been even worse for the British government. The price of UK government debt, because this is a global market, has been falling even more sharply. And poor old Andy Burnham has now got a situation, which I don't think he was expecting, but is now front of mind for him, where the price of borrowing for the UK for 10 years and for 30 years has risen to levels we have not seen for decades.

7:29Robert Peston:Well over, you know, sort of up to five and a quarter percent for 10 years and actually not that far off 6 % to borrow for 30 years. And one of the things I think about in these contexts is, you know, if you're a homeowner and you're facing a 6 % mortgage rate, that's horrific. or it would be in the context of what's been going on over the last few years. And the poor government is facing that on its massive stock of debt, which I will come back to the UK aspects in a bit. This is the manifestation in part of, you know, the damage done by Trump's war in Iran. But there are also wider financial concerns, aren't there, Steph?

8:08Steph McGovern:Yeah, because one of the other things that's really interesting that's going on at the moment is what's happening in the tech world. The big US tech firms who obviously are developing AI as fast as they can. And the way that lots of these big firms are doing that is borrowing to fund their investment. So, you know, what that means is now markets are getting a lot more choice over who they decide to lend money to in the form of bonds or, you know, whichever debt offering they're using. And that means that, you know, somebody who's investing might go, hang on a minute, do I want to give, do I want to want to buy a UK bond or do I want to buy one in a, you know, lend money to a big US tech firm?

8:53Steph McGovern:And so that's the competition that's also gone in the bond markets. And just to give you some statistics on that, according to Goldman Sachs, roughly a quarter of, and this sounds a bit technical, but US gross investment grade debt assurance. so the money loan to these big tech firms, this year has come from AI related companies. So your hyperscalers, your data sector funders, your software providers, you know, there's a big chunk of money now going to them, which could have gone to lending central governments money. And so there's competition there. And obviously now if you're trying to convince, you know, if you want them to buy your debt, You're going to give them a better rate.

9:36Steph McGovern:So there's the pressure there from the tech firms, which I think is really interesting as well. And then on top of that, Robert, what you've also got is just countries borrowing more money generally to try and fund their increase in spending. And that's another big issue, isn't it?

9:51Robert Peston:It certainly is. And let's because this is the moment where it's always important to get people's brains exploding. it's worth just for a second looking at the biggest borrower in the world, Trump and America. And there are sort of three numbers I'm going to share with you, but they are the kind of numbers which are almost impossible to comprehend. So just to refinance maturing debt every year, maturing American government debt, The American government has to find 10 billion pounds a year. Right. On top of that, because Donald Trump turns out, despite what he promised to be pretty spendthrift, they've got to borrow new money.

10:40Robert Peston:I'm talking trillions here. Right. So that's 12 trillion. Right. But and this is the bit where you where honestly, it's like going to the edge of a really high cliff and looking over. The American government borrows an enormous amount in the form of bills, which is very short term borrowing, borrowing that lasts for only a few weeks. And that has to be rolled over in new auctions every few weeks. Right. So if you add together both the maturing short term debt. Right. And the longer term debt and the new money. Right. The American government has to refinance every year something like 30 trillion dollars, right?

11:31Robert Peston:Sort of two and a half trillion every month. They've got to find two and a half. And one of the reasons why people get anxious about, you know, America's ability to pay its way is let's just say, right? You've been talking about the enormous amounts of money being raised by the artificial intelligence hyperscalers, the money that's coming from private credit, the money that's backed, the private credit money that's somehow underwritten in some cases by the banking system. You know, we've got more than a trillion dollars of capital investment in AI infrastructure just this year on most forecasts.

12:08Robert Peston:Right. If in six months time, the markets decide, oh, we've got I mean, even though this AI thing is really exciting, we've slightly exaggerated the revenues that we think are going to come out of AI. And we're not sure the debt associated with AI is going to be repaid. And you had a combination of both tumbling share prices and an AI debt looking as though it's not going to be repaid. And you had that kind of shock. Right now, it is theoretically possible that you'd get the normal flight to safety in those circumstances. And investors around the world will think, oh, maybe we'll just put our money in the dollar.

12:46Robert Peston:And maybe in those circumstances, we will back President Trump. And actually, you know, it would be good for purchases of U.S. government debt. But actually, if that were to happen and we were to see a massive fall in the price of AI related stocks, that would be associated also with a very big drop in expectations of US economic growth. Right. Because it is so much of America's economic growth is being powered by this AI investment. And so, I mean, you might just get investors saying, oh, hang on a second. The reason I've been lending to the US is because it's one of the fastest growing economies.

13:31Robert Peston:It's not because of the AI collapse going to be a fast growing economy, certainly for a while. And I mean, you could have a situation where you had a twin crisis of both an American sovereign debt crisis coupled with an AI equity and debt crisis. There's just an enormous amount of anxiety at the moment about how close to genuine Armageddon financial markets are. I'm not, to be absolutely clear, forecasting Armageddon tomorrow. But there are some, to use a phrase, really huge financial imbalances in the world. And most of them are located right now in both the American private and public sector.

14:20Steph McGovern:The other interesting thing is if you look at what like Scott Besson is doing, who is obviously the US Treasury Secretary. and there's been a lot of speculation about why the Treasury have been buying back some of the bonds and obviously people are saying this is because this is their attempt to try and bring down the yields, the cost of borrowing. If they buy some of them back then this will help to bring down the cost but obviously now everyone's going well hang on a minute the markets are like why Like, why is, you know, how are they trying, what are they doing? What's going on here? Then they're trying to control this.

14:57Steph McGovern:And then on top of that, you've got, you know, what we're seeing happening with Japan as well. And what's happening there in terms of how the US Treasury have been involved in trying to control the price of the yen as well. And, you know, Japan in itself, I mean, we can do a whole episode on Japan, which we probably should about what's going on there and how Japan has been used for a long time because it's got this low interest rate. So people have been, you know, borrowing cheaply in its currency and then buying, you know, higher yielding assets elsewhere. But that's all looks like it's starting to fall apart.

15:34Steph McGovern:It's called the yen carry trade. That looks like it's starting to fall apart because of the weakening yen and the rise in inflation in Japan. And, you know, the fact that they, a bit like us at the minute, have got these plans to spend, but there's questions around how they're going to fund that. And that's then putting pressure on the central bank there to put up rates, which then will obviously impact this yen carry trade because it will mean it's not as cheap to borrow money from Japan in order to buy these high yield assets. So there's so much to this, isn't there? And the US is not painting itself in a good picture because it looks like it is concerned with all of these things it's doing, trying to control the price of the yen, trying to buy back bonds.

16:14Steph McGovern:and, as you say, deal with the Iranian crisis and deal with the fact that they're so impacted by what's happening in AI, which we've often talked about as, you know, what are the US doing right? How can we beat the US? But it could all come tumbling down if things change on what actually is the money that's going to come from AI. And obviously that means there's a really complex picture across the world. There's so much to this.

16:38Robert Peston:There is. And I mean, I think you hit on something really important there, which is Scott Besant. in buying back US debt. And he did something else. You talked about Japan. He did something else that was really quite remarkable, which is in order to help the Japanese strengthen the yen, this happened a few weeks ago, but it was really striking. Normally, you would, you know, essentially facilitate the sale of US assets to strengthen, because, I mean, he is American after all. He's the US Treasury Secretary. What America did, which was bizarre, was they sold euro-denominated government debt rather than American government debt to strengthen the yen.

17:19Robert Peston:And so what this led investors to say in both cases, both the way that he's buying back dollar assets and selling other assets other than the dollar, is he is obviously deeply worried of declining confidence in the dollar, in dollar assets. And of course, that then has, for some investors, precisely the opposite effect that he wants. He wants to strengthen the dollar. But people are saying, oh, gosh, the US Treasury Secretary obviously, you know, is anxious. People don't want the dollar anymore. And that becomes potentially a self-fulfilling downward spiral. Now, we're not in anything like that catastrophe right now.

18:01Robert Peston:But, you know, these are very uncertain times. And, you know, I'm afraid all of everything that's going on does just remind me of the kind of sort of weirdness that I have seen, you know, leading up to other crashes. And that is that is, you know, we hope things stabilize. We should point out that what we're not saying about AI is that AI is some kind of illusory, you know, the idea of an industrial revolution or economic revolution tied to AI is in doubt. No, I mean, AI is changing the world. But two things can be true, that AI is changing the world and there could still be, probably is, a significant financial bubble there, which will be pricked at some point.

18:47Robert Peston:So, you know, deeply worrying times.

18:50Steph McGovern:And so obviously we need to talk about what this means for Burnham. We've got a budget coming up. Originally, our Chancellor Healy said that or was implying it wasn't going to be a big budget, but he might not have any choice given how much the fiscal headroom will have been squeezed by what's happening with borrowing costs and everything else. So let's talk about that after a quick break.

19:18Steph McGovern:This episode is brought to you by Google Chrome. You think you know a browser, but Gemini and Chrome? That's new. It can help you with practically anything on the web, like restoring a vintage motorcycle from a 50-page restoration block, or finally break down that long article you've had open for weeks. Gemini and Chrome is here for it. Ready to make anything online make sense? There's no place like Chrome. Check responses set up required, compatibility and availability varies 18+. trading at schwab is now powered by ameritrade unlocking the power of thinkorswim the award-winning trading platforms loaded with features that let you dive deeper into the market visualize your trades in a new light on thinkorswim desktop with robust charting and analysis tools all while you uncover new opportunities with up-to-the-minute market news and insights thinkorswim is available on desktop web and mobile to meet you where you are it's built by the trading obsessed to help You trade brilliantly.

20:11Robert Peston:Learn more at schwab.com slash trading. Hello and welcome back to The Rest is Money with me, Robert Pestle.

20:17Steph McGovern:And me, Steph McGovern. So we have given you the global picture in terms of the concerns about inflation, about borrowing costs, about what might happen with interest rates across the world, about what's going on in AI and their borrowing, how that might impact us. But let's look at the UK now, because the UK is often more exposed to these shocks, these concerns about inflation than lots of other countries. We're going to talk about why. But just to remind you, we started right at the beginning of the podcast talking about bond yields. The UK borrowing is now its highest. It's been since 2008, the global financial crisis.

20:57Steph McGovern:If you look at 10-year gilts, which is kind of the benchmark for countries borrowing costs, that went up to 5.29%. So, you know, that is worrying for us. It means it's adding a lot more interest to our debt. And just to tell you where we're at on that, because it's interesting. So the interest we pay on our debt as a country, it was at£109 billion last year. It was expected to be more than that this year. If that were a government department, it is bigger, that value, that money there in debt interest, than defence, than energy, than transport. It's bigger as well than the school's budget. So this is a huge amount of money that we are paying simply in interest on our debt.

21:42Steph McGovern:It's not even bringing down our debt if we just pay that. So obviously this is a big worry now for the Chancellor coming in with his first budget on the 28th of October, because that buffer we have as a country, you know, the fiscal headroom, Rachel Reeves thought she'd set aside about£24 billion for that in her last budget before she left the job. It doesn't look like we're anywhere near that. You know,£14 billion at best is what lots of people are saying. But Robert, what's your feeling on what this budget is going to be like this October?

22:17Robert Peston:So you were saying a little bit earlier that the government was hoping that this budget would not be a massive affair. They were hoping just to get through it, you know, with some not exactly tinkering, but with some not massive tax changes, for example, which could be deferred to after the publication of the so-called 10-year plan, which is when in probably December, could slip to early January, the Prime Minister will set out his really big ambitions if he's allowed to stay in office for up to 10 years, as it were. But that now looks like a naive hope. I mean, you talked about the astonishing amounts of, that we're shelling out in interest on this three trillion, almost three trillion pounds worth of government debt, as you said, well over 100 billion every single year.