Britain is not lacking in seemingly clever financial schemes that have turned sour.
Whether it be Tony Blair’s private finance initiative (PFI) contracts or the Bank of England’s money-printing programme during Covid, both initially saved money but became catastrophically expensive.
However, one regrettable initiative with a longer lifespan than most was the decision to link debt interest payments to inflation.
That strategy, launched in 1981, initially saved the Government a fortune. Investors paid a premium for in-built protection against inflation as the headline rate fell.
Now that inflation remains stubbornly high, these so-called linker debt instruments are costing tens of billions of pounds more than anticipated.
This is because the Government must compensate investors for the rising cost of living.
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Britain currently has the highest inflation rate in the G7, partly because of the Government’s tax rises.
This outlook worsened further on Wednesday when the headline consumer price inflation rate remained locked at 3.8pc for the third month in a row, nearly double the Bank of England’s target.
The retail price index, an older measure of inflation on which the interest payments on linkers are based, is even higher.
RPI inflation stood at 4.5pc in September, easing slightly from 4.6pc in August.
Every extra bump in inflation translates into extra cash for the shrewd investors who bought the linkers, which include defined benefit pension funds. Owing to their inflation guardrails, they are particularly large holders of index-linked debt.
Conversely, it is a painful blow to an indebted Government already struggling to bring the deficit under control.
Over the past 12 months, the retail price index has risen from 2.7pc to 4.5pc, pushing up the Treasury’s debt interest costs in the process.
According to the latest figures, September’s bill alone rose to almost £10bn, far higher than the £5.8bn recorded this time last year.
Yet despite these spiralling costs, the Treasury still plans to issue £20bn of linkers this year through its agent, the Debt Management Office.
That is 10pc of total debt issuance, down from almost a quarter a decade ago, as officials responded to surging inflation during the cost of living crisis as well as the Covid crisis.
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However, despite scaling back the issuance of linkers, the Government is still using expensive borrowing to help balance the books.
Worse still, linkers have an average maturity of 17 years, longer than conventional gilts’ 13 years.
This means that the Treasury will remain exposed to inflation volatility for decades to come, even if it stops using the instruments now.
Given the recent impact of geopolitical events on price rises, this will worry the Chancellor.
The most telling example in recent years was sparked by the energy crisis, which drove retail price inflation to a peak of more than 14pc in October 2022.
In that year alone, the interest bill for linkers soared to a staggering £67bn, compared to an average of less than £10bn a year in the decade before the pandemic.
Economists hoped this would be an anomaly.
In 2023, the Office for Budget Responsibility (OBR) predicted inflation would fall, leading to the interest bill tumbling back to £7bn this year.
However, price rises have proven to be much more stubborn than expected, meaning that by March of this year, the OBR had upgraded the annual interest bill to £26.2bn.
An additional £2bn is also now expected on top of that after the Retail Prices Index (RPI) rose again faster than expected.
In part, that is due to the Government’s policies, which have been blamed for keeping inflation high.
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Higher employer National Insurance rates have pushed up the cost of doing business, which in turn has led to higher prices for customers.
The same is true of the latest increase in the minimum wage.
Britain’s costly green energy policies have also ramped up household and business bills, as they help pay for the mass roll-out of wind and solar farms.
Martin Beck, chief economist at WPI Strategy, says the combination of high inflation and a long-standing obsession with issuing linkers has left Britain uniquely exposed to inflation.
“The UK’s reliance on index-linked debt is far greater than in most other advanced economies,” he says. “Roughly 25pc of the total compared with around 5-10pc in the US or Germany.
“As a result, any sustained or unexpected rise in inflation feeds quickly and directly into higher debt interest spending, worsening the fiscal outlook.
“This structure made sense when index-linked gilts were first introduced in the 1980s. But it now leaves the Government highly exposed to inflation surprises – of which recent years have provided plenty.”
An expensive blowback
An extra £20bn of interest payments annually equates to double the Chancellor’s fiscal headroom at the spring statement in March.
The scale of the swings in the cost of linkers also dwarfs the £5bn that Reeves hoped to save through her welfare reforms, as well as the £1.5bn raised via the tax raid on private school fees.
It even rivals the £25bn anticipated gain from Reeves’s National Insurance tax raid last year, which effectively shattered business confidence and crushed hiring.
The pain from linkers represents an expensive blowback from one key plank of the British state’s debt strategy – more than four decades after its invention.
Concocted by Nigel Lawson in 1981, the idea of linking interest payments to inflation was intended to prove the Thatcher government was serious about clamping down on price rises.
For decades, this strategy seemed to work, saving the Government an estimated £90.8bn in net interest payments since 1981, according to the Debt Management Office.
However, with growing fears over persistent inflation, these profits could quickly unravel, proving linkers to be an experiment that has done more harm than good.
The UK hosts the City Of London. I assume that entity also controls the USA.
“We decided to gather all our money and come today because we knew prices had dropped.”
ya but why didn’t they buy 10 years ago.
I just noticed that Walmart sells PAMP Fortuna 1 oz Gold Bars. And that’s kinda odd, however I assume Walmart accepts them back as payment for larger purchases. I’ll have to ask customer service next time i’m in one of their stores.
A Gold Crash Everyone Saw Coming Lures Bargain Hunters Worldwide
(Bloomberg) — As pictures of queues outside gold stores flooded social media over the past month, professional precious metals traders were getting increasingly nervous.
Gold is “an overcrowded trade that’s overextended by every technical metric,” Nicky Shiels, head of research at precious metals refiner MKS Pamp SA, wrote to clients on Oct. 6. On Monday, as prices soared to new record highs near $4,400 an ounce, Marc Loeffert, a trader at Heraeus Precious Metals, warned that the metal was “getting even more overbought.”
The reckoning came this week. Gold prices plunged by as much as 6.3% on Tuesday, in the biggest drop since 2013, and held losses through Friday to close at $4,113.05 an ounce. In dollar terms, its $138.77 weekly drop was among the largest ever.
Was it a turning point in gold’s multiyear bull market, or just a dip? In Bangkok’s Chinatown, the nation’s gold trading hub, Sunisa Kodkasorn, a 57-year-old textile factory worker, had no doubt about the answer.
“Gold is the best investment,” she said. “We decided to gather all our money and come today because we knew prices had dropped.”
She’s not alone: from Singapore to the US, dealers told Bloomberg they had seen a rush of interest from people looking to buy gold as prices dropped this week. Kodkasorn’s attempt to buy the dip was stymied because the size of gold bar she could afford was sold out.
And another kind of gold rush is unfolding this weekend in Kyoto, where nearly one thousand professional gold traders, brokers and refiners are descending on Japan’s ancient capital for the largest annual precious metal conference, which begins on Sunday. The professionals — notwithstanding their caution in the recent run-up — are similarly enthused by the gold market: attendance at the conference is at a record high.
“Bull markets always need a healthy correction to weed out froth and ensure the cycle has duration,” Shiels, whose initial note came a fortnight before prices peaked, said this week. “Prices should consolidate and revert to a more measured bullish trajectory.”
The gold price peaked just above $4,381 an ounce toward the end of trading on Monday. What was unusual about what came next was that it was largely confined to the precious metals markets: other major markets, from equities to Treasuries to oil, were little moved on Tuesday as bullion slid.
There was no obvious catalyst for the move: some traders pointed to profit-taking by hedge funds, others said there had been selling by Chinese banks.
But it was a reversal that gold specialists had been anticipating for some time, as the precious metal — after already smashing record highs this year — soared a further 30% in just two months.
On New York’s Comex futures market, interest in bearish put options on gold rose to some of the highest levels relative to bullish call options since the global financial crisis of 2008. The manager of one commodities-focused hedge fund expressed frustration that, despite being a long-term gold bull, he had failed to fully capitalize on the rally because he had started betting on a correction too early.
Still, it remains hard to find a gold bear among precious metals analysts whose forecasts — for the most part — have been bullish but not bullish enough over the course of the last two years. When the London Bullion Market Association carried out a survey of analysts at the start of the year, almost every respondent expected prices to rise, but none thought it could trade above $3,300 during 2025.
“We expect de-risking and profit taking by investors to be met by dip buying from other segments of demand including central banks and other physical buyers, ultimately keeping reversals relatively shallow,” Gregory Shearer at JPMorgan Chase & Co. said in a note this week.
Yet the gold market’s history gives some reasons for caution. In September 2011, when gold hit a high of $1,921 before falling back, traders and analysts who gathered that month for the annual LBMA conference were almost universally bullish. As it turned out, it would take another nine years before gold reclaimed that high.
The current surge in gold has been driven by a wave of central bank buying, which accelerated dramatically after sanctions on the Russian central bank in 2022, and fears about unsustainable levels of government debt around the world.
JPMorgan’s Shearer highlighted the possibility that central banks will take a step back from the market as the major risk to his bullish forecasts, which see gold averaging more than $5,000 by the final quarter of next year.
But the most recent leg of the rally — coming after US President Donald Trump attempted to fire US Federal Reserve governor Lisa Cook — has been turbocharged by a wave of buying from ordinary “retail” investors, with gold shops running out of stock and more money piling into exchange-traded funds than ever before.
In some of the world’s main gold-buying hubs, there was little sign this week that the fall in prices had dented their enthusiasm. Some dealers reported less interest after a hectic two months, but others had record sales.
Pete Walden, deputy chief executive officer at BullionStar, a dealership in Singapore, said his company had had its busiest day ever on Tuesday. “We had a queue before opening, with many more buyers than sellers,” he said. “I think many are using it as an opportunity to buy the dip.”
In the US, Stefan Gleason of dealer Money Metals Exchange LLC, said his company had more interest from “bargain hunting” buyers than it could handle.
And in Tokyo’s swanky Ginza district, Vietnamese student Hang Viet, who is in his 20s and has lived in Japan for about a decade, arrived at a branch of Tanaka Precious Metal Group Co hoping to buy a small gold bar.
“I believe gold prices will keep rising in the long run,” he said. “I saw the current dip as an opportunity.”