The Opportunity Cost of Debt

A phrase that often comes appears in essays on government borrowing is that ‘higher interest repayments on borrowing has an opportunity cost, the money could have been spent on other areas of government spending.’ Of course much of the borrowing itself is being used to fund public sector spending in areas such as education, health care, transport infrastructure or to finance a tax cut! But the phrase does have a resonance at the moment given just how much the UK government is scheduled to borrow this year and for the foreseeable future.

Attention turns to the handling of the many billions of pounds worth of new debt issue that will be released onto the bond markets in the weeks and months to come. For the moment, bond yields on longer-dated government debt remain low mainly due to the financial market’s appetite for relatively low-risk Treasury Bonds of different duration. Whether this can last is open to considerable doubt - is there the pent-up demand for £148bn worth of gilts that the UK Debt Management Office will issue this year. With further bail-outs likely, the debt issue might scale up to £220bn or higher.

Back to the idea of opportunity cost! I was struck by a comment made in the Lex column this morning which highlighted the financial cost of minute changes in bond yields.

100 basis points equates to 1 per cent. With that in mind, Lex reports that every 5 basis points (0.05%) saved on £220bn of new debt pays one year’s salary for 46,000 teachers.

The UK economy is fortunate in that we retain - for the moment - sufficient credibility in global financial markets that our budget deficit can be financed without a sharp spike in bond yields. Other European Union countries are not so fortunate - just ask the Hungarians (in receipt of one of the biggest IMF support packages) and also the Irish whose troubles I blogged about yesterday.