Speaking to Portfolio Adviser, Doran outlined why, despite the supposed positive effect of UK quantitative easing, he is staunchly against what he calls the ‘Japanification’ of Europe – or, in other words, the introduction of accelerated QE.
“All gilts are overvalued,” he explained. “The UK government should change their policy. All bonds over 30 years should come with a free gift, and that should be a body bag.”
“If you buy any index-linked or nominal government bond you are guaranteed to destroy your purchasing power. The yield on a 10-year government bond is currently about 1.5%, and that is comprised of two elements – regional yield and inflation expectation. I can work out what the real yield is by going to the 10-year index-linked market, and the real yield on 10-year UK government bond is -1%. So over 10 years I lose 10% purchasing power.”
“If I buy a 10-year gilt I don’t face any inflation, credit or liquidity risk,” he continued. “The UK government bond market is worth about £1.5tn, but we don’t hold any in our portfolio – we are that negative.”
“The next layer of risk is if I buy a nominal government bond, and that is the risk of inflation. If I go back and look at what the market thinks of a nominal government bond, which is 1.5%, and I know that real yields are -1%, which means that my expectation versus the marketplace is 2.5%.”
Doran believes that the UK faces one of two outcomes over the next decade – either low inflation, or a wave of inflation, and in line with this “absolutely guarantees” that a year-on-year rate of 2.5% is out of the question.
“Most economists don’t understand inflation,” he said. “The output gap model that economists use to determine the rate at which an economy can produce doesn’t work because it doesn’t take asset prices into account. There is an excess of £600bn in the UK economy. When the banking system creates money that money can only be used to buy new things, such as a car, or old things such as property. When used to buy new things it shows up in GDP, RPI and CPI.”
“But quite often it is used to buy old things. For example, more than 95% of property transactions in the UK involve second-hand properties. And when you buy old car, old property and so on, that is a trade within that asset. All of the bonds, equities, commodities and currencies that we buy day-to-day are second-hand goods – a closed loop of transactions. And too much money in the financial industry always leads to inflation of asset prices, and gets trapped in those asset prices.”
Doran is sceptical of the purported intentions behind the introduction of QE policies, which he says is simply a surreptitious method of allowing governments to gradually renege on their dues, as illustrated by the devaluing of sterling.
“If I lend the UK government money for 10 years they will give me a return of 1.5% per annum, despite the fact that they have a debt to GDP ratio of more than 80%,” he elaborated. “The UK, US, European and Japanese governments will all default on their debt. It is happening right now,” he said.
“There are two ways of doing it. They can default on their foreign creditors by devaluing their currency. Every pound of UK government bonds will be paid back, but in the meantime the value of the sterling will have fallen against those surplus nation currencies. It is a slow default over time.”
“More than 70% of UK government debt is owned by the UK population, so they can default on their domestic creditors by creating inflation. Inflation is the unspoken monetary policy of the day. They created all this money via quantitative easing, which raises the money supply. But it doesn’t lead to economic recovery or CPI and RPI-based inflation – the first thing it does is lead to an asset price bubble.”
Despite the positivity surrounding the healthy amount of consumer spending in the UK, Doran forecasts the trend to grind to a halt as the tailwinds of the Bank of England’s QE policy start to take effect.
“Entrepreneurs in the economy arbitrage between the real world and financial markets,” he said. “Creating money in the UK has led to an asset price bubble, then it will affect entrepreneurs, and ultimately real world inflation.
“Inflation is, was and always will be the function of too much money in the economy. We are seeing inflation in asset prices, but over the next four to five years that will seep out of asset prices into the real world. Which is why we do not advocate QE in Europe.”
