Bare minimum, I reckoned, when I heard poor young 'croak-throat' Osborne dish out his supposedly harsh medicine on Wednesday. It certainly didn't impress me so I was a bit surprised when the bond markets marked down the yield on HMG's loan notes! In fact, the yield on British government bonds is less than you will receive if you buy German ones. "Shome mishtake, surely"! Now, I barely understand international finance - what was that? You guessed already! - but what I do know is that if people are eager to buy your bonds you need only give them a paltry yield, or interest. If, on the other hand, your bonds are as dodgy as some of my old cars used to be, then you have to offer blood money in order to tempt the Shylocks into the market. So why are British bonds so sought after? All is explained by Jeremy Warner, assistant editor of The Telegraph and a bit of a financial whizz.
According to him those red-bracer rascals are at it again, rushing into anything that looks as though it will earn a crust - in the short term! This, as we have learned the hard way, is the classic explanation for the making of a bubble:
The UK Government likes to think of the record lows to which gilt yields have sunk to be a vote of confidence by international investors in its plans for fiscal consolidation, and no doubt there is a small element of truth in this contention. But the main factors driving government bond yields ever lower, not just here in the UK, but in the US too, are much more worrying and have little to do with the bravery of George Osborne’s deficit reduction programme.
Oh dear, I sense an incoming 'on the other hand' comment!
In essence, both the UK and US government bond markets have become giant bubbles which are now largely divorced from underlying realities and almost bound to end badly. Yes, for sure if the UK Government hadn’t done something about the deficit, then we might be looking at far less benign conditions in the gilts market, but just to repeat the point, it’s not really enhanced credit worthiness which is causing these abnormally low yields.
The US is experiencing much the same phenomenon, even though its public finances are in just as big a mess as the UK’s and it has virtually no plan that I can discern for deficit reduction, besides the wing and a prayer hope that growth will eventually come to the rescue.
So why are our bonds so popular?
[...]the real reason lies in the market distortions that result from ultra easy monetary policy and the demands being put by regulators on banks to hold “riskless” assets. This is leading to a profound mis-pricing of government bonds, which now take virtually no account of significant medium term inflation risks.
Or, to put it in plain English (no disrepect to Mr. Warner), our government is maintaining ludicrously low interest rates so that bond dealerss can borrow cheap but still make a buck on low government debt yields. That's the carrot, the stick is that with their new regulatory powers they can insist that Banks do not invest in anything risky - and I ask you, gentlemen of the City, what is safer than lending money to HMG?
Putting it rather more expertly than I can manage, Mr. Warner writes this:
A second distortion is caused by the “carry trade” opportunities of exceptionally low short term interest rates. Put crudely, you can borrow from the central bank for next to zero, lend the money out at a higher rate further up the yield curve, and pocket the difference. In a sense, that’s the purpose of ultra-easy monetary policy – to create a generally low interest rate environment – but the dangers of it are obvious. Central banks are creating a bubble in government debt.
Well, as they often sing in all those City pubs late on a Friday night, "I'm forever blowing bubbles, pretty bubbles in the air".
(*) Macbeth I.iii l79
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