It’s never been cheaper for governments to borrow. In a post on the Zero Hedge blog, the pseudonymous author points out that “more than half of all global bonds traded under 1% recently”. Indeed, there are some instances of governments borrowing money at negative interest rates.
With interest rates so low, it’s hard to resist those who implore our governments to load up with even more debt. At the very least, sing the sirens, we can afford to go slow on deficit reduction.
However, there’s a counter-argument, which is that unusually low interest rates are the very reason why we should kick our debt addiction. In this regard, a recent letter from the investor and philanthropist Paul Singer (excerpts of which are featured in the Zero Hedge post) is worth studying:
“…the current prices of bonds are at all-time highs, and thus yields are at record lows, because the central banks are buying bonds with trillions of dollars of newly printed money, despite the facts that 1) the global financial emergency ended over six years ago and 2) the developed world has not suffered a renewed financial collapse or deep recession. The central bank actions are unprecedented under these conditions…”
In other words, bond yields and interest rates are being artificially suppressed by central bank interventions. Moreover, bond holdings that offer very low fixed yields are highly vulnerable to inflation (which governments are doing their best to push upwards):
“At currently prevailing interest rates in the developed world, if there is ANY inflation in the next 10 to 30 years, investors who buy or hold bonds at today’s prices and rates will have made a bad deal. And if inflation emerges from the stone-cold dead and walks, trots or (heaven forbid) gallops into the future, they will have made a very, very bad deal.”
One might wonder why investors continue to sink their money into a market that is rigged against them. The answer comes from a consideration of the alternatives. One could invest in shares, property, gold or even Bitcoins – but all of those markets are subject to volatility. Bonds, on the other hand, are reckoned to be safe – precisely because governments have both the means and the motive to rig the market. Investors assume that the consequences of a collapse in investor confidence are so extreme that governments will do what it takes to maintain it (especially by using funny money to buy bonds back from the market).
If this seems to be all a bit circular, then that’s because it is. We should never forget Herbert Stein’s Law – which is that “if something cannot go on forever, it will stop”. Mr Singer describes how this might play out in the bond markets:
“No investor’s actuarial requirements or investment return goals can possibly be met by today’s long-term bond interest rates, but investors are holding them nonetheless because they have been making money on their bond holdings persistently and seemingly inexorably for the last few years. The day when their perceptions are challenged and they change their minds, only to find that the exit door has been blocked by everyone else doing an about-face at the same time, is going to be one heck of a day for those who have positions in bonds, whether long or short.”
It’s impossible to say precisely when this day will come – but, as with sub-prime mortgage market before the credit crunch, assuming it will never come is blatantly irresponsible.
We all need to be prepared – and for government that means not having a deficit that needs to be financed (or debt that needs to be refinanced) on terms that won’t be cheap at all.