The bubble in UK government debt
Gilts look just as dangerous a proposition as internet stocks did during the dotcom era
Remember when internet stocks were riding high, everybody under 30 seemed to be starting their own dotcom and private investors were starting up their own share trading clubs?
We look back at those days and smile at how gullible everyone seems to be. As The Who sang, surely “we won’t be fooled again”. But the behaviour of bond markets today is almost as remarkable as the behaviour of equity markets back then.
As I write, the UK government can borrow money for 10 years at 1.7 per cent. The Bank of England has an inflation target of 2 per cent.
The last time gilt yields were anything like this low, according to the Barclays Capital Equity-Gilt study, was 1946
The corollary is that, even if the Bank meets its target – which it hasn’t for a while – gilt investors will lose money in real terms.
A government supporter might say that these low yields are down to the government’s success in controlling the deficit. But the latest figures from the Office for National Statistics show that the deficit in May 2012 was £2.7bn, larger than for May 2011.
For all the talk of cuts, spending was up by £4.1bn, not down. The image of George Osborne as an “iron chancellor” has been rather dented by the various U-turns, including the postponement of a 3p a litre rise in petrol duty.
It is worth noting that “pro-austerity” Britain is not planning to balance its budget until 2017, the same year as “anti-austerity” France.
It may be that the Bank of England’s purchases of gilts through its quantitative easing programme are holding yields down. Or it may be that the UK’s status as a “safe haven” from the eurozone crisis is attracting investors from Spain and Greece, worrying about the safety of their own banks and markets.
After all, there is plenty of anecdotal evidence of Europeans putting money into the London housing market.
Any explanation for the current level of low yields cannot relate solely to conditions in the UK.
Both US and German 10-year bond yields are even lower than those prevailing in this country. Investors are flocking into safe assets where they believe they can be found.
There is a clear division between Premier League markets – in which the UK is lucky to be situated – and the rest. Even a low yield looks good if you fear, like Greek investors, that your euros may be replaced by devalued drachma, involving a potential 40-50 per cent loss.
Nevertheless, a sense of perspective is needed. Those who bought equities on stratospheric price-earnings ratios in 1999 were betting on a new era of rising profits.
A glance at history would have suggested that returns would be poor. Those who buy bonds on current yields are betting on a new era of Japanese-style stagnation and indeed deflation, even though the Bank of England has the power to create money and has so far not been afraid to use it.