Magazine article The Spectator

This Is Going to Hurt

Magazine article The Spectator

This Is Going to Hurt

Article excerpt

The worldwide bond bubble will burst, and Britain is not prepared

There is much to be terrified about in today's global economy. The eurozone's death dance, China's slowdown and America's inability to create jobs are enough to make the most upbeat investors gloomy. But even these problems pale in comparison with the biggest threat, one with implications so hideous that financiers are reluctant to talk about it even now. The truth is that the economies of rich countries, including the UK, are being kept alive by another and astonishingly under-reported bull market - in government debt. This is the bond bubble; and when it bursts, as it surely will, the result will be a recession far deeper than the crash from which we are trying to recover.

This danger is ignored for a very understandable reason:

government bonds are so boring that most people pay them no attention. Yet they fulfil a vital role, crucial to Britain's nascent economic recovery. Bonds are, in effect, the IOU notes issued by debt-hungry governments.

America, unsurprisingly, is the biggest issuer. The bond market is the pipeline of debt, flowing into the British economy and setting the price at which banks lend to mortgage holders and small businesses, as well as the cost of borrowing for the large multinationals that employ so many Britons. Bonds have also become the drug to which the political establishment is now addicted.

These bonds have become dangerously cheap. A new record was set this week, when George Osborne's Treasury was able to borrow at an astonishing 2.2 per cent a year over a ten-year period. The German government can do so at 1.8 per cent a year, and America at 2 per cent. Crucially, in many cases, the interest rate is less than the expected inflation rate. So the 'real terms' interest rate at which governments borrow is actually negative. Lending anyone money at zero interest is weird enough. But the bond bubble now means that UK and American governments can be loaned money - and, in effect, be paid for the privilege.

This is crazy. It shows that the bond markets are well and truly in major bubble territory, their valuations as absurd as the rocketing subprime properties of yore. And, just like last time, hardly anyone is sounding the alarm. The bond bubble means that banks can also borrow at very low rates - and pass it on, allowing us to carry on taking out cheap mortgages. Fatally, we have come to think of 3 per cent mortgages as the new normal.

Companies, home-owners, storecard holders - everyone is being lulled into a false sense of security. No one is prepared for when the bond bubble bursts and interest rates shoot back to their norm.

So why has debt become so cheap? There are three reasons. The first is Alan Greenspan, former chairman of the US Federal Reserve, who tried to recover from the post-9/11 slowdown by lowering interest rates - a hubristic decision which imagined that cheap debt would generate permanent and real growth.

These new, ultra-low American base rates soon spilt over to government bonds, fuelling the bubble.

The second is the rise of the services sector. As developed economies moved away from being reliant on expensive factories, they didn't have to invest so much in new machines. More money was left over to invest in other things, such as bonds, which pushed down the cost of borrowing.

The third and most dramatic cause of the bond bubble is the savings glut in the emerging markets. Developing countries have been saving their pennies - and lending them to the debt-addicted countries. Thrift, which used to be a virtue of the West, has now gone east. The sums involved are staggering. In 1995, foreign exchange reserves held by the world's central banks (mainly in emerging countries) stood at about $1.4 trillion. It is now $9.7 trillion, a third of it Chinese, and with an additional $4.7 trillion in sovereign wealth funds held by cash-rich countries like Norway and Qatar. …

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