Friday, 24 April 2009

From Gilts to Class Struggle in Five Easy Quotes

1. What's a gilt when it's at home then? Over to Paul :

"...gilts are IOUs issued by the government over periods of 5, 10, 30, and 50 years and bring a guaranteed interest payment for the buyer, paid every six months. Two thirds are held by pension funds, as they supply a ready and predictable source of income. Once issued gilts can be traded, so their price can go up or down compared to the interest rate guaranteed. Out of this relationship you get a yield - which is a bit like a "real" interest rate. If the price of gilts goes down, because there's not enough demand, the yield goes up - and the government effectively ends up paying a higher interest rate on its debt."

2. Sorry, I'm struggling to say awake here - why does that matter? Alice reckons it matters because:

"Even under the best case scenario, New Labour has bequeathed this country a decade of historically unprecedented fiscal problems. In the worst-case scenario, the UK could be slipping towards a fiscal crisis, where financial markets question the long run solvency of the UK government and refuse to finance this profligacy."
3. Blimey, that sounds scary - is it likely? Chris doesn't think so:
"The most important number about today’s Budget is $12.5 trillion. That’s the amount of money the private sector is likely to save around the world this year. This means that the government can raise the £220bn it plans to borrow in the gilt market merely by attracting 2.5 pence for every pound saved**. This is smaller than the share of the UK in the global economy..... the world has a shortage of safe liquid assets. Issuing gilts therefore meets global savers’ needs. This is why the UK - and governments of developed countries generally - has enjoyed very low borrowing costs as debt has soared."
4. Phew, so I can rest easy then? I mean, the FT says we're so safe we're rated AAA:

"As Moody’s says in its overview of sovereign ratings:The probability of default for a government depends on both the ability and willingness to pay.

Countries with long-term, firm financial systems that lock them firmly into the global economy are, of course, much more “willing” to pay than those without them.

Or to flip all this seeming optimism around: the UK won’t lose it’s triple-A rating because Moody’s knows the government would rather cut public spending to the bone first."(My emphasis)

5. Ah. I think the penny's beginning to drop here. So that's what Willem Buiter was on above when he said,
"The long-term pain of higher taxes and lower public spending is not the result of public debt and deficits incurred because of a war fought by a united nation against a hated external enemy. It is the result of an economic civil war, a massive systemic peacetime economic failure, with a large domestic component. It is therefore not clear that the necessary social and political cohesion - readiness to accept joint fiscal burden-sharing - will be present. If the necessary fiscal tightening is not forthcoming because different groups and vested interests are engaged in a war of attrition aimed at shifting the fiscal burden to the other guy, markets could easily panic and Britain could face..... the rest of the world withholding financing from its public and private sectors."


  1. "This means that the government can raise the £220bn it plans to borrow in the gilt market merely by attracting 2.5 pence for every pound saved**. This is smaller than the share of the UK in the global economy"

    I'm still worried that this is a false analogy. Surely using that percentage implies that people who save into the UK do so only by buying gilts, and only buying them from the UK Government.

    We would need to attract more like 10% if investment into the UK was evenly split between buying the shares of UK companies, buying the bonds of UK companies, buying UK gilts from current holders, and buying UK gilts from the government.

    Chris thinks it's ok because "companies are net lenders". I think that speaks of crowding out - if the Government can only fund itself by reducing the net debt position of companies then, while I personally think reducing private sector debt is a good idea, won't it have failed massively in its mission to 'get credit flowing again'?

    Chris clearly thinks the 'savings' ratio is a net number, meaning that much is saved over and above how much is borrowed. He may be right, but I fail to see how - unless the saving is done at the bank of mattress, the 'net' savings ratio for the world would necessarily approach zero. If someone saves, someone else borrows.

  2. John - the reason I mentioned that $12.5trn was merely to show the size of the pot of world savings that can be tapped. Obviously, there are countless other claims on that - as you say, around the world borrowing must equal lending. But very few of these claims offer the security of gilts.
    I was merely trying to point out that £220bn isn't as big a number as it seems, in isolation.
    And I don't think it's government borrowing that's responsible for companies being net lenders. They are lending because those that want to borrow are unable to do so because of the credit crunch, and because others don't want to invest because of the recession.
    If anything, I think the causality goes the other way - the government is borrowing because companies are net lenders.

  3. Thanks Chris - not sure how secure gilts are though. If someone in the US or Germany or China bought UK gilts a year ago then sure their face value has gone up, but the conversion back to Dollars or Euros or Renmimbi is going to hurt. What is going to make UK gilts sufficiently attractive compared to those of many other governments?

    I can only think that it will require higher rates, particularly once the Bank of England stop being net buyers. At that point we can assume the worst of the recession is over and many holders of gilts will want to sell and get back into shares and company bonds, potentially causing a real glut and lack of demand.

  4. What makes Gilts and Government Bonds in the US and elsewhere attractive at the moment is that Government's are buying them back with freshly printed money. As Bill Gross of the world's biggest Bond Fund, PIMCO, said, his strategy was to do what the Government is doing, but do it first. That is buy these Gilts on the market, then when the Government steps in to buy them, the demand will push the price up so he makes a big Capital Gain!

    So, the big boys get to make big bucks now, and offload the Treasuries, whilst everyone else is being encouraged to save a few quid into their ISA's, which will beocme next to worthless when inflation hits 20% for a few years, thereby using the funds of the plebs to clear the Government's debts through inflation. In the meantime, the higher rate of inflation down the road means that Governments will have to pay out higher interest payments - means lower Bond Prices - to get the big boys to buy their debt. So, they win again because they but this debt cheap, and get a high rate of interest from it.