It always comes down to supply and demand in the end. Take the problems created by nearly $7 trillion in government bonds trading with a negative yield. Why would you pay to loan money to a government? And if you desire at least some return on your investment, how can you get it in a low interest rate world?
Governments have rushed in to solve the problem created by central banks. The answer: issue 20-year, 50-year and even 100-year maturity bonds. Those bonds will pay yields that attract investors who are not attracted by 2-year, 5-year and 7-year government debt with vanishingly small yields.
Mexico sold ‘century bonds’ last year. The 100-year bonds debuted with a yield-to-maturity of 4.2%. Like nearly every other fixed income investment in the last 18 months, yields have been falling. Bonds being bonds, when yields fall, prices rise. Is it all making sense now?
Think about it. You don’t have to think that loaning money to Mexico for 100 years is a good idea. You just have to want a capital gain from the bond, plus the benefits of operating in a liquid market in an otherwise dangerous financial world.
France has €11.9 billion in 50-year debt already outstanding. It announced plans this week to sell another €6 billion in 50-year bonds maturing in 2066. It will test the waters with a €3 billion issue of 100-year bonds maturing in 2116. Any takers?
Don’t get me wrong. France — the land, the wine, the mountains, the coast and the food — is a great country. But it’s not exactly a model of political stability, seen through the long lens of history. It’s on its Fifth Republic right now. If you’re lending to it for 100 years, you aren’t just taking an investment risk and a political risk, you’re taking a kind of existential risk.
You might say that’s exaggerating. But is it? We live in an era where capital and labour are mobile. Long-term welfare state liabilities are not mobile. Governments face rising social welfare obligations at the same time they face a shrinking tax base. And it gets worse.
Without higher birth rates, you can only grow the tax base through immigration. That’s a political issue as well as an economic one. In Europe, growing the tax base through immigration means cheaper labour from the Middle East and North Africa. This whole process, a) creates additional welfare state obligations, b) threatens social cohesion, and c) is not something anyone voted on.
A discussion of benefits and costs of large waves of migration is beyond the scope of today’s letter. But back to my original question: would you be willing to lend to France for 100 years? The answer is probably no. But then, that’s not what investors are really doing.
Unless there is a major breakthrough in medicine/technology/longevity, nobody reading this will be alive in 100 years. The obligation to repay the debt will be someone else’s problem. France will enjoy the financial benefit of selling the bonds now. Investors will earn interest or sell at a profit in the near future. And the debt will be repaid…later…by the unborn.
This is the intellectual underpinning of the idea of perpetual debt. Government deficits don’t matter because they never really have to be repaid. Only refinanced. And as long as the government generates enough tax revenue to pay bondholders, the ‘market’ will never really question the underlying quality of government credits.
Less philosophically, eurozone government bonds with maturities longer than ten years had a very good first quarter — up an average of 8% according to Bloomberg. German bunds were up 10%. UK gilts were up 7%. Long live the long bond bubble!
Facebook backer says everything overvalued
Peter Thiel, one of the early backers of Facebook, is concerned about ‘the frothiness of the markets.’ At a conference about the future of the payments system, Thiel responded to an audience question about values. He said: ‘Startup tech stocks may be overvalued, but so are public equities, so are houses, so are government bonds.’
Venture capital and private equity can generate much bigger returns than you or I because they pay a lot less for their original stake. But they’re taking more risk. If they measure the risk correctly — and back the right winner — the pay day is huge. The public is left with table scraps in an initial public offering.
At that point, it’s simply a question of how much growth there is and how much you should pay for it. There is a lot more growth in technology stocks than government bonds (even though the supply of government bonds is likely to grow in coming years). Owning shares in fast-growing publicly traded stocks — real companies that create real value and have real sales — is going to be a much better strategy than making 8% on government bonds.
There’s no reason you can’t do both, of course. I’m talking to Charlie Morris and Nick O’Connor on the podcast today. They’re coming at the investment problem from different angles and have different solutions. I’ll post the link tomorrow.
‘Severe damage’ from Brexit says IMF, Soros warns
The International Monetary Fund (IMF) has weighed in on the Brexit issue. IMF says Brexit could do ‘severe regional and global damage.’ It added that the disruption of existing trade relationships between Britain and the Continent would pose ‘major challenges.’
Sounds about right. And I would argue that the EU needs some major disruptive change, lest it become an overbearing and menacing uber nanny state with the power to tax, regulate, borrow, and jail.
But it would be wrong to dismiss the IMF analysis as mere scaremongering. It’s a dead set fact that if Britain leaves the EU, things are going to change. Like most of the future, exactly how things will change is something we can’t know. But is not knowing what the future will bring the best reason for not leaving?
Is it really fair for the Bremainers to demand an exact forecast of what will happen when no one can ever know what’s going to happen? What do you think? Before I give you my answer, I’m going to read the handy literature the government has printed and mailed at taxpayer expense. I’m sure it will have all the answers.
In the meantime, let’s keep in mind the relationship the Bremainers would like to preserve. The European Union is in ‘mortal danger’ if it doesn’t find the cash to settle 500,000 refugees a year, according to George Soros. Justifying a €30 billion debt splurge in an essay for the New York Review of Books, Soros writes that:
‘Throughout history, governments have issued bonds in response to national emergencies. That is the case in Europe today. When should the triple-A credit of the EU be mobilized if not at a moment when the European Union is in mortal danger?’
First off, Europe is not a government. It’s a continent. But the European Union has given itself permission to borrow money in global capital markets on behalf of member governments (who presumably have lousy credit ratings and can’t borrow themselves, or at least not at low rates of interest).
But I’m quibbling over details. Soros wants the EU to either spend money it already has or borrow new money to address the migration crisis. It is the only way, in his view, to preserve the free movement of people (Schengen) and keep the European project alive.
The superstate needs money. Soros wants it to take money from the future. Can 100-year EU bonds be far away? The interest can be paid by raising VAT, or some sort of Union-wide levy. Border security has a price. Time to pay.
Contributing Editor, Money Morning
Ed note: Long time readers will remember Dan Denning, former Publisher of Money Morning. Dan has now gone on to the UK, where he writes for our friends at Capital and Conflict. The above article is an edited extract from that publication.