Saturday, 31 March 2012

Last piece of entertainment: 100 year gilts

The UK announcement that it would start offering sovereign bonds with a maturity of 100 years was greeted with a lukewarm reception by investors. It reminds some of us of the perpetuities issued in 1752 by the Chancellor of the Exchequer Sir Henry Pelham which started as 3.5% annuities and, after a series of "consolidations", ended up with coupons of 2.50%. Truth be told, now with the inflation monster surfacing more and more, issuing 100 year debt without inflation links is nothing more than a bad joke.

"Financial credibility - Fiscal credibility"

To use a analogy: what would you say about a company that issues short term debt, say 1 year notes, then runs into some kind of financial difficulties, starts buying up its own notes without actually retiring them. By purchasing its own debt (by the cleverly forged academically sterile term of "Quantitative Easing",) the company is able to prop up the prices and therefore drive down the yields. Now that the yields on this short term debt are artificially low (for a finite period), the company tries to persuade investors that it considers issuing very long term debt, so as to bank on its record low yields thanks to its "outstanding financial credibility". Now, to add a bit of complexity to this situation, the company is also issuing debt in its own currency and is able to increase or decrease this money supply as it pleases. You would probably have to think twice before embarking on a journey of ups and downs (more probably downs) with this company. 

Now back to the United Kingdom

Whether this is a blunder or a marketing stunt, the massive failure and the future under-subscription of these long dated gilts will definitely have its own place in financial history.
"(UK Daily Telegraph): Britain is to offer 100-year gilts, meaning current Government borrowing will not be repaid until the next century, ...

The Chancellor hopes that the 100-year gilts will help to “lock in” the benefits of Britain’s international “safe haven” status. The interest rates paid by the Government to borrow money have recently fallen to a record low and it is hoped the new gilts will mean “our great-grandchildren” can benefit from the low rates."

Now, about the fiscal credibility, the Guardian managed to sum it all up, quite nicely may I say, in one massive infogram:

"(UK Daily Telegraph): Currently, the average duration of the Government’s £1 trillion debt is around 14 years – with maturities ranging from months to a 50-year bond issued in 2005. Longer-dated debt is widely thought to offer a country more stability
A Treasury source said tonight: “This is about locking in for the future the tangible benefits of the safe haven status we have today. The prize is lower debt interest repayments for decades to come.
“It is a chance for our great-grandchildren to pay less than they otherwise would have done because of the government’s fiscal credibility.”

Living aside the sheer populism of saying that these time ticking non-inflation linked time bombs would entail that the grandchildren of UK citizen would pay less, what is really mind boggling is that it would probably mean for some well connected pension funds a bond purchase at the very top (and consequently at the very lowest yield possible) for the rest of this century. The pensioners, incidentally net savers, who already suffer from these artificially record low yields, are to be welcomed into what would probably be one of the biggest wealth redistribution. I`ll leave you with Warner Grant`s words on what happened with the last "investors" in 100 year dated bonds:

"From the Government’s point of view it was a masterstroke which transformed the public finances, but it was a disaster for  investors. The new stock immediately plunged in value, yet the real damage was to come later from the value destructive effects of
inflation. £1,000 invested in the War Loan back then would in today’s money be worth less than £20."

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