Things That Make You Go Hmmm... Such As A "Fiscally Credible" UK And Its Upcoming 100 Year Gilts


From Grant Williams' latest Things That Make You Go Hmmm...

The popularity of Liability Matching amongst UK pension funds has all but guaranteed a disastrous outcome for a generation of ‘savers’ as rates have been held artificially low in a highly inflationary environment but perhaps the biggest ‘tell’ that the status quo cannot possibly go on for much longer came last week when George Osborne tabled an idea not used since the aftermath of WWI - 100-year gilts:

(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.


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.” 


Firstly, Britain’s ‘safe-haven status’ is a fallacy. It is no more safe than many of the other major economies who are choking on debts that cannot be paid off. The only reason it HAS that status currently is because of the very Achilles Heel that will ultimately prove to be its demise - the ability to print its own currency. By NOT being a part of the euro experiment, Britain has kept control of its fate and has been able to print its way out of trouble - so far - while its neighbours to the east have all been lashed to the deck of the same sinking boat, but the day is coming when Britain’s profligacy will become important again. As I keep saying; none of this matters to anyone until it matters to everyone.

Secondly, interest rates may have ‘fallen to a record low’ but they have done so in the same way heavily-indebted gamblers often ‘fall’ from hotel rooms - with a big push (only this time from the Bank of England and not a guy called Fat Tony). Like US Treasurys,  the price of UK gilts would be nowhere near these levels without a captive and very friendly buyer in the shape of the central bank.

And then there’s the ‘treasury source’ who spoke of ‘locking in for the future the tangible benefits of the safe haven status we have today’ before finishing with a flourish when he tugged at the heartstrings of investors by referring to great-grandchildren who would be paying less in interest repayments than they otherwise would have done because of (and I’m going to give this last comment the space it deserves;

“...the government’s fiscal credibility”

I have yet to find anything remotely credible about the UK governments fiscal policy - it’s marketing policy, yes, but fiscal policy?  Not so much.

Clearly, any government looking to lock in rates for 100 years is supremely confident of two things:
1: Rates are as low as they are going to be for 100 years
2: They have suckers at the table willing to lock those rates in for that length of time.

But a funny thing happened on the way to locking in for the future the tangible benefits of the safe haven status Britain enjoys today - the once-in-a-lifetime offer received withering criticism:

(Jeremy Warner): ...from the investors’ point of view it makes no sense whatsoever and if it ever comes to pass, I can guarantee it will eventually be seen as one of the most colossal cases of mis-selling ever seen in the UK – and there have been quite a few.


As any student of economic history knows, periods of very low interest rates can last an awfully long time, but they have never lasted 100 years or anywhere close. Any such gilt is therefore a hostage to long term fluctuations in interest rates and inflation. One thing is absolutely guaranteed – inflation adjusted, £1,000 invested in a 100-year bond today, even with interest re-invested, won’t be worth anywhere close at maturity.


Anyone who invests is therefore more or less agreeing to a long term loss, or to a net transfer of part of his wealth to the Government.

Warner went on to examine how the last buyers of 100-year gilts made out:

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.

The National Association of Pension Fund Managers were similarly scathing:

(FT): The National Association of Pension Funds on Wednesday criticised the chancellor’s plans for an “Osborne bond” – a 100-year debt issue or even a perpetual gilt that never matures – saying it would prefer shorter maturity debt that was protected against inflation.


One senior UK fund manager said: “This could be of interest for pension funds as it would be a good match for their liabilities.” But another said: “We would not be buyers of this debt because the yields are too low. It would be great for the government and the British taxpayer, but I don’t think we would want to lock in yields so low for such a long time. Yields are artificially low because of the Bank of England’s quantitative easing initiative.”

And it is in this reaction that the writing on the wall for government bonds becomes clearer still.

We have reached the point where investors are comfortable enough that the fear of a systemic collapse has now more or less dissipated and faith in a resumption of growth (at least in the US) is slowly returning (though I have my doubts about that being the case but more of that another day). It was precisely this fear that drove them into government bonds in the first place but now that they have started to care once again about such trivial matters as price and yield, there is only one price-insensitive buyer left in the game - and that buyer (at least in the UK) only has £25 billion in his pocket. Sounds like a lot of money, huh? It used to be.

And so, Greece and Spain fail to reach the limits imposed by the fiscal compact, now it’s Holland’s turn and the UK couldn’t get near it even if it WERE a signatory. Portugal is sinking rapidly into the swamp and this week Ireland, poster child for austerity, has announced that it has slipped back into recession.

Anybody out there think we have heard the last of this whole ‘Europe thing’?

Me either.

Of course, if Europe WERE to completely collapse, just think how low yields of government bonds would be...


Full TTMYGH report