Bubble in safety
(June 1, 2012) Just seven basis points more than zero was the yield on Germany’s zero-coupon notes of June 2014 that came to market two Wednesdays ago. “That is symbolic of the desperate need for security in today’s troubled times,” a French bank’s interest-rate analyst told Bloomberg. The times may be troubled (they often are) and people may be desperate (someone usually is), but that doesn’t mean that low-yielding sovereign debt is the last word in safety and soundness.HT: History Squared
Now under way is an exploration of the alternatives. The creditworthiness of highly regarded governments is one topic. A 30,000-foot survey of highly unpopular equities is another. And the intersection of sovereign credit with the euro kerfuffle is a third. In general, this publication is bullish on things certified to be unsafe, bearish on things certified to be safe (assuming always that the respective prices are right). In the meantime, we remain bullish on the time-tested haven that you can find in better-stocked bank vaults and safe-deposit boxes.
Claims on the governments of Switzerland, Germany, Japan and the United States are the favored investment ports in today’s financial storms. In real terms, none yields much more than nothing while many yield less. Yes, a creditor of these sovereigns stands a good chance of receiving his money back at par—then again, the creditor had his money before he lent it. Besides, what will that money buy after the central banks get through printing more of it?
Before getting down to the overvaluation of the debts of the world’s most-favored nations, we pause to note the overvaluation of the debts of one of the world’s less-favored nations. Not so much less favored, in fact. That nation is the Republic of Lebanon, whose single-B-rated 81/4s of 2021 are quoted at 116.9, a price to yield 5.79%. For perspective, a single-B-rated American corporate offers 8.29%. Contemplating the ungenerous yield on Lebanese government debt, we think first not of geopolitical risk but of the post-1981 bond market. Interest rates have been falling for 31 years. Equities have been lost in space for a dozen or more years. Thursday’s Financial Times’s teasing “Death of equities?” on its front page recites the facts that, in the United States, bond funds have attracted more money than stock funds every year since 2007, “with outright net redemptions from equity funds in each of the past overvalufive years.” A concerned British actuary tells the paper that, concerning the lopsided investment-allocation preferences in place today, and likely to continue (in his view) for decades, “There are not enough bonds in the world.”
So investors pay 117 cents on the dollar for Lebanese 81/4s. Lebanon does boast a growing labor force, it’s true, and in that important detail it presents a happy contrast to Japan, Germany and Switzerland. However, neither Japan nor Germany nor Switzerland borders Syria. Then, too, Lebanon is running a 4% inflation rate, a current-account deficit of more than 14% of GDP (compared to 9.7% for Greece) and a ratio of government debt to GDP of 136.2%. Not unlike Germany, Lebanon tends to attract money when its neighbors quarrel. And its neighbors do quarrel. Why, then, do Lebanon’s creditors not demand a higher rate of pay for the risks they take? One might well ask the same question of the creditors of the world’s most prestigious sovereign borrowers—Germany, first and foremost.
Rated triple-A by every licensed ratings agency except Egan-Jones, Germany posts a budget deficit of just 1% of GDP (compared to America’s 9.6%) and a ratio of total debt to GDP of only 81.5% (compared to America’s 102.9%). The German unemployment rate stands at 6.8% vs. 10.9% for the 17-nation euro zone. In the past 10 years, the German economy has grown at an average annual rate of 1.05%, compared to 0.63% for Japan and 1.73% for Switzerland. As for the German commitment to financial orthodoxy and fiscal austerity, Germany’s monetary co-venturers can all too readily attest to it.
But these virtues (if virtues they all be) pertain to the past. A set of euro-related risks clouds the future. The fact is that Germany has massive exposure, actual and contingent, to the so-called European periphery. The market can’t help but know it, though it seems to avert its eyes. Perhaps we humans need to believe that somewhere exists a safe haven. Anyway, for now, Germany is Europe’s chosen bolt hole. It’s the Japan or United States—or Lebanon—of the Continent.
We don’t gainsay Germany’s economic prowess. What we do question is the risk-and-reward proposition presented by Germany’s debt....MUCH MUCH MORE (24 page PDF)