Free money for governments is a grave threat to investors

IF you want proof that the global economy’s woes are increasing, as a result of extreme imbalances, look no further than some countries’ borrowing costs. Germany has set a zero per cent coupon on its 2-year government bonds (or Schatz) due to be sold today – in other words, borrowers will not be paid for the privilege of lending money to the German state. They will provide their funds for free – or actually at a loss, given that inflation will eat away at the real value of their assets. Germany is due to auction €5bn of bonds; we will soon find out if it has been successful. I suspect that it will be. This was meant to be a regular bond with a coupon, but with market yields at 0.06 per cent on the current 2-year, the German authorities had no choice given market issuance rules but to set a zero coupon. This is yet another sign of profound turmoil and distortions in the financial markets and in monetary policy.

The first reason for the ultra-low yields, of course, is the desperate need by investors to find ultra safe-haven investments and their flight from risky ones. Hence this rush into ludicrously priced German, US and UK bonds, which are seen as safe.

But there is another consequence to this: other investors with fewer restrictions or greater imagination will increasingly become disenchanted with all financial assets. With equities still at extremely weak levels, and the possibility of far worse to come if the Eurozone crisis intensifies, it is becoming increasingly tough to find a good risk and reward balance for paper assets. Of course, some investors do manage – but Facebook’s disastrous float isn’t helping either.

Hence why many will again be tempted by hard, non-paper assets (land, property, gold, commodities, art and so on), fuelling fresh bubbles. Some – such as Marc Ostwald of Monument Securities – believe this collapse in returns will deal a devastating blow to the very foundations of government issued paper money. It certainly makes the challenge of wealth preservation even tougher – and that is even before Eurogeddon kicks off in earnest.

DEFICIT WOES

Here is an intriguing question for those who believe the UK should not be attempting to reduce its public spending, or at least that cuts should be reduced. Stripping out a one-off accounting transfer of £28bn, the public finances actually worsened in April. Borrowing went up by over £2bn compared to the same time last year, the current budget deficit widened by over £4bn, central government tax receipts on production, income and wealth were down 0.9 per cent year-on-year while current expenditure rose 3.8 per cent.

How much larger do the (misguided) anti-austerity folk believe that the government’s borrowing needs to be to make a difference to “growth” (or at least GDP)? Another £25bn a year? £50bn? Do we need a deficit of 10 per cent, or 12, or what? For how long? I don’t buy any of it. It was also interesting to hear renewed calls for a cut in interest rates, in the wake of yesterday’s IMF report which discussed the idea (and other) “stimulus” measures in case the Eurozone worsens. There would clearly be a strong case to review all monetary policy if the Eurozone implodes – that would be a real emergency. But those getting carried away and calling for immediate rate cuts need to stop and think: why would cutting rates right now from 0.5 per cent to 0.25 per cent or zero be the answer to any of our problems? We need to make the UK a better place to work or invest in, and fix the banking system, not obsess with micro-managing demand at the cost of ever-increasing debt.