On Wednesday, I said 2013 will be the year of the central banker. The central banks are set to print more money than ever. And much of it will go into foreign government bonds. Our very own gilts are hot property right now...
Perversely, this is seen as a good thing. George Osborne is incredibly proud of the fact that he’s able to continue borrowing from where the previous government left off.
Today I want to see where this whole thing takes us. And ultimately what we should do as the cracks start to appear.
Trading taxes for energy
The idea of nations buying the bonds of other nations is of course nothing new.
My native Norway has amassed the world’s largest sovereign wealth fund – and government bonds feature very heavily in the portfolio. The Nordics have sold oil and gas, and recycled the cash into foreign promises.
What they’ve actually got are claims on our taxes. More than that, they’ve collected claims on our children’s taxes and most likely our children’s children's too.
Okay – fair enough. We got oil to drive our cars and gas to fire our stoves; and we’ll have to stump up for that – we’ve effectively bought energy on the never-never.
But now, the deal is somewhat different. What exactly do central banks such as the Bank of Japan give us in return for our future taxation? As I explained on Wednesday, Japan plans to collect our taxes in return for simply minting more yen. In fact, they don’t even need to mint it... it’s just a matter of keying some figures into a database – it’s free!
And it’s little wonder Japan’s keen on the idea. They get to pick up our taxes for free, and as a real kicker, the policy pushes the yen down – helping revive their export trade.
When the music is playing, you keep dancing
The concern must be that the likes of the UK ultimately won’t be able to make good on its promises. It’s hard to imagine how we can. I mean, as a nation, borrowing keeps rising. So instead of repaying debt through taxation, we actually use the very same monetary tricks as Japan.
We print money to pay our debts. And everything seems to be working out just fine... for the moment anyway.
As Osborne rightly notes, other nations have faith in the UK, so they continue to buy our junk bonds.
Until the credit crisis of 2008, everyone had faith in southern Europe’s ability to pay too. Then suddenly faith was lost. Was this a sudden and collective realisation that the periphery states were a bad credit risk? I suspect not.
I suspect that market participants were fully aware of how weak the periphery promises were. But they carried on regardless. To quote Citigroup’s Chuck Prince: "when the music is playing, you keep dancing".
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It was much the same during the dotcom frenzy. Only the truly naive believed the dotcom bluster – but that didn’t mean there wasn’t a lot of clever money still in the game. It’s just that the clever money keeps its eye on the exits.
I suspect that’s where we are today. A lot of the clever money has left the UK’s shores – I’m thinking of the largest bond fund in the world, PIMCO, whose boss Bill Gross famously described UK gilts as “sitting on a bed of nitro glycerine”. But there’s a lot of money still in the game.
And it leaves us with a rather frightening prospect. What happens when faith in gilts finally starts to evaporate? What happens when the cash heads for the exits? We’re talking about not only a crash in the bond market, but in sterling too.
And for anyone with an eye on the exit, the question is of course, when?
The gilts bubble…
Calling the top of the market is a mug's game. All we can do is look for signs – the first cracks, if you like. And from what I can see, the central authorities are still very much in control. The music is still playing.
Markets carry on climbing long after they’re declared a bubble. The fact that more people now see gilts as being in a bubble doesn’t mean it can’t carry on climbing.
The other clue that the world's collective Feds are still in control is the precious metals market. The last week or so has seen a big sell off in gold and silver. The fact that global investors aren’t snapping up these metals show that there’s still plenty of faith in paper.
Despite my concerns for government promises (and the financial system they support), I’m still sticking with my overall asset allocation. 25% bonds, 25% cash 25% equities and 25% commodities.
That said, I will be making some changes to my portfolio as we move into the new year. I suspect I’ll have to start spending some of that cash pile. I’ve had a decent amount of liquidity held in reserve, just waiting for a nasty drop in the markets. But with the central planners looking to up the ante, an immediate market smash looks more distant.
More of my cash will be going into precious metals in 2013. That is, away from immediate insurance and into long-term insurance.
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Now back to the bond manipulators - they are risking long-term instability in return for short term stability. Not only is the music still playing, but the volume has been cranked up to full. Investors know the dangers, but few want to be the first party-poopers out the door.
For the moment, the dancing frenzy continues. The manipulators trade thin air for vacuous promises... let’s see how long they keep it up before the mad crowd calls it a day.
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