The Madness of Modern ‘Money’

You may have seen in the news yesterday that Argentina has issued a 100 year bond… and people bought them all!  Seriously!  Why our surprise?

Let’s first get back to basics. When a government needs more money than it gets from income like tax receipts etc, it sells bonds (debt) to raise more cash.  If you are not too young you might remember things called ‘surpluses’ where governments spent less than they received.  Seriously it used to happen…  Well, nowadays governments don’t have a gold standard to limit ‘money’ production and have discovered this really cool trick of promising stuff for everyone (getting them re-elected) and borrowing to pay for it all (running deficits and robbing future generations).  Eventually all that debt starts to burden the economy (that might sound familiar about now) and tax receipts suffer and more people are on government support plus you have an aging demographic with insufficient savings, etc etc.  You start to see the spiral yeah? Common bonds have durations of say 2, 5, 10 and 30 years.  That’s the period after which the government needs to give the principle back having paid the interest or yield along the way.  Government bonds tend to pay a lower yield as they are less risky (because the above business model sounds oh so robust…) and for sitting governments those bond durations are usually beyond their term and so someone else’s problem in the future.

But what if one of the historically more unstable countries of the world issued a 100 year bond?  Would you smell a rat?  MarketWatch put it beautifully:

“True, the country is currently deemed credit-worthy, and 8% is an attractive yield. A 10-year Argentinean bond is currently yielding 4.5%, so the rate is a lot higher. Elsewhere, emerging-market debt has seen rapidly falling yields, and of course in the developed world, government bonds pay next to nothing.

In the case of eurozone countries such as Germany, yields have literally dropped below zero, meaning you end up paying the government to take cash off your hands. In that context, 8% doesn’t seem like such a bad offer.

Even so, and with no disrespect to the country, this is Argentina we are talking about. Whatever it’s other virtues, it has never exactly been synonymous with financial or political stability.

It has only just settled a long running dispute over a $95 billion default. It has defaulted on its debts seven times in the last 200 years, and three times in the last 23 years. It has been through military rule in the 1930s, the Second World War, the populism of the Peron era, war with the British over the Falklands, and its own terrorist insurgency.

What can anyone owning their brand new 100-year Argentinean bond expect? A couple of defaults, at least one war, and probably a revolution as well. The chances of collecting your 8% every year through all that? Perhaps not quite zero — but surely something very close to it.

Argentina is far from alone, however. Last year Mexico issued a 100-year bond, and so did Ireland. Belgium has done the same thing. The French have put out a 50-year bond. The Spanish and the Italians have both successfully launched 45-year bonds, and will probably go up to 100 years just as soon as they think they can get away with it (we can only assume that someone in the Italian Treasury is gleefully studying the Argentinean issue right now).”

They go on to rightly point out that such madness is not uncommon at the top of every cycle:

In any great boom, there is always a signal that it is spilling over into a bubble. In the dot-com boom, flimsy web companies were suddenly worth more than well-established businesses. At the height of the subprime boom, flaky bundles of second-rate mortgages were worth as much as debt issued by Coca-Cola or GlaxoSmithKline.

The proliferation of 100-year bonds may be a signal that point has been reached in the fixed-income market. In reality, someone is going to get badly burned by these issues. And it won’t take a century for it to happen. The only rational response is to make sure it isn’t you.”