Bond Issuers Headed for ‘Collision With Reality’?

How much interest would you want back if you lent to huge amounts of money to someone on an unsecured basis, and if that person had unaudited accounts and a history of playing dirty when the chips are down?


That’s the question being asked by Societe Generale strategist Dylan Grice in relation to the bond market, who warned that the artificially low cost of borrowing for some governments will come back to bite them.

“Maybe I’m missing something, but 150 basis points sounds on the low side to me,” Grice said, drawing a comparison to what he sees as the artificially low yields on some governments’ bonds.

In a research note this week, Grice made the point that if you applied the same rules to governments as you did people, then the cost of borrowing for many governments would be far higher than it currently is.

Grice questioned why the rules of economics do not seem to apply to governments. The nasty truth, his note explained, is that those governments — and their electorates — don’t want them to.

“Our demands are infinite, but the resources we have at our disposal to satisfy them are finite. And the thing is, scarcity is annoying. We don’t like not having. Bumping up against our budget constraint is no fun. It means we have to do something unpleasant like work harder, sell something we own, or go without. Riots in Greece, protests in Madrid, governors recalled in Wisconsin, governments toppled in Rome, Paris, and now Amsterdam … it all attests to the pain of a head-on collision with reality,” he said.

One relatively easy way to avoid that reality, Grice said, is to misrepresent your financial health, and he sees some major sovereign lenders doing just that.

“With 10-year yields below 1.5 percent in the U.S. (well, 1.7 percent in the U.S.) and Germany, the smell around these sovereigns is pungent indeed,” said Grice who believes governments are as inclined to tells fibs as any individual or household. He noted that the U.S. budget deficit is skewed downward by being reported on a cash basis rather than a more comprehensive accrued basis.

“So all we know about the size of U.S. federal government debt is that we don’t know how big it is. And that it’s likely to be much bigger than we’re told,” Grice said. “This all serves to give the happy appearance of a borrower living comfortably within its budget constraint. So does the yield.”

Another Untruth: Printing Money

By printing whatever money they need, central banks of the Anglo-Saxon world engage in further misrepresentation.

“Since (government) jealously reserves for itself the right to supply the nation’s medium of exchange, it has recourse to the most splendid of all budget constraint avoidance maneuvers: If tax revenues or the trust of honest creditors are insufficient, the government can simply print any money it needs,” Grice said.

He suggested that without the ability to print more money, bond yields in those money-printing countries would look very similar to those in peripheral European nations such as Portugal, Italy, Spain, and the like.

“Maybe it all just goes to show how dependent our economic and political structures are on the white lie of money printing. Maybe all the Anglo-Saxon central banks have done is create the illusion that our sovereigns are more solvent than they are, and that our budget constraints are really a safe distance away,” he said.

“But I don’t think they are. And I think the truth gets out eventually. The Enrons, the Allied Capitals, the Bernie Madoffs … they all get their comeuppance. Indeed, it’s what’s happening today in the euro zone,” Grice said. “The accounting shenanigans euro zone governments resorted to in order to meet the entry criteria have been found out.”