In bondage to the bond markets

[Joanne98]

The global economy continues its swan dive. In the three months to November, UK industrial production fell by 2.7 per cent. US unemployment surged by 524,000 in December alone and purchasing managers’ indices suggest the quagmire is deepening in Asia. The only growing sector is government. But questions are now being raised about whether states can finance their widening deficits.

The flow of public spending around the world is growing while tax revenues are thinning. Investors are lending enormous volumes to states to make up the difference. Governments can borrow cheaply, but will still need to service the debt. It is not clear in every case how they will afford to do so: around the world, lots of taxable productive capacity is being destroyed.

This week, investors chose not to take up all the debt on offer at a German Bund auction, leaving nearly €2bn of debt unsold. The price of insuring government debt is rising: it costs more to insure against US and UK government default with a credit default swap than against the collapse of McDonald’s, the fast-food chain.

Investors, however, have not sated their appetite for debt backed by strong governments. The failed auction was a quirk of the German bond sale process. Rather than holding a reverse auction for debts, it fixes a price. If debt is left unsold, it will try again on another day. It was certainly not good news, but is not a reason to panic. France and Spain held auctions after the Germans and these passed without incident, while there was strong demand for Commerzbank’s German-state-backed debt. Lenders want large quantities of safe, liquid assets: governments are able to borrow at unsustainably cheap rates.

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http://www.ft.com/cms/s/0/bdc19686-de96-11dd-9464-000077b07658.html