No more boom and bust, no more bubbles?

Bubbles are great whilst they last. Eventually hubris is eclipsed by nemesis.

In the late 1980s I was in Japan at the peak of their property bubble. They proudly told me the land surrounding the Emperor’s Palace, had it been a development site, was worth more than the state of California. I suggested to my British companions on the trip if that little thought experiment were true it was time figuratively to sell the Palace and buy California. So it proved. Over the next decade California took off, pioneering a digital revolution which left Japan standing, whilst Japan wallowed in the aftermath of her property bubble bursting.

In 1999 I could not see why people found internet based company shares so attractive – other than the bigger fool theory that they could sell them on to someone else even more love struck by them before the mass psychology changed. People piled their money in to companies that not only lacked any profit and dividend, but in many cases had very little revenue as they were offering much of their service free. Some made big money by not only buying in but selling out before the music stopped. One day people awoke from their trance, and the shares plunged back to earth.

In 2006/7 I remember several discussions with property experts in London. I asserted that £120 a square foot rentals in the West End were over the top and the market had to fall. They told me there was a continuing shortage of West End property, and the Hedge Funds, the masters of the Universe were in town and could afford it. Now those same experts tell me rents are falling and the shortage of space is mysteriously correcting itself without new build. Maybe the rents were too high after all.

Yesterday I read that people are now lending to the UK government for two years for less than 1% interest. Some seem to think this is a good deal. Inflation after all is falling. Interest rates are likely to be cut further by the incompetent Monetary Policy Committee. People are worried by any private sector risk these days, so they conclude it makes sense to lend to the government at these very low rates. After all, someone may lend to the government at a lower rate next week or next month, so grab 0.98% while you can.

On the greater fool theory this may be right. There may well be people who want to lend at even lower rates. After all, the authorities are going to effectively make the banks do this with their new proposals for banks to be more liquid and hold more gilts. Of course if people buy shorter dated gilts they can hold them to repayment so market price movements do not necessarily worry them.

Yet I can’t avoid a nagging feeling that when we come to look back on this period of our troubled financial history it will look as if there were a bond bubble in the midst of all the grief in other asset markets. Only if we go into slump with falling prices, does lending to the government at such a rate provide a reasonable real return.

If the authorities now regret the property bubble they encouraged, they should ask themselves if this growing bond bubble is healthy, and should understand just how much of it is of their making. It could be stopped slowly and gently now, or they could inflate it more and have a bond crash sometime later. If they want to begin to stop it they should announce no more interest rate cuts for the time being, and cancel their proposed new liquidity measures for banks. They should worry a bit more about the inflationary consequences of the big drop in sterling.

As always, I am not making recommendations to readers on whether to buy hold or sell gilts themselves. They may go up and down, and not necessarily in that order! As the regulators say, please take proper advice relevant to your own circumstances.


  1. Mark Wadsworth
    January 4, 2009

    Sure, but you can lend money to the government without buying gilts (i.e. via NS&I) which means you have the security without the risk that your bonds will fall in value.

    As far as gilts goes, provided you don’t pay more than par value and you are genuinely intending to hold to redemption, you can’t really lose money on those either.

    As to the property price bubble, that started in 2000 at the latest. I am amazed it lasted abother seven years before it finally popped.

    Reply: Yes, all true. I did mention you can hold to redemption. The issue is what kind of after inflation return you will get.

  2. StevenL
    January 4, 2009

    You forgot to mention the ‘luxury’ ‘penthouse’ shoebox flat bubble. I was ridiculed for well over a year trying to warn people about that one.

  3. mikestallard
    January 4, 2009

    Let me see now.
    I am reading Nial Ferguson at the moment and he attributes the first bonds to the Italians. So aren’t bonds only as secure as the government that issues them? That was the case in Venice, I understand. When it crashed: so did they. (Russia 1917? Confederate States of America?)
    At the moment, the government is running at a most serious loss as taxation doesn’t meet the vast, uncontrolled, expenditure. And that is not going to change, because of the Labour con that “spending cuts” must mean cuts in “front line services.”
    Doesn’t confidence in bonds affect things like the pound too?
    Isn’t this getting a little bit too serious for comfort?

    (PS I liked the way the Telegraph today quoted your blog at length as an expert conservative opinion. That really was encouraging.)

  4. Robert
    January 4, 2009

    Yes you mean inflation adjusted return. Personally. I would not buy Gilts though, I agree index linked may be tempting to some. Bottom line this government is the challenging for the title of the most incompetant government of the last 30 years, though I have to admit that Heath’s sorry excuse of government would take third place!

  5. APL
    January 4, 2009

    JR: “Yet I can’t avoid a nagging feeling that when we come to look back on this period of our troubled financial history it will look as if there were a bond bubble in the midst of all the grief in other asset markets.”

    Imagine if the bubble in guilts burst, not a little leak, but a huge overinflated rupture of its skin. What happens to UK government financing?

    Or, imagine if the bubble (by some extraordinary miracle) doesn’t burst, but carries on growing. How long before the interest on the debt starts to equal revenue from tax?

    It seems to me, in the short term we could have a crash, but in the long term we will have a crash anyway.

  6. Adam Collyer
    January 4, 2009

    “People are worried by any private sector risk these days, so they conclude it makes sense to lend to the government”

    So if the government were not borrowing, they would be lending to the private sector instead? So the government borrows, then the government lends to banks, car manufacturers – in fact whoever it deems worthy of State loans.

    I’m really not sure whether the government are just stupid, or whether this is all actually a scam to gain control of the “means of distribution and exchange” without ever mentioning “Socialism”.

  7. mart
    January 5, 2009

    Dear John, Presumably bond prices would fall back if investors chose to sell larger than normal quantities of them for cash.

    Why would anyone do that as long as cash earns interest at the low rates that are offered these days?

    reply: The seller will be the government, raising new money on a huge scale!

  8. Rare Breed
    January 5, 2009

    There needs to be a massive cut in public spending to protect the tax payer from the worst of this thing.

    All the costs of the bailout should be matched with an exactly equal reduction in Govt. spending. Preferably a greater reduction.

    I thought we had proved Keynes wrong???? Since when have the facts changed?

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