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.