Debt crisis: markets bet Germany will be dragged down with everyone else

Thursday, June 21, 2012
By Paul Martin

Nobody ever got rich shorting Japanese government bonds, it is often said. Are those now aggressively shorting German bunds about to fall into the same trap?

By Jeremy Warner
TelegraphUK
20 Jun 2012

To investors who think the ever more mountainous size of Japan’s national debt is eventually bound to end in fiscal disaster, shorting Japanese bonds has long seemed the closest thing to a certain bet the international capital markets are capable of.

Yet J-bonds continue to defy the bears; just when you think yields can go no lower, they fall even more. However apparently illogical and damaging to economic redemption it might seem, government debt has remained the asset class of choice for the land of the setting sun.

Regrettably, it’s a disease which since the financial crisis began nearly five years ago now seems to afflict virtually all major, advanced economies. A little while back, Bill Gross, head of the world’s largest bond fund, Pimco, said that gilts (UK government bonds) were “resting on a bed of nitroglycerine”, and that the British economy was a “must to avoid”. It was a not uncommon point of view as the eurozone debt crisis began to mount. With even higher debts than some of the troubled eurozone economies – once financial, household and private sector indebtedness had been taken into account – it was surely only a matter of time before the UK succumbed to the same sort of fiscal crisis.

But since Mr Gross made his headline grabbing remarks, yields on 10-year gilts have more than halved to less than 2pc. He could not have been more wrong. The same has been true of German bunds and US Treasuries. Almost everywhere other than the eurozone periphery, extreme risk aversion has been driving savings out of productive investment into the supposed “safe haven” of government debt. So extreme has the phenomenon become that Germany was recently able to raise two year money on a zero coupon.

What we’ve been witnessing is “safe deposit box” investing, where savers are prepared to accept some marginal loss of capital to inflation rather than risk the possibility of catastrophic loss by investing in almost anything else.

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