Government Debt is the New Subprime

With at least part of the subprime crisis behind us, Gillian Tett of The Financial Times questions if policy makers are focused upon solving what is likely to be the next danger, or if they are simply avoiding a repeat of the last one.

What is the next subprime crisis? According to Tett, it’s quite possibly sovereign debt, such as government bonds. The US, for example, has been issuing massive amounts of debt in order to soak up toxic assets and stimulate the economy. Government bonds are supposed to be safe and provide a “risk-free rate,” but there was a time when subprime mortgage bonds and collateralized debt obligations were also considered highly-rated safe investments. These beliefs have a tendency of changing when least expected…and often least convenient.

So Tett asks, “could this flight to the ‘safety’ of government bonds in itself be creating subtle new dangers? Government debt, after all, has soared to levels not seen in peacetime for centuries, if ever, in many countries, not least the US and UK. Fiscal deficits are swelling across the western world. And the level of political commitment to curbing those deficits remains uncertain – not least because with yields currently so low there is less pressure on politicians to push through reform.

“…it is easy to imagine that some countries will end up eroding the value of their bonds by debasing their currencies in the coming years, printing money and stoking inflation.

“It is even easier to anticipate a sharp rise in bond yields – and a corresponding sharp fall in bond prices – particularly when central banks stop their quantitative easing programmes.”

More information on what is likely to cause the next banking shock is available from The Financial Times in its coverage of how sovereign debt could be the new subprime.

The Daily Reckoning