Gold, Recession and Why Britain’s Winning the Currency War

 A Greek-style debt crisis?

Five years ago, Greek government bonds were treated as risk free assets. In May 2007, Greek 10-Year bonds yielded around 4.5%. German 10-Year bonds meantime were trading at yields of around 4.3% that same month.

Granted, this is a snapshot of one brief period, but it illustrates a point: Greek bond yields were not pricing in any of what was about to happen.

That changed, and it changed very quickly. This is what tends to happen in a debt crisis – there is a sudden reappraisal of a borrower’s creditworthiness. The amount lenders are willing to lend goes down, while the rates a borrower needs to pay goes up. Suddenly, it becomes harder to roll over debt, and harder to borrower on sustainable terms.

The factors that can prompt this “sudden reappraisal” include:

• A growth shock, since it makes debt repayment and servicing harder;
• A sudden rise in levels of debt, since it too makes repayment harder and default more likely;
• A general rise in investor risk aversion, since they are likely to favor safer assets and prioritize getting their capital back over how much it might grow.

Greece, as is often the case, was hit by all three at once.

Britain, with a much longer debt maturity profile than Greece, remains a long way from that scenario. Or so we would like to think. In truth, though, sluggish growth and rising sovereign debt levels are moving us closer than we would like.

So far, though, UK gilts have continued to be regarded more-or-less as a safe haven, with yields hitting record lows this year (we will leave for another day the reasons why this might be, and how justified and sustainable is this phenomenon).

Britain has a key advantage over the likes of Greece (and Ireland… Portugal… Italy…Spain… The Netherlands… France… etc.). An ace up the sleeve: monetary sovereignty.

But is this a game where aces are high or low? That depends on whether we end up with the second nightmare scenario.