And Daniel had a great slide showing how much greater the market value of UK government debt is than its nominal value. The excess is about £500 billion right now – all of which has, by definition, to unwind before these debts are repaid.
Now someone who knew about financial markets would mention this to disabuse people of the notion. Market value is above nominal? Sure it is. 15 years ago we were issuing debt for 30 years at what, 5% interest rates? 10 years ago we collapsed interest rates to, effectively, 0 %. Those old bonds are therefore worth more than new ones being issued at 0%.
Their nominal value is above par, which is what is being said.
But does this have to be unwound? No, because bonds are valued on yield to maturity. I don’t think we’ve any permanent bonds left do we, didn’t they pay off all the Consols? Meaning that everyone knows that those 5% bonds are only going to pay that much until they mature, in 15 years. Then they will be replaced with new bonds – rolled over, not actually paid off that is – at whatever the interest rate is then, perhaps 0%.
Note that such bonds collapse back to par value as they mature whatever happens to the general interest rate environment around them.
OK, that’s the background, here’s the Sage of Ely:
September 15 2017 at 10:44 am
“how much greater the market value of UK government debt is than its nominal value. The excess is about £500 billion right now – all of which has, by definition, to unwind before these debts are repaid.”
Forgive the stupid question, but what’s the significance of the gap opening up between nominal and market value?
Richard Murphy says:
September 15 2017 at 10:48 am
The significance is that in pensions funds, insurance companies and banks there is a massive pile of assets valued at vastly more than they can ever actually be worth because they only ever eventually pay back their nominal value
Sigh. The value comes in two parts, doesn’t it? They get 5% interest on the par value for 15 years, not 0% interest. Both get paid back at par then. 5% interest for 15 years is worth more than 0% interest. They have a higher value because they’ll get paid more.
To make it even clearer. Liquidity issues aside – an old bond with a coupon of 5% and par of £100 with 5 years to maturity is worth more than a new 5 year bond of £100 par and 0% interest. It’s worth more by the net present value of those future income streams, £5 a year and £100 in 5 years. The new bond, of the same maturity note, pays only the £100 back. Ignoring time value therefore the old bond has a capital value £25 higher than the new one. A value that is going to disappear as the old bond moves to par value as maturity gets closer.
We would expect our old bond to be trading at £125, well above par therefore. The Sage is saying that £25 will never be paid to the holder. I insist that it’s worth more because the £25 will be paid to the holder.
Now think on this. One of the two of us is nominally a professor of some form of economics at a UK university. And it’s not me, me with the right answer now, is it?
And he’s really, really, not getting it, is he?
Paul Smith says:
September 15 2017 at 12:03 pm
I agree with your general hypothesis that there’s going to be a crash soon (after all it’s 10 years since the last one so it’s time for it), and it may be fairly devastating, mainly because the economy is in a much worse state than it was last time, and, of course, the impact of Brexit.
However I don’t follow your argument re the gap between the market and nominal values of government debt. This arises because we have much lower interest rates now than we did at the time most of this debt was issued. So the gap represents the capital losses that have already been incurred by the holders of the bonds, not as something that has to be repaid in the future. What it does mean is that the government now has relatively expensive debts on which it is paying interest above the current rates.
Richard Murphy says:
September 15 2017 at 12:32 pm
I am baffled
How have you made a capital loss when the asset has risen in price, because that is what has happened?
And no, the government does not have expensive debt: it has incredibly cheap debt because it only has to repay the nominal sum meaning that future capital losses are guaranteed to those buying at current prices or valuing them at these marked up rates
He’s entirely ignoring the value of the interest stream on a bond. Amazing.