“I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”
– James Carville, US political strategist and director of Bill Clinton’s successful 1992 campaign for US president
It may seem a distant memory given all the political drama of late but less than two years ago UK Prime Minister Liz Truss was shown the door by her colleagues who, to borrow from Mr Carville, quoted above, had been intimidated by the bond market.
She and her chancellor, Kwasi Kwarteng, had proposed what amounted to a large, unfunded tax cut in their 2022 “mini-budget”. The UK government bond market immediately sold off, and sharply.
It was a shot across the bow. UK government finances had been deteriorating for some time and the Covid lockdowns had made a bad situation worse. Inflation and interest rates were both rising.
The Bank of England stood by at first but, once it was clear the government had got the message, it stepped in to stabilise the situation with sizeable, supposedly temporary bond purchases. (Which tells you something about who is really in charge.)
Last week, Bloomberg reported another shot across another bow. This time, it was the Saudi government that fired the shot. The bow it crossed over was that of the euro-area, or France specifically.
What, exactly, happened? And why?
According to Bloomberg, the Saudis hinted earlier this year to European G7 member countries that their proposed plan to confiscate Russian assets abroad – much of which is European government debt – would result in them selling their holdings of European debt, in particular that of France.
In a way, this makes sense. If Europe sets such a precedent with Russia, then at some unknown point in future, due to some potential point of dispute, Europe might seek to confiscate Saudi holdings of European debt too.
We have thus seen two instances recently of the bond market being the lever for influencing government policies, in the UK and in France. The Bank of England has asserted its power in the UK and the Saudis have threatened to arm the European bond market vigilantes.
This is however not the first time the Saudis have brandished the bond market weapon to influence government policy. As reported by the New York Times, in April 2016 they threatened US President Barack Obama that, if a US court found them responsible for the September 11, 2001 attacks, they would liquidate their entire $750 billion holdings of US government debt.
Such a huge sale would have caused an immediate US financial crisis and possibly a run on the dollar.
As it happened, the Saudis eventually reduced their holdings of US debt by some 50%, but they did so over a period of time, so as not to trigger a sudden financial crisis.
Heavily indebted countries have little room for manoeuvre. Above are several real-world examples. Those of us who live in heavily indebted democracies like to believe that “the people” remain in charge. But are they – we – really?
These events also serve as a timely reminder that government debt is hardly risk free. Governments might not necessarily default on it, as their central banks can come to the rescue and buy it up with freshly printed money.
But that merely substitutes devaluation for default risk. Either way, those investors holding the paper lose real purchasing power.
While it is unclear where and to what extent global powers, public or private, are prepared to weaponise bond or currency markets to get what they want, the threat is very real. And so is the risk to investors.
There is, however, one tried and tested hedge against such risks: gold. As a non-financial, non-nation-specific asset not requiring any particular legal system to give it value, gold is the timeless hedge against both bad government policies and the weaponisation of bond and currency markets.
If you’d like to hear some fresh thoughts on gold and other precious metals, I suggest you watch the discussion I recently had with Adrian Ash.
The research director for UK precious metals platform BullionVault, Adrian has much to say about the unique role gold has played in history and continues to do today. He also offers a few thoughts on silver and platinum group metals.
Click on the image below to watch the video.
John Butler
Investment Director, Fortune & Freedom
PS If you haven’t seen it yet, I recommend you see this. My colleague Nick has been signalling his own warning about where the true power lies in the government of the UK – and importantly, the risks it poses to you, as an investor. That’s why he’s put together some simple steps to help protect your wealth, as well as potentially profit. All the details are here.
Southbank Investment Research receives referral commission from BullionVault.
