Encyclopedia Britannica – Debt Bondage — description ( in slavery (sociology) )
A person became an indentured servant by borrowing money and then voluntarily agreeing to work off the debt during a specified term. In some societies indentured servants probably differed little from debt slaves (i.e., persons who initially were unable to pay off obligations and thus were forced to work them off at an amount per year specified by law) . . .
UK Prime Minister Gordon Brown finally admitted this week that his government will have to cut public spending to reduce the country’s deficit — which just posted a record £10.78bn cash requirement for August. Those spending cuts, combined with tax increases, should help reduce Britain’s funding shortfall by half over the next four years, according to the PM.
But there is another way to help finance the deficit — massive government bond issuance.
In fact, the outstanding stock of gilts is already set to increase from £642bn at the start of the year to £997bn at the end of the next — a 55 per cent jump, according to RBC Capital Markets.
So who will be buying all those gilts?
You — assuming you’re British — probably will. And Britain’s banks, of course.
As RBC analyst Richard McGuire explains:
The key uncertainty, though, is who will take down this [gilt] supply even assuming the official “optimistic” issuance projections are correct. If recent history is a guide then one might look to overseas investors, after all these investors took a little over half of the increase in outstanding debt stock witnessed since the beginning of this decade. This, in turn, sees them as the most important investor in terms of holdings – accounting for a little over 36% of total as of Q1/09, more than double the proportion seen in 2000. Global FX reserves more than doubled during this same period, however (rising to a peak of US$4.4trn as of Q3/08 from US$1.4trn at the beginning of the decade). With these reserves falling a little under 5% in the six months to end-Q1/09 and collapsing trade volumes pointing to further marked declines ahead (the IMF expecting world trade to contract by 12.2% this year), it seems doubtful, to say the least, that the official overseas investment community will prove similarly supportive going forward.
Looking to the domestic front, the pensions and insurance sector looks, at first glance, a potential candidate holding as it does, a shade under 36% of total gilts outstanding. The “marginal” importance of this sector as a consumer is, however, limited – holdings of gilts by these investors were broadly steady around the £230bn mark in recent years [see chart at left] which, given the rise in issuance, helps explain why their overall share of ownership has halved since the late 1990s.
Conversely, households are largely insignificant in terms of holdings (a little over 1.0% of total) but are much more promising in terms of marginal importance. Assuming the household savings rate rises 9ppt from trough to peak over a little under four years (i.e. exactly replicating the move seen in the wake of the housing crash of the early 90s), and, optimistically, holding disposable income constant, this sector is set to accrue £72bn worth of savings by the end of 2010. Some of this amount will be used to fund the purchase of Gilts directly or otherwise.
Most promising, however, is the imminent unveiling of the FSA’s capital buffer regulations. These potentially see banking sector demand for bonds rise by between £84bn and £324bn (this based on the FSA’s estimate that banks will increase their holdings of bonds from 4.6% to between 6% and 10% and employing end-December 2007 total sector assets of £6trn). Aside from the wide ranging nature of this estimate, there is added uncertainty in the fact that gilts are not the only eligible bonds (bonds from a number of jurisdictions including the EEA and Canada are also permissible). More importantly, though, is the fact that BoE reserves may also count toward a bank’s liquidity buffer.
Related links:
A bit of a floppy gilt auction – FT Alphaville
UnQEasy drama – FT Alphaville
The FSA and bondage – FT Alphaville