Tuesday 26 September 2017

So tell me again... why do bonds matter?

Q: I know nothing about bonds. Tell me again why they matter?

Almost all countries are borrowing at the moment -- even countries doing well.

These countries use bonds to raise funds to pay for schools and hospitals.

Bonds also tell us about a government's financial health in the same way that your pulse tells you quite a bit about your health.

Countries have to pay high rates of interest if the money men in places such as London and New York don't trust those countries.

Q: So that's what happened to us?

Basically, people stopped believing that the Government had the ability to repay the money it was borrowing so dealers stopped lending.

With a large country like the US, this is almost impossible; some people will always want to have investments in the world's largest economy. It's different for us. Small countries such as Ireland compete with other small countries for attention and funds. Investors like to spread their money and have some investments in smaller economies but not too much.

Q: What happened in the US to drive the financial world so crazy?

There are three big companies called rating agencies which try to determine how safe investments are.

One of those agencies said on Friday that the US was no longer as safe as it had been because political leaders were not able to reach solutions.

Many pension funds and other organisations which like to buy bonds have rules that only allow them to buy the safest bonds. If one or two more rating agencies did the same thing, trillions of dollars would have to leave US bonds and find a new home.

Q: How did the US government react to being told they are less creditworthy than Britain, France or Germany?

They didn't like it and reacted the way Brian Cowen had reacted here by claiming that the rating agencies didn't understand what was going on.

Q: Is that why gold hit yet another record of $1,700 (e1,187) an ounce yesterday?

Yes it is. Governments can print money or decide not to repay their bonds but they certainly can't make gold.

Very unlikely. Nobody would take money out of a very safe country and then put it into Irish bonds when most analysts think we have very little chance of repaying the money.

America is almost our second largest trading partner. If the US gets in trouble, we will feel it very quickly.

Q: What about Italy and Spain? They are having problems as well?

Indeed they are, much more serious problems than the US. It now costs Italy and Spain about twice as much to borrow as America.

The cost of borrowing fell yesterday because Europe's central bankers are now buying Italian and Spanish bonds. This means speculators are now pitted against the European Central Bank. Nobody felt like doing that yesterday but they probably will.

The ECB will have to spend about €320bn of Italian and Spanish government bonds to repeat what they did for Ireland, Greece and Portugal.

Q: So what's the solution? I keep hearing about euro bonds. What are they?

Euro bonds will be a mechanism to allow countries to borrow with a German guarantee.

Nobody wants it and it will change our political system beyond recognition but it will probably have to be done.

Irish Independent

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