When I read the following story in the FT, I immediately thought of UK gilts. Darling plans to run up the biggest deficit in a generation. Including existing debt that is about to mature, the government needs to borrow around £150 billion every year until 2011.
Investors shunned one of the most liquid and safest assets in the world on Wednesday as a German bond auction failed in a warning for governments seeking to raise record amounts of debt to stimulate their slowing economies.
It is the first eurozone bond auction of the year and an ominous sign of potential trouble ahead for governments around the world, with an estimated $3,000bn expected to be issued in sovereign debt this year – three times more than in 2008.
The auction of 10-year bonds failed to attract enough bids to reach the €6bn the government wanted to raise. Although a number of German bond auctions failed last year, it was almost unheard of before the credit crisis.
Meyrick Chapman, a fixed-income strategist at UBS, said: “When a German bond auction fails, then that does suggest there is trouble ahead for governments wanting to raise money in the debt markets.
If the Germans can't sell their debt, what hope is there for the UK government?
If Darling can't shift the paper, he has only two options. Either he raises government bond yields or he goes to the Bank of England and asks Mr. King to buy the bonds in return for newly printed pounds.
With the first option, interest rates throughout the economy willl creep up. Rather than sustain economic growth, Darling will prolong a recession as the fiscal deficit crowds out private investment.
With the second option, he risks a sudden pick up of inflation. Darling's deficit plans accounts for the recent crash in sterling. Foreigners are anticipating a surge in money creation. Therefore, they are wisely dumping sterling before it becomes worthless due to an unprecedented surge in inflation.
The sensible thing would be to pare back the fiscal deficit drastically. This would reduce long term interest rates, create some space for private investment and prevent the UK from becoming a quasi-socialist basket case.
Today's news from Germany is a very helpful and timely warning. Lets hope those jokers in the Treasury can send a short memo to Darling telling him where he is leading the UK economy.