The eurozone debt crisis has pushed yields for sovereign debt of some of the currency union’s weaker members to unsustainable levels, forcing the ECB to intervene repeatedly in order to regain control of interest rates and fight speculation of a currency breakup.
ECB policy makers have finally agreed to an unlimited bond purchase programme of one to three-year debt in secondary markets which has immediately reduced interest rates for government paper of the tarnished eurozone members.
During the same period, Germany, being the economic powerhouse of Europe, has benefitted from its status as a safe haven, and was able to increase its own sovereign debt almost for free.
After the ECB’s decision to launch the unlimited Outright Monetary Transactions programme, Germany was able to sell €3.4bn of short-term paper at an average yield of -0.0147%. In other words, the German Government doesn’t need to pay interest to its investors and is even getting compensated for being in debt.
While this may be a convenient situation for the German Government when it needs to refinance its still rising public debt, it is far less comfortable for investors in bunds, despite the fact that Germany is assumed to be the ultimate safe haven in the eurozone. Investors are therefore well advised to consider a number of issues.
Hidden wealth destruction
It is hard to see how a lack of compensation for lending money to someone, especially if the borrower has already accumulated a substantial amount of debt, can be an efficient allocation of capital from an economic point of view, especially not on a risk-adjusted base. History gives us plenty of evidence that sovereign debt is not a risk-free investment.
Failing to be compensated in nominal terms means losing money in real terms. This loss of purchasing power is a form of hidden wealth destruction which helps borrowers reduce their debt burden at investors’ expense.
And, if we take into consideration the massive efforts to reflate the eurozone and devalue the euro, the outlook for real returns from investments in German bunds is even less appealing.
Finally, investors should realise that Germany is poised to become the only lender of last resort for the eurozone including the European Financial Stability Facility (EFSF), the European Stability Mechanism (ESM) and any other bailout fund, as well as for the mutualisation of liabilities from the prospective banking and a fiscal union.
All of this will have unforeseeable consequences for Germany’s public finances.
As a result, bond investors turning to Germany as a safe haven not only lose purchasing power with their investments, but also bear the full downside risk of a worsening credit rating and rising inflation, without any compensation.
If someone has to pay to turn around the eurozone in its current crisis, Germany is the only credible candidate left; therefore, flocking to bunds doesn’t look like a particularly smart move. For long-term investors there are more attractive investment opportunities by far at hand.
