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THE WORLD has changed in the past few years in more ways than we might have imagined were possible in such a short period of time.
Few of us would have been as aware as we now are about the price of oil and the consequence of difficulties in the Middle East, or the level of unemployment in the USA, or even that the world’s economies are now so intrinsically interlinked that a failure of a country tens of thousands of miles away from our own could actually have a major impact on the way we live our lives.
The global financial crisis has meant that areas which were previously not discussed by the majority of people because of a lack of necessity, or if I am being less kind, interest, are now being talked about more openly than ever before. On one level, that is a good thing.
I am a great believer in people being able to talk to each other about money, and if there can be one positive that comes out of the global financial crisis, it is that global financial affairs are becoming much less niche and a lot more mainstream as a topic.
You cannot watch a newscast at present without the financial crisis being discussed, and you are now hearing many more people generally talking about what is going on in the financial world than you used to. But you still hear a lot of misinformation, which is as bad if not worse than no information at all. That is where I think there is a downfall, as many people hear the words being used on the news, but far fewer of us understand the potential impact of what is being discussed.
Take, as an example, one of the key economic indicators to dictate whether or not a country – yes, not a company, but a country – will manage to continue making its debt repayments or not. I am talking about ‘bond yields’.
For most of us – unless we were working in financial circles – the words ‘bond yields’ would have rarely come into our vocabulary until a few years ago, but now they appear on almost every newscast you hear.
A bond yield is simply the amount of interest a government – in this instance, but companies can also issue bonds – will pay to an investor who is prepared to buy its bonds. A government issues bonds when it needs to borrow money to invest in infrastructure or services, and it is effectively an ‘IOU’ that will be redeemed at a fixed date in the future, which in the meantime the government will agree to pay you a fixed amount of annual interest on.
As with equities, bonds are subject to prices that reflect supply and demand, and that will also determine the amount of interest the government will have to pay investors to make the bonds appealing enough to buy. So, in short, the less likely it is that the government will be able to give you your money back when the bond matures, the higher the amount of interest it has to pay to encourage investors to ‘buy’ the bonds in the first place. It is a classic risk and reward argument.
When it comes to world governments being able to continue to meet their obligations without the bailouts already received by the likes of Ireland, Portugal and Greece, the amount they have to pay to their bond investors really does matter.
The point at which government funding starts to creak has so far been at around 7 per cent – so when the interest that the government is paying on its bonds reaches this level, serious concerns are raised about whether that country is, in fact, about to go bust. This was the point at which Portugal, Ireland and Greece had to seek outside assistance, and it is seen as something of a watershed.
Worryingly, Spanish bond yields are currently hovering near this precipice, with a peak of 6.83per cent reached in June. Since this is the fourth largest economy in the Eurozone and already owes bondholders more than €730 billion – more than all three of the countries that had received the initial bailouts combined – a failure here would be absolutely catastrophic. Do not think that this would only affect Europe either – global financial affairs are far more complex than that, with a veritable Cat’s Cradle of intertwined investments in Asia that would also be affected.
Spain has already had to ask for help to bailout its banks to the tune of €100 billion, and the fear is that the impact of such a large country’s economy collapsing would be enough to topple other countries that areclosely related, such as Italy, like dominoes. If Spain alone fell, it would potentially bring an end tothe euro, if Italy also fell, the result for world economics is hard to imagine.
So next time you are watching the news and you hear them talking about bond yields, pay attention.Even if you are not investing in them directly, it really does matter a lot more to you than you might think.
First published in Expatriate Lifestyle
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