Today the credit rating agency Standard & Poor’s cut the UK’s top credit rating by 2 notches from AAA to AA. (One notch would have been AA+).
They are thus implying that the government of the UK will be less likely to be able to make payments on its long term government bonds as a result of leaving the European Union.
We can also observe that currency traders have been selling off the UK Pound against other currencies, sending it to new record lows:
If you’ve read my post about Modern Monetary Theory you may have learned that it is impossible for a sovereign government that issues its own freely floating currency to be forced to default on its debts:
In a free floating irredeemable fiat currency system the government cannot be forced to default on its debts (it could of course choose to suspend interest and/or principal payments, but that would be a policy choice, not one of financial necessity)
The only way a government that issues its own currency could miss payments would be if it were to voluntarily choose to suspend such payments.
As long as a country is a EU member there is actually an increased likelihood of such an outcome, since it may be subject to treaties restricting its ability to incur budget deficits.
The UK was never member of the Eurozone, so in that sense it was never explicitly subjected to such restrictions, however we never know what future treaties may hold in store.
From that perspective, if anything, leaving the EU would have given the UK government more financial independence than it had been enjoying anyway.
So one could reasonably expect the opposite of S&P’s outlook to be true.
Let’s see if the bond market agrees with my assessment, here’s a chart for late June 2016:
You can see here that right after Brexit the yield on 30 year UK government bonds dropped from around 2.2% to around 1.8% at the moment. That’s an 18% relative decline in just over a few days.
Let’s put this into long term perspective:
We observe that in response to Brexit the UK’s long term government bond yield has not only dropped noticeably, but has even hit new record lows.
For the time being the bond market is shrugging off the credit rating downgrade and the general notion of supposed problems with the UK’s ability to pay principal and interest on its long term government debt.
In my personal opinion the UK Pound’s recent plunge is not fundamentally justified long term, and it may well come back stronger than it ever was while the UK was still a EU member. The bond market’s behavior right now could be evidence for long term faith in the government’s ability to pay, but could also be purely due to safe haven buying as an alternative to crashing stocks. Ultimately time will tell.
This post was written by Nima Mahdjour.
The views expressed here belong to the author and do not necessarily reflect our views and opinions.
Latest posts by Nima Mahdjour (see all)
- What I Saw at the Anti-Milo, UC Berkeley Riots! - February 5, 2017
- Trump’s #MuslimBan Doesn’t Target Muslims And Isn’t A Ban - January 31, 2017
- Official US Intel Report Confirms: No Russian Hacking - January 7, 2017