Cambridge University Bond Issues Highlights Madness of Moody’s Sovereign Ratings Methods

The University of Cambridge in the UK is going to be tapping the bond market for the first time after receiving an Aaa-stable bond rating from Moody’s that’s actually lower than the Aaa with negative outlook rating that Moody’s gives the UK’s sovereign debt.

This helps highlight two related issues, the insanity of UK fiscal policy right now and the insantiy of the ratings agencies’ approach to sovereign debt ratings. When the UK government borrows money, it borrows pounds sterling. The UK government also has the capacity to create infinite quantities of pounds sterling instantaneously. Therefore, the UK government can never be forced by economic circumstances into defaulting on its debt obligations. At worst it could be forced into inflationary policies that erode the value of its pound-denominated debt. If you’re an investor, that’s a real thing to worry about when buying British debt. But any such inflation would equally impact any pound-denominated debt no matter what the circumstances of the issuer. University of Cambridge debt can’t be safer than UK sovereign debt in inflation terms.

Now what’s true is that the UK government could nonetheless choose to default, as the Russian government did in 1998. But guess what happens when a sovereign defaults on its debt? The value of the currency collapses. As it happens I was in Russia when this happened so I remember it quite vividly. All dbet agreements go to seed in the case of a sovereign default, which turns out to be one of the best reasons to avoid one. If you hold pound-denominated Cambridge bonds at a time the UK sovereign chooses to default you’re much more screwed than you would be if the UK just adopted mildly inflationary policies for a decade.

Conversely, the existence of seemingly robust demand for University of Cambridge debt underscores the fact that the Cameron/Clegg government is undersupplying the world with British sovereign debt. On some level they seem to be doing this because of the Conservative Party’s ideological commitment to rolling back increases in public spending enacted by the Blair and Brown governments. But rather than moderating this passion for austerity as a condition for cooperating in the Tory-led coalition, the Liberal Democrats’ contribution has been to insist on pairing these cuts with higher taxes so as to make them more destructive (shades of Obama). A properly right-wing government in the UK might at least combine these spending cuts with gigantic debt expanding tax cuts, which wouldn’t be my favorite idea but would be a good deal better than the current situation.