Government Bond Markets: Unfeeling Psychopaths or Rational Keynesians?

We're blaming the fire alarm for the fire.

With the latest round of “markets can’t handle democracy” after a minor selloff in BTPs (Italian government bonds) following their election, the idea that “government finance is too important to be left to the markets” is emerging from the swamp of Guardian comment threads, and shambling back into the mainstream. With all but a few Austrian dead-enders acknowledging that austerity has been disastrous for growth, the accusation of market culpability is a serious one.

The case for the prosecution is that government bond markets irrationally panicked at modest debt increases following the 2008 financial crisis, demanding appeasement in the form of “austerity”, ideally targeted at the poor and vulnerable. (One may need to sprinkle the preceding sentence with the word “neoliberal” to get the full flavour). This case was made most recently in a paper by Paul DeGrauwe of VoxEu, and is noticeable for attracting sympathetic comments from normally sensible people.

Professor DeGrauwe argues convincingly that the countries which instigated the largest austerity programmes suffered the worst damage from markets in terms of both quantity and price of fresh borrowing (his Figure 1 below). He goes on to note that none of the austerity measures introduced pacified markets.

He draws the slightly eccentric conclusion from this that markets love and demand austerity. Possibly for reasons of space he omits that the two biggest rallies in EU peripheral sovereign debt before the ECB’s Outright Monetary Transactions (OMT) were driven by monetary actions—the injection of ECB liquidity into the market via SMP and later LTRO. But he does note that the prospect of unlimited monetary intervention by the ECB in the form of OMT is what appears to have convinced markets that investing in the periphery is safe.

So there you have it: fiscal measures did nothing to convince markets to buy peripheral debt; monetary measures were repeatedly successful.

Yet the conclusion drawn is that:

Austerity dynamics were forced by fear and panic that erupted in the financial markets and then gripped policymakers.

What worked: hint - not austerity

What worked: hint – not austerity.

Panic is a funny word. Jumping out of a moving bus can look like panic. However, if the driver—let’s call him Jean-Claude—is absolutely adamant that he wants to drive said bus off a cliff (think of M. Trichet’s threats to pull the repo-able status of Greek debt and later refusal to allow the ECB to get involved in a rescue), and the conductor (Wolfgang) is similarly vehement about fiscal assistance—jumping out starts to look quite rational. The ECB (especially) and the core countries spent most of 2010–mid-2012 declaring an absolute refusal to assist the peripheral nations. As a result, Europe’s money supply began to resemble a badly-sloping field, where all the liquidity is drained from one end (the periphery) and swamps the core.

Where’d all the money go?

The huge underperformance of peripheral growth owes at least as much to monetary as to fiscal factors. Hence, despite the UK’s utterly dire fiscal performance—and misguided austerity, my homeland never suffered remotely the sort of spread explosion that Euroland saw. Similarly, Denmark—even whilst retaining a peg to the Euro—didn’t suffer contagion. The “panic” Professor DeGrauwe refers to looks a lot more like a rational response to a thoroughly dysfunctional system. The end of this panic coincided nicely with the introduction of monetary measure—the OMT—with the potential to provide Italy with the sort of central bank support that the UK has enjoyed.

From Wikipedia. Look, I’m busy.

In this case, blaming the markets is actually blaming the alarm for the fire, and measures to control spread volatility like measures to prevent fire casualties by removing the alarms. Professor Paul Krugman has been vocal about the indisputable absence of “bond vigilantes” from markets spared the various monetary perversions that Euroland is subject to. The fit between spreads and recession looks a whole lot worse once you include countries which aren’t in the Euro. Looking at the above chart, lifted off Wikipedia, UK fundamentals nestle in the middle of a group of countries which were in deep trouble, whereas Japan has so much debt it’s literally off the scale of the chart (at 230 per cent of GDP). But neither has seen any significant rise at all it its credit spreads. I suggest therefore that Eurowonks stop throwing stones in glass houses.

This piece was originally posted on Some Of It Was True…, and is reposted with permission.

Xavier Rolet, the Chief Executive of the London Stock Exchange, poses for photographs in front of giant letter blocks spelling the word 'Bonds'. Photograph: Getty Images

Pawe? Morski is a fund manager who blogs at Some of it was true…

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Keir Starmer MP: Choosing ideological purity before power is a dereliction of duty

The former director of public prosecutions believes getting involved with Brexit negotiations is crucial. 

 

Three weeks after Brexit, Keir Starmer held a public meeting in his London constituency of Holborn and St Pancras. “We had hundreds turning up,” he remembered. “The town hall was absolutely packed - it was standing room only and we had to turn people away. We haven’t had a public meeting of that size for some time.”

When it comes to Brexit, Starmer is an obvious Labour asset. Director of public prosecutions from 2008 to 2013, he has the legal background to properly scrutinise an EU deal. His time spent as a shadow immigration minister means he understands some of the thorniest problems facing negotiators.

But instead, the MP finds himself on the shadow back benches.

“My decision to resign was driven by Jeremy’s decision on the referendum,” he told The Staggers. “I was particularly troubled by his suggestion that we should invoke Article 50 straight away, and start the exit process [Corbyn has since backtracked on this suggestion]. 

“That is not for me a question of left-right politics. When he said that, I felt he was in fundamentally a different place from me in terms of how we fight for the future of our country.”

Starmer is not a man to enjoy life in opposition, and he has little time for airy promises. “Jeremy talks of dealing with inequality and housing projects, and a fairer society - all of which I would agree,” he said. “What I haven’t seen is the emergence of detailed policy that would get us to these places.”

He also gives purists in the party short shrift. “I would reject wholeheartedly any notion of a Labour Party that is not committed to returning to power at the first opportunity,” he said. “Of course that needs to be principled power. But standing on the sidelines looking for the purest ideology is a dereliction of the duty for any Labour member.”

Starmer believes Labour should be joining Scottish and Northern Irish leaders in trying to influence Brexit negotiations. He sees the time before invoking Article 50, the EU exit button, as crucial. 

Nevertheless, the man named after the Scottish founder of Labour, Keir Hardie, is pessimistic about the future of the UK. 

“It is going to be increasingly difficult to resist a further referendum in Scotland,” he said. “It will be increasingly difficult to keep Scotland as a part of the UK. I hope that doesn’t happen, but everyone knows David Cameron has put that at risk.”

Starmer may be a London MP, but he follows events in the rest of the country closely. While still in his shadow cabinet post, he embarked on a countrywide tour to learn more about attitudes to immigration.  

He condemns the increase in racist attacks post-Brexit as “despicable”, but insists there is “a world of difference” between these and genuine concerns about resources. “If you lose your job because there has been an influx of labour from another country, that is a legitimate cause for concern.”

He is equally scathing about the Government’s net migration cap. “If immigration is simply seen as a numbers game, nobody will ever win that debate,” he said. “The question should be: what is it we want to achieve?

“What do we expect of those who are arriving? What is the basic deal?”

In January, Starmer visited the informal camps in Calais and Dunkirk. “What I saw in Calais was appalling,” he said. “It is an hour from London. 

“To see families and children in freezing, squalid conditions without any real hope of a positive outcome was enough to make anybody think: ‘This is not the way to solve the refugee crisis.’”

The new PM, Theresa May, built her reputation on a rigid asylum policy, but Starmer believes a strong opposition can still force change. “If you take the Syrian resettlement scheme, that started life as a scheme for victims of sexual violence,” he said. “When pushed, it became a scheme for 20,000 Syrians but not if they reached Europe. When pushed, the Government accepted the case for some unaccompanied children in Europe to come to this country. 

“Labour needs to keep pushing.”

For now, though, Labour is divided. Starmer has been tipped as a future leader before, in 2015, but declined to run because of a lack of political experience. One year and a Brexit on, he certainly has some of that under his belt. But he rules himself out of the current leadership challenge: “I am 100 per cent behind Owen.” What will he do if Jeremy Corbyn wins? “Let’s cross each bridge when we come to it.”

Starmer is clear, though, that Labour can only win an election if it comes up with a more ambitious project, an economy with purpose. And the Brexit negotiations provide an opportunity. “We have to ask ourselves,” he said. “Do we simply want a series of trade agreements, the more the merrier? Or do we want deals that achieve certain ends? It is a moment to recast the future.”