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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The Tories are the zombie party: with an ageing, falling membership, still they stagger on to victory

One Labour MP in Brighton spotted a baby in a red Babygro and said to me: “There’s our next [Labour] prime minister.”

All football clubs have “ultras” – and, increasingly, political parties do, too: although, in the case of political parties, their loudest and angriest supporters are mostly found on the internet. The SNP got there first: in the early days of email, journalists at the Scotsman used to receive bilious missives complaining about its coverage – or, on occasion, lack of coverage – of what the Scottish National Party was up to. The rest soon followed, with Ukip, the Labour Party and even the crushed Liberal Democrats now boasting a furious electronic horde.

The exception is the Conservative Party. Britain’s table-topping team might have its first majority in 18 years and is widely expected in Westminster to remain in power for another decade. But it doesn’t have any fans. The party’s conference in Manchester, like Labour’s in Brighton, will be full to bursting. But where the Labour shindig is chock-full of members, trade unionists and hangers-on from the charitable sector, the Conservative gathering is a more corporate affair: at the fringes I attended last year, lobbyists outnumbered members by four to one. At one, the journalist Peter Oborne demanded to know how many people in the room were party members. It was standing room only – but just four people put their hands up.

During Grant Shapps’s stint at Conservative headquarters, serious attempts were made to revive membership. Shapps, a figure who is underrated because of his online blunders, and his co-chair Andrew Feldman were able to reverse some of the decline, but they were running just to stand still. Some of the biggest increases in membership came in urban centres where the Tories are not in contention to win a seat.

All this made the 2015 election win the triumph of a husk. A party with a membership in long-term and perhaps irreversible decline, which in many seats had no activists at all, delivered crushing defeats to its opponents across England and Wales.

Like José Mourinho’s sides, which, he once boasted, won “without the ball”, the Conservatives won without members. In Cumbria the party had no ground campaign and two paper candidates. But letters written by the Defence Secretary, Michael Fallon, were posted to every household where someone was employed making Trident submarines, warning that their jobs would be under threat under a Labour government. This helped the Tories come close to taking out both Labour MPs, John Woodcock in Barrow and Furness and Jamie Reed in Copeland. It was no small feat: Labour has held Barrow since 1992 and has won Copeland at every election it has fought.

The Tories have become the zombies of British politics: still moving though dead from the neck down. And not only moving, but thriving. One Labour MP in Brighton spotted a baby in a red Babygro and said to me: “There’s our next [Labour] prime minister.” His Conservative counterparts also believe that their rivals are out of power for at least a decade.

Yet there are more threats to the zombie Tories than commonly believed. The European referendum will cause endless trouble for their whips over the coming years. And for all there’s a spring in the Conservative step at the moment, the party has a majority of only 12 in the Commons. Parliamentary defeats could easily become commonplace. But now that Labour has elected Jeremy Corbyn – either a more consensual or a more chaotic leader than his predecessors, depending on your perspective – division within parties will become a feature, rather than a quirk, at Westminster. There will be “splits” aplenty on both sides of the House.

The bigger threat to Tory hegemony is the spending cuts to come, and the still vulnerable state of the British economy. In the last parliament, George Osborne’s cuts fell predominantly on the poorest and those working in the public sector. They were accompanied by an extravagant outlay to affluent retirees. As my colleague Helen Lewis wrote last week, over the next five years, cuts will fall on the sharp-elbowed middle classes, not just the vulnerable. Reductions in tax credits, so popular among voters in the abstract, may prove just as toxic as the poll tax and the abolition of the 10p bottom income-tax rate – both of which were popular until they were actually implemented.

Added to that, the British economy has what the economist Stephen King calls “the Titanic problem”: a surplus of icebergs, a deficit of lifeboats. Many of the levers used by Gordon Brown and Mervyn King in the last recession are not available to David Cameron and the chief of the Bank of England, Mark Carney: debt-funded fiscal stimulus is off the table because the public finances are already in the red. Interest rates are already at rock bottom.

Yet against that grim backdrop, the Conservatives retain the two trump cards that allowed them to win in May: questions about Labour’s economic competence, and the personal allure of David Cameron. The public is still convinced that the cuts are the result of “the mess” left by Labour, however unfair that charge may be. If a second crisis strikes, it could still be the Tories who feel the benefit, if they can convince voters that the poor state of the finances is still the result of New Labour excess rather than Cameroon failure.

As for Cameron, in 2015 it was his lead over Ed Miliband as Britons’ preferred prime minister that helped the Conservatives over the line. This time, it is his withdrawal from politics which could hand the Tories a victory even if the economy tanks or cuts become widely unpopular. He could absorb the hatred for the failures and the U-turns, and then hand over to a fresher face. Nicky Morgan or a Sajid Javid, say, could yet repeat John Major’s trick in 1992, breathing life into a seemingly doomed Conservative project. For Labour, the Tory zombie remains frustratingly lively. 

Stephen Bush is editor of the Staggers, the New Statesman’s political blog.

This article first appeared in the 01 October 2015 issue of the New Statesman, The Tory tide