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…

Photo: Getty Images
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Stella Creasy targeted for deselection

Organisers on the left believe the Walthamstow MP is the ideal target for political, personal and geographical reasons.

Stella Creasy, the high-profile MP for Walthamstow and defeated deputy Labour leadership candidate, is the first serious target of an attempt to deselect a sitting Labour MP, the New Statesman has learnt.

Creasy, who is on the right of the party, is believed to be particularly vulnerable to an attempt to replace her with an MP closer to the Labour party’s left. Her constituency, and the surrounding borough of Waltham Forest, as well as the neighbouring borough of Leyton and Wanstead, has a large number both of new members, inspired either to join or return to Labour by Jeremy Corbyn, plus a strong existing network of leftwing groupings and minor parties.

An anti-bombing demonstration outside of Creasy’s constituency offices in Walthamstow – the MP is one of around 80 members of Parliament who have yet to decide how to vote on today’s motion on airstrikes in Syria – is the latest in a series of clashes between supporters of Creasy and a series of organized leftwing campaigns.

Allies of Creasy were perturbed when Momentum, the grassroots body that represents the continuation of Corbyn’s leadership campaign, held a rally in her constituency the night of the Autumn Statement, without inviting the MP. They point out that Momentum is supposedly an outward-facing campaign supporting Jeremy Corbyn and the Labour party towards the 2020 general election and the forthcoming local and European elections. Labour holds 27 out of 27 council seats in Creasy’s constituency, while Creasy herself has a majority of 23,195 votes.

“If you look at the seat, there is nothing to win here,” said one Labour member, who believes that Momentum and other groups are planning to depose Creasy. Momentum has denied any plot to remove Creasy as the MP.

However, Creasy has come under pressure from within her local party in recent weeks over the coming vote on bombing Syria. Asim Mahmood, a Labour councilor in Creasy’s constituency, has called for any MP who votes for bombing to face a trigger ballot and reselection. Creasy hit back at Mahmood on Facebook, saying that while she remained uncertain of how to vote: “the one thing I will not do is be bullied by a sitting Walthamstow Labour councilor with the threat of deselection if I don’t do what he wants”.

Local members believe that Mahmood may be acting as the stalking horse for his sister, the current mayor of Waltham Forest, Saima Mahmud, who may be a candidate in the event of a trigger ballot against Creasy. Another possible candidate in a selection battle is Steven Saxby, a local vicar. Unite, the recognized trade union of the Anglican Communion, is a power player in internal Labour politics.

Although Creasy has kept her own counsel about the direction of the party under Corbyn, she is believed to be more vulnerable to deselection than some of the leader’s vocal critics, as her personal style has led to her being isolated in her constituency party. Creasy is believed to be no longer on speaking terms with Chris Robbins, the leader of the council, also from the right of the party.

Others fear that the moves are an attempt by Creasy’s local opponents to prepare the ground for a challenge to Creasy should the seat be redrawn following boundary changes. The mood in the local party is increasingly febrile.  The chair of the parliamentary Labour party, John Cryer, whose Leyton and Wanstead seat is next to Creasy’s constituency, is said to fear that a fundraiser featuring the shadow foreign secretary, Hilary Benn, will take an acrimonious turn. Cryer was one of just four shadow cabinet ministers to speak against airstrikes in Syria.

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