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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England is now a more expensive place to study than the US. Why?

Is a university education in this country really worth £44,000, and how does our system compare to higher education funding elsewhere?

England has long sneered at American universities and their exorbitant fees. It cannot do so any longer: England is now a more expensive country to study than the US, and is easily the most expensive of eight Anglophone countries – the four UK nations, Australia, Canada, New Zealand and the US – analysed in a new Sutton Trust report. English students graduating from last year left university with an average of £44,000 in debt £15,000 more than Americans studying at for-profit universities across the pond.

Why do English students have it so much worse than other students in the UK? There are two answers. The first is the government's decision in 2010 to shift much of the cost of university from the general taxpayer to the beneficiaries: the students themselves. The second answer is devolution. The devolved governments in Northern Ireland, Scotland and Wales have made political choices to differentiate themselves from Westminster by prioritising keeping fees down – even when, as in Scotland, the effect is to benefit middle-class students at the expense of disadvantaged ones. Students in Wales who study in England are eligible for generous grants, meaning they pay less than £4,000 a year rather than up to £9,000. Those studying in Northern Ireland have their fees capped at £3,925. 

Even England's £9,000 fees are puny set against those at elite American universities. In 2016/17 annual, tuition fees at Harvard are $59,550 and, when all else is accounted for, Harvard reckon each year costs students $88,600. But such exorbitant numbers are not the real story. About 60% of Harvard students receive the Harvard Scholarship: a microcosm of how US students benefit from a culture of graduates giving endowents to their old universities that is still lacking in England. Scholarships and bursaries at universities in the US are far more generous than in other countries. And those who go to public universities within their own state pay far less: those graduating after four years leave with an average debt of only US$27,100 [£19,100]. This is why the average debt of US graduates is now considerably less than in England. But those who berate that even America now has a more benign system for students than England should not be so hasty. The majority of US loans are not income contingent, meaning that low earners who are already struggling still have to pay.

Governments throughout the world are grappling with how to fund send an increasing proportion of students to university in an era of austerity. In the last two decades at least 14 countries in the OECD, including Australia, Canada, New Zealand and the UK, have implemented major reforms to fees, according to the Sutton Trust. In general these reforms have led to students paying a greater share of the cost of their tuition. 

So in a sense what has happened in England is merely an extreme example of an international trend. And the introduction of tuition fees in 1998, which have been hiked up twice since, has been managed better than most acknowledge: indeed, the proportion of disadvantaged students at university has actually risen by one-fifth since tuition fees rose to £9,000.

But, with the poorest students in England now graduating with £50,000 in debt, more students will be driven to ask whether a university education is really worth it. For a small but significant minority, it isn’t. A recent IFS report found that male graduates from 23 low performing institutions – though it sadly declined to name them - earn less, on average, than those who do not go to university, and end up with huge debt to boot.

No matter how expensive a university education has become, not having one is even more expensive. Throughout the world demand for university education continues to soar; in England the average graduate premium is £200,000 over a lifetime. Yet too many dunce universities are saddling students with debt without giving them anything in return.    

Tim Wigmore is a contributing writer to the New Statesman and the author of Second XI: Cricket In Its Outposts.