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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Andy Burnham quits shadow cabinet: "Let's end divisive talk of deselections"

The shadow home secretary reflected on a "profoundly sad" year. 

Andy Burnham will leave the shadow cabinet in the reshuffle to focus on his bid to become Manchester's metro mayor in 2017. 

In his swansong as shadow home secretary, Burnham said serving Labour had been a privilege but certain moments over the last 12 months had made him "profoundly sad".

He said:

"This is my tenth Conference speaking to you as a Cabinet or shadow cabinet minister.

"And it will be my last.

"It is time for me to turn my full focus to Greater Manchester. 

"That's why I can tell you all first today that I have asked Jeremy to plan a new shadow cabinet without me, although I will of course stay until it is in place."

Burnham devoted a large part of his speech to reflecting on the Hillsborough campaign, in which he played a major part, and the more recent campaign to find out the truth of the clash between police and miners at Orgreave in 1984.

He defended his record in the party, saying he had not inconsistent, but loyal to each Labour leader in turn. 

Burnham ran in the 2015 Labour leadership election as a soft left candidate, but found himself outflanked by Jeremy Corbyn on the left. 

He was one of the few shadow cabinet ministers not to resign in the wake of Brexit.

Burnham spoke of his sadness over the turbulent last year: He was, he said:

"Sad to hear the achievements of our Labour Government, in which I was proud to serve, being dismissed as if they were nothing.

"Sad that old friendships have been strained; 

"Sad that some seem to prefer fighting each other than the Tories."

He called for Labour to unite and end "divisive talk about deselections" while respecting the democratic will of members.

On the controversial debate of Brexit, and controls on immigration, he criticised Theresa May for her uncompromising stance, and he described Britain during the refugee crisis as appearing to be "wrapped up in its own selfish little world".

But he added that voters do not want the status quo:

"Labour voters in constituencies like mine are not narrow-minded, nor xenophobic, as some would say. 

"They are warm and giving. Their parents and grandparents welcomed thousands of Ukrainians and Poles to Leigh after the Second World War.

"And today they continue to welcome refugees from all over the world. They have no problem with people coming here to work.

"But they do have a problem with people taking them for granted and with unlimited, unfunded, unskilled migration which damages their own living standards. 

"And they have an even bigger problem with an out-of-touch elite who don't seem to care about it."

Burnham has summed up Labour's immigration dilemma with more nuance and sensitivity than many of his colleagues. But perhaps it is easier to do so when you're leaving your job.