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…

Show Hide image

For the first time in my life I have a sworn enemy – and I don’t even know her name

The cyclist, though, was enraged. “THAT’S CLEVER, ISN’T IT?” she yelled. “WALKING IN THE ROAD!”

Last month, I made an enemy. I do not say this lightly, and I certainly don’t say it with pride, as a more aggressive male might. Throughout my life I have avoided confrontation with a scrupulousness that an unkind observer would call out-and-out cowardice. A waiter could bring the wrong order, cold and crawling with maggots, and in response to “How is everything?” I’d still manage a grin and a “lovely, thanks”.

On the Underground, I’m so wary of being a bad citizen that I often give up my seat to people who aren’t pregnant, aren’t significantly older than me, and in some cases are far better equipped to stand than I am. If there’s one thing I am not, it’s any sort of provocateur. And yet now this: a feud.

And I don’t even know my enemy’s name.

She was on a bike when I accidentally entered her life. I was pushing a buggy and I wandered – rashly, in her view – into her path. There’s little doubt that I was to blame: walking on the road while in charge of a minor is not something encouraged by the Highway Code. In my defence, it was a quiet, suburban street; the cyclist was the only vehicle of any kind; and I was half a street’s length away from physically colliding with her. It was the misjudgment of a sleep-deprived parent rather than an act of malice.

The cyclist, though, was enraged. “THAT’S CLEVER, ISN’T IT?” she yelled. “WALKING IN THE ROAD!”

I was stung by what someone on The Apprentice might refer to as her negative feedback, and walked on with a redoubled sense of the parental inadequacy that is my default state even at the best of times.

A sad little incident, but a one-off, you would think. Only a week later, though, I was walking in a different part of town, this time without the toddler and engrossed in my phone. Again, I accept my culpability in crossing the road without paying due attention; again, I have to point out that it was only a “close shave” in the sense that meteorites are sometimes reported to have “narrowly missed crashing into the Earth” by 50,000 miles. It might have merited, at worst, a reproving ting of the bell. Instead came a familiar voice. “IT’S YOU AGAIN!” she yelled, wrathfully.

This time the shock brought a retort out of me, probably the harshest thing I have ever shouted at a stranger: “WHY ARE YOU SO UNPLEASANT?”

None of this is X-rated stuff, but it adds up to what I can only call a vendetta – something I never expected to pick up on the way to Waitrose. So I am writing this, as much as anything, in the spirit of rapprochement. I really believe that our third meeting, whenever it comes, can be a much happier affair. People can change. Who knows: maybe I’ll even be walking on the pavement

Mark Watson is a stand-up comedian and novelist. His most recent book, Crap at the Environment, follows his own efforts to halve his carbon footprint over one year.

This article first appeared in the 20 October 2016 issue of the New Statesman, Brothers in blood