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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Who is the EU's chief Brexit negotiator Michel Barnier?

The former French foreign minister has shown signs that he will play hardball in negotiations.

The European Commission’s chief Brexit negotiator today set an October 2018 deadline for the terms of Britain’s divorce from the European Union to be agreed. Michel Barnier gave his first press conference since being appointed to head up what will be tough talks between the EU and UK.

Speaking in Brussels, he warned that UK-EU relations had entered “uncharted waters”. He used the conference to effectively shorten the time period for negotiations under Article 50 of the Lisbon Treaty, the legal process to take Britain out of the EU. The article sets out a two year period for a country to leave the bloc.

But Barnier, 65, warned that the period of actual negotiations would be shorter than two years and there would be less than 18 months to agree Brexit.  If the terms were set in October 2018, there would be five months for the European Parliament, European Council and UK Parliament to approve the deal before a March 2019 Brexit.

But who is the urbane Frenchman who was handpicked by Commission President Jean-Claude Juncker to steer the talks?

A centre-right career politician, Barnier is a member of the pan-EU European People’s Party, like Juncker and German Chancellor Angela Merkel.

A committed European and architect of closer eurozone banking integration, Barnier rose to prominence after being elected aged just 27 to the French National Assembly.  He is notorious in Brussels for his repeated references to the 1992 Winter Olympics he organised in Albertville with triple Olympic ski champion Jean-Claude Killy.

He first joined the French cabinet in 1993 as minister of the environment. In 1995, Jacques Chirac made him Secretary of State for European Affairs, teeing up a long and close relationship with Brussels.

Barnier has twice served as France’s European Commissioner, under the administrations of Romano Prodi and José Manuel BarrosoMost recently he was serving as an unpaid special advisor on European Defence Policy to Juncker until the former prime minister of Luxembourg made him Brexit boss.“I wanted an experienced politician for this difficult job,” Juncker said at the time of Barnier, who has supported moves towards an EU army.

 

Barnier and the Brits

Barnier’s appointment was controversial. Under Barroso, he was Internal Market commissioner. Responsible for financial services legislation at the height of the crisis, he clashed with the City of London.

During this period he was memorably described as a man who, in a hall of mirrors, would stop and check his reflection in every one.

Although his battles with London’s bankers were often exaggerated, the choice of Barnier was described as an “act of war” by some British journalists and was greeted with undisguised glee by Brussels europhiles.

Barnier moved to calm those fears today. At the press conference, he said, “I was 20 years old, a very long time ago, when I voted for the first time and it was in the French referendum on the accession of the UK to the EU.

“That time I campaigned for a yes vote. And I still think today that I made right choice.”

But Barnier, seen by some as aloof and arrogant, also showed a mischievous side.  It was reported during Theresa May’s first visit to Brussels as prime minister that he was demanding that all the Brexit talks be conducted in French.

While Barnier does speak English, he is far more comfortable talking in his native French. But the story, since denied, was seen as a snub to the notoriously monolingual Brits.

The long lens photo of a British Brexit strategy note that warned the EU team was “very French” may also have been on his mind as he took the podium in Brussels today.

Barnier asked, “In French or in English?” to laughter from the press.

He switched between English and French in his opening remarks but only answered questions in French, using translation to ensure he understood the questions.

Since his appointment Barnier has posted a series of tweets which could be seen as poking fun at Brexit. On a tour of Croatia to discuss the negotiations, he posed outside Zagreb’s Museum of Broken Relationships asking, “Guess where we are today?”

 

 

He also tweeted a picture of himself drinking prosecco after Boris Johnson sparked ridicule by telling an Italian economics minister his country would have to offer the UK tariff-free trade to sell the drink in Britain.

But Barnier can also be tough. He forced through laws to regulate every financial sector, 40 pieces of legislation in four years, when he was internal market commissioner, in the face of sustained opposition from industry and some governments.

He warned today, "Being a member of the EU comes with rights and benefits. Third countries [the UK] can never have the same rights and benefits since they are not subject to same obligations.”

On the possibility of Britain curbing free movement of EU citizens and keeping access to the single market, he was unequivocal.

“The single market and four freedoms are indivisible. Cherry-picking is not an option,” he said.

He stressed that his priority in the Brexit negotiations would be the interests of the remaining 27 member states of the European Union, not Britain.

“Unity is the strength of the EU and President Juncker and I are determined to preserve the unity and interest of the EU-27 in the Brexit negotiations.”

In a thinly veiled swipe at the British, again greeted with laughter in the press room, he told reporters, “It is much better to show solidarity than stand alone. I repeat, it is much better to show solidarity than stand alone”.

Referring to the iconic British poster that urged Brits to "Keep Calm and Carry On” during World War Two, he today told reporters, “We are ready. Keep calm and negotiate.”

But Barnier’s calm in the face of the unprecedented challenge to the EU posed by Brexit masks a cold determination to defend the European project at any cost.

James Crisp is the news editor at EurActiv, an online EU news service.