The world is watching Britain at the moment. It is casting doubt on our country’s creditworthiness. It is questioning our resolve to deal with our debts. And when that starts to happen, then long term interest rates rise.Meanwhile on planet earth the opposite is happening. Real long-term interest rates - yields on index-linked gilts - have fallen to record lows.
Far from “questioning our resolve”, bond markets have never been happier to lend to the government.
There’s a reason for this - the same recession that has increased government borrowing has increased demand for government bonds around the world. This works through several channels, among them:
1. Global savings are high. Yes, the recession has reduced the global savings ratio, thanks to the paradox of thrift. But it’s still high - over 20%. The IMF estimates that the world economy will save £7.8 trillion this year and £8.5 trn next.
2. High risk aversion is raising demand for bonds. 10 year US Treasury yields have fallen half a percentage point since the summer, in part because of doubts about the US economy.
3.The policy response to the recession entails buying bonds. This means not just QE, but also the requirement that banks hold more liquid assets. It’s a little erroneous to regard these policies as a deus ex machina. They’re not. They are part of the story of recession.
In other words, the deficit is no problem, because the same recession that caused it also gives us the means to finance it cheaply.
Of course, things could change; I wouldn’t be surprised if yields do rise in coming years.
But the fact is that, for now at least, bond markets are telling us that there‘s no urgent need for big, quick spending cuts.
Could it be that talk about the huge deficit is just a handy excuse for bashing the poor?