Osborne vs the markets

George Osborne says:

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?

Comments

[chrisg]

That seems a bit unfair on the Tories! There's not much poor bashing in their specific proposals, is there? If so I quake to think what the Lib Dems would do given Vince Cable has called their proposals 'Lib Dem Lite'.

Also, the proposals seem designed to kick in in 2011 at the earliest (the pensions change won't have an impact until much later), so not particularly quickly. If the UK economy is still up sh** creek come 2011, we can hope the Tories would delay their fiscal retrenchment.

For all their many faults, the Tories have been pretty consistent over time in their view that the current government ran too high a structural fiscal deficit ('they didn't mend the roof while the sun shined'). Unless you disagree with that view it seems fair for them to be coming up with more or less sensible and equitable ways of trimming that deficit back over time.

[The Great Simpleton]

Serious question: Have they already priced in a Tory victory?

[Guido Fawkes]

Chris, would you rather be long or short of gilts?

Yields are low soley because of QE bond buying. This is not sustainable economics.

[chris]

Guido - I'm a passive investor. If anything, I'd expect yields to rise over the longer-term. This isn't just because QE will end (QE is only a minor cause of low yields), but because the global economic upturn could raise yields around the world.
Had Osborne said: "there's a danger that investors will lose confidence in gilts. To prevent this, we need contingency plans to cut the deficit", I'd have no problem.
But to pretend that markets are worrying about the deficit now is plain wrong.

[Alistair Darling]

So am I okay to keep borrowing large sums then?

[Alen Mattich]

Chris,

If investors are so sanguine about government finances (not just in the UK, by the way) and bonds are warning about low growth, then why are other markets - equities, corporate bonds, commodities - signalling the exact opposite, including an added dose of high inflation. I suspect the distortions caused by QE are considerably greater than you credit. As someone pointed out recently, central banks don't just control official interest rates any more, they control all interest rates. The only thing they can't control in flexible currency regimes are relative exchange rates. And here sterling has taken a beating.

[Alex]

"Serious question: Have they already priced in a Tory victory?"

Gilts up - Jock McBottler's ZaNuLiebour and the EUSSR are bankrupting the country!

Gilts down - It's because they're looking forward to a Tory future.

Unfalsifiable, and therefore worthless.