Which market failure?

Liam Halligan says: "The UK remains in grave danger of a sovereign bond market meltdown." This puzzles me.

I don't disagree that there's a good chance of bond yields rising over the long-term. But a return to normalish interest rates that is anticipated by the market - an upward sloping yield curve implies that investors expect yields to rise - is not a "meltdown."

Instead, Mr Halligan is, I guess, making a stronger claim - that government bonds are now mispriced; long-term real yields of around zero are not pricing in any "grave dangers."

But if there's one market you'd expect to be efficient it is, surely, the sovereign bond market. It's a large, liquid market in which there is little private information and countless intelligent buyers none of whom have pricing power. But Mr Halligan seems to be saying that even this market is inefficient, that it is misallocating trillions of pounds of capital; the world sovereign bond market is worth some £26.6 trillion (pdf).

If you think sovereign bond markets can misallocate resources on a massive scale, you got to believe that ordinary markets for goods, labour and services are even more prone to huge misallocations. 

It's quite coherent to believe there's a "grave danger of a sovereign bond market meltdown" if you are sceptical about the functioning of markets generally. But how can you do so if you believe in free market policies? (It should be obvious that I'm not having a go at Mr Halligan specifically here; I suspect lots of conservative-minded folk think similarly).

One possibility is that you think that governments and regulators are even more incompetent than private sector agents, and so even if the market is inefficient, state intervention is more so. But I'm not sure this applies in this case. Mr Halligan is claiming that someone does have the ability to identify market malfunctions - himself. Why can't the state draw upon such reserves of competence?

Another possibility is that markets are "micro efficient but macro inefficient". This might be true of asset markets - for example it's possible for gilts to be overpriced even if (say) seven year issues are correctly priced relative to five-year ones. But to claim that goods and services markets are micro efficient is surely a big ask.

A third possibility is that one recognizes the ubiquity of market failure but favours limited government for other reasons - say because you value (negative) freedom or because even malfunctioning markets are conducive to economic growth.

This is, I think, coherent. But there is, nevertheless, an inconsistency here. Mr Halligan wants the government to do something about the (possible) failure in bond markets - cut spending. But he - and more significantly those who think like him - seem relaxed about the failures in goods and labour markets that cause at least 2.5 million people to be out of work.

It's strange how some market failures demand action and some don't, isn't it? If I didn't know better I'd suspect the right of merely pursuing class interest without regard to intellectual consistency.

Another thing: Mr Halligan claims that such a meltdown would have disastrous effects. This too is questionable.

Comments

[Anonymous]

Spot on!

[Zorblog]

"Mr Halligan wants the government to do something about the (possible) failure in bond markets - cut spending. But he - and more significantly those who think like him - seem relaxed about the failures in goods and labour markets that cause at least 2.5 million people to be out of work."

This is indeed a fine example of inconsistency, ideological bias and intellectual dishonesty.
And once again, this is denounced by Chris not on the merits of economics or (opposed) ideology, but on the merits of pure logic.

[john problem]

2,5 million people out of work is a loss of £8000 on average to the treasury in income tax and NHI. Then benefits must be paid to them at the rate of £10,000 on average. My calculator cannot cope with the calculation as to how much 2.5 million people out of work will cost the country. Why do our leaders not understand the prime formula: jobs pay wages, wages pay taxes, taxes pay government bills. Beats me.

[Keith]

May be Mr Halligan is suffering from hysteria?

The Imaginary bond vigilantes are just around the corner.

[Neil]

ITYF the unemployment thing is a feature in this system, not a bug.

[Simon Reynolds]

Good, thoughtful post from Chris as usual.

According to the nice summary of UK public spending at the Institute for Fiscal Studies:

http://www.ifs.org.uk/ff/lr_spending.xls

public sector gross debt interest payments over the 64 years from 1948-49 to 2011-12 averaged almost exactly 4.0% of GDP per year, while over the same period public sector net debt interest payments averaged almost exactly 3.0% of GDP per year.

Halligan gets into a lather, saying that by 2016/17 debt interest costs, "are set to soar by a staggering 107pc to £64bn a year – and that’s on benign interest rate assumptions, assuming credit markets don’t revolt."

Liam is like David Cameron -- someone who is staggered by large numbers. What Halligan doesn't say is that with a likely nominal GDP of around £1940 billion in 2016-17, the gross debt interest will be around 3.3% of GDP -- well below the long term post war average. Net interest will be even lower. Liam needs to relax -- the public finances are not the UK's biggest economic problem. Unemployment is.

Halligan admits: "This column has been warning about Britain’s impending budgetary ruin, and the danger of gilt market meltdown, for many years, not least during the middle and late 2000s..."

Er, well where is the gilt market meltdown?

Anyway, why should we care what the sovereign bond markets think? I'm with Ralph Musgrave on this one.

[James James]

Actually, the monied class interest is in supporting govt bonds: a nice risk-free return on their money.

The existence of the govt bond market is govt failure. There's no inconsistency in a free marketeer wanting to eliminate government-created rents.

[Ed Rector]

What do you expect to read from the chief economist of Prosperity Capital Company??