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It’s strange. First, we had the issue that there was a black hole in the nation’s finances, and things were so dire that they had to cut winter fuel allocations to start trying to fill it.
Rachel Reeves then told the party conference that everything would get better and that good times were just around the corner.
And now, the Office for Budget Responsibility will apparently give it room to borrow more by changing the fiscal rules, as Patrick Tooher explains today.
First, we had the issue of there being a black hole in the nation’s finances. Then Rachel Reeves told the party conference that things would get better.
This doesn’t fit. Changing fiscal rules does not change the size of the National Debt.
It just means we’re not supposed to worry about it so much. This does not fool the markets. We are now being charged more to borrow than the United States, even though the United States has a larger deficit and higher debt relative to GDP.
At the beginning of this year, the yield on 10-year government bonds was 3.5 percent, while 10-year U.S. Treasury bonds were at 3.9 percent. Now we are up to 4 percent, but they are down 3.8 percent.
Perhaps lenders can be persuaded to fund genuine public investment, but not if they are vanity projects that cannot be delivered, such as New Labour’s latest big idea, HS2.
There is a broader point here. The public finances of most developed countries are in chaos. Our National Debt just surpassed 100 percent of GDP.
But outside the G7, only Germany and, depending on how you do the sums, Canada, are in a better position than us.
It may seem great to be able to borrow more, and even if short-term rates continue to fall, I think rates on government bonds, treasuries, etc., will remain reasonable. But history – and common sense – tell us that this relative calm will not last.
The big threat is that inflation stops falling and starts rising. As that happens, the driving force behind current market confidence (perhaps overconfidence), the prospect of ever-cheaper money, will fade.
Faced with higher inflation, central banks would have to start raising rates again, and when that happens, bond markets would demand higher yields to finance all that government debt.
They can cut into large pieces. James Carville, Bill Clinton’s political strategist – best known for his phrase “It’s the economy, stupid” – also paid tribute to the power of bond markets. “I used to think,” he said, “that if there was reincarnation, I wanted to come back as President or Pope.” But now I would like to return to the bond market. You can intimidate everyone.
Carville’s comment dates back to 1994. When central banks were spreading money, that wasn’t true. The combination of low inflation, near-zero interest rates, and quantitative easing policies meant that markets had lost their power.
But then the catastrophe of double-digit inflation, the fear it caused central banks and the social and economic damage that resulted, mean that ultra-loose monetary policies will not happen again for a long time.
So the bond markets have taken control again, as demonstrated when Liz Truss refused to be intimidated by them. The damage they inflicted on the gold market brought down their government.
This government is terrified of that happening to them, as evidenced by this nonsense about not cutting winter fuel payments, leading to a run on the markets.
It is impossible to see the details or the moment. I don’t think a bond buyers’ strike is imminent here in the United States or anywhere else.
Governments around the world will introduce regulations and incentives to try to persuade people to buy their debt. They will try to keep maintenance costs down. And they will allow a little more inflation to reduce their real value, hoping that the rest of us won’t notice.
However, the nature of markets is that while things often take longer than expected, when they happen, they move faster and more cruelly than anyone imagined.
Moral: Don’t invest in long-term bonds and if you can get a decent fixed rate on your mortgage, it might not be a bad idea to do so.
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