I had a twitter exchange with Adam Lent, with whom I worked at the TUC, last evening.
Adam is, it seems, firmly in the 'we've got to worry about the bond markets' camp of economic commentators, seemingly believing that just around every corner there is a bond vigilante waiting the perfect moment to strike the UK economy down. In fairness, he is far from alone: this logic underpins the whole of the Conservative party's economic policy, although in their case it's not at all clear that they aren't closely related to such vigilantes, if they were to exist.
The last point is, though, the important one. As Paul Krugman points out, often, there is absolutely no evidence that there are such things as bond vigilantes, at least until such occasion that politicians give them the opportunity to strike. German politicians have given bond vigilantes the opportunity to strike at Greece and Portugal; Irish politicians created the opportunity all for themselves. Republicans in the USA are certainly going about creating market turmoil in a way that only they seem capable of, seemingly willingly wishing to destroy the credibility of US debt in pursuit of petty smallmindedness. But the UK? Come on, let's get real.
The UK is far removed from risk of bond vigilante action that to make the fear of something that is such a remote possibility the basis for economic policy is simply absurd. Our average debt in the UK is 14 years old. Our debt ratios are very low compared with most countries. You don't believe me? Then look at this chart of debt to GDP ratios for EU countries using Eurostat data, (hat tip to RWER):
We're doing fine right now, as someone once sang, and historically our debt is so much lower than throughout most of our history that we are in an extraordinarily strong position, and not the opposite.
What is more, the demand for our gilts is high, and rising partly precisely because we have an ageing population, many of whom will want to buy UK government gilts as the basis of their annuities as they come to retirement ( which is why we actually need more of them, and so can afford to borrow). In addition, we have also proven beyond a shadow of a doubt that the government is capable of using quantitative easing to create significant amounts of cash if need be without having any impact whatsoever on the real interest rate or long-term inflation in domestic markets ( all that we are now suffering being the result of government tax policy or commodity prices that are beyond our control, even when adjusting for exchange rates).
In other words, our financial position is at least relatively strong. That is especially true precisely because the euro is in a mess, the dollar is heading for a mess, and like it or not if people want somewhere to put their money then UK gilts look one of the best places to be right now. We do really have an attractive proposition to sell.
In that circumstance an astute government would see the current situation as a position of strength and not look at the markets and think that they represent a threat. They don't. There is a wall of money in the markets that needs somewhere to invest: somewhere where the currency has reasonable backing, there is limited risk of Euro contagion, somewhere where right wing zealots intent on destroying well-being are being held reasonably at bay, where if only a little stimulus were provided to the economy the prospects for growth might exist. Look around the world and, believe it or not, amongst the major nations that leaves the UK as one of the safest bets on the planet.
In the circumstances, the Office for Budget Responsibility report suggesting that the UK has a problem because its debt might rise to 100% of GDP over the next 50 years because of the need for increased healthcare, pension provision, the social services as a result of an ageing population seems to me to be a simple recognition of the fact that we have an entirely manageable position, which we can afford to finance, and which requires absolutely no panic reaction of any sort whatsoever, let alone the demand for cuts that appear to be emanating from right-wing newspapers and others who live in fear of the market.
What those who react in this way ignore is the fact that we have choice available to us in the UK. Partly that's the result of the democratic process (now reinvigorated?). As populations age they will vote for higher proportions of tax to be paid to cover the pensions, health care and the other services they need. The current resistance to making such provision will disappear as demands become apparent and the younger generations realise that this is the only cost-effective way of making provision for their parents. Change is, in other words, possible expecially when the alternative will be seeing the old living in abject poverty. I don't think people will accept that.
More than that though, as is becoming readily apparent, markets are failing in very many ways. I believe very strongly in the importance of a mixed economy, but I also believe that this is utterly dependent upon the existence of firm regulation, sound ethics, accountability, transparency, and the payment of tax by all who participate in those markets so that a level playing field is created between honest, dishonest and just incompetent participants so that all do genuinely play their part in the maintenance of a good society. We do not have that at the moment. We have a society corrupted by bankers. We have a society corrupted by the media. We have a society corrupted by endemic tax evasion in the small-business sector as is evidenced by my research in this area, and we have an enormous tax gap that the government refuses to tackle since it believes that it is better to leave cash in the pockets of crooks and cheats instead of providing healthcare, education, social services and opportunities that the young.
We have the choice of correcting this. In fact we may have no choice but do so: unless we are to see our markets collapse under the weight of corruption we will have to tackle these issues. The cancer that is currently eating its way into the core of our capitalist system has to be eliminated. Then we can also create the basis of prosperity to provide the services that we need.
But to assume in that case that the status quo will continue is absurd. To assume that we cannot take on these issues is also absurd. As absurd as assuming that there is a bond vigilantes around the corner.
It's time to take courage from the facts - not cower in the shadow of myths. I do, of course, call the result a Courageous State.
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The whole bond vigilantes thing… it’s the Boogeyman, isn’t it? “Give us all your money or the Boogeyman will get you!” – Conservative policy in a nutshell. It’s only when you’ve duly given them all your money – and they’ve said thanks and pocketed it and gone off to the Bahamas leaving you with nothing – that you realise they themselves were the Boogeymen.
BB
You are right that UK government debt is not the problem. For the UK the problem was always private debt created by the banks (it only takes a few mouse clicks and it’s immensely profitable during the upswing until it suddenly overwhelms the economy and collapses bankrupting the banks in a tsunami of bad debts). Unfortunately, the neoclassical economists who dominate public discourse simply don’t see private debt as a problem. They think that, since debtors and creditors cancel out by definition, individuals might loose but the system as a whole is safe. Like hell! It seems they’ve never heard of dominoes.
The danger for the UK is if the government is too close to the banks and bankers and is persuaded that they are TBTF and must be saved and then bails them out at the taxpayers’ expense. Doing that and leaving substantially the same people and incentive systems in place would only encourage them to go back to their destructive habits.
Oops! That’s a pretty fair discription of the strategy so far, disguised only by the fact that it’s mostly been guarantees which have yet to be called. But, bearing in mind that exposure to Ireland alone (bankrupt but pretending not to be) is something close to $200 billion according to the Bank for International Settlements, we need to have Plan B firmly in place or our national debt could soar overnight.
So, government needs to quickly cut the apron strings and have a resolution strategy in place to preserve the ‘money national grid’ element of banking – the High Street branches and money transmission network – as the utility it really is.
You are right to point out that our national debt is low, in fact it is amongst the lowest. In fact, it had probably been unnecessarily low for decades, as governments of both shades have seeked to slash the national debt at great expense to the economy. Borrowing has probably never been as cheap as it is at the moment.
I am massively in favour of QE (as long as it directly finiances the real economy) and debt-free money. Why go into debt to private banks when a government can simply create our medium of exchange for nowt?
There is a lot of rubbish talked about the national debt, though. Sure, there are far better ways to run things and there are horrifying statistics describing present and future debt, but the national debt is never actually paid off – it is continually rolled over and re-mortgaged. Any payments of treasury bonds as they mature are paid by the government re-borrowing to pay off past debts. Only when there is a zero deficit are taxpayers required to pay towards the national debt.
Therefore, we are only heavily in debt on paper. In fact, a big deficit can be good for an economy as consumers and industry need to borrow less as there is an influx of money distributed through public services that didn’t have to be borrowed into existence by both industry and consumers, thus helping to take the strain off the economy.
Never believe governments when they say they cannot afford to do something that will be hugely benificial to ordinary working people. They patently can!
It seems to me that most of the evidence is that the causality runs from the enactment of austerity policies to bond market downgrades rather than the other way round. That is, a country decides to enact austerity measures in response to a deficit, BUT in doing so increases the deficit, which makes it less likely that its debt trajectory is sustainable, leading to downgrades by the ratings agencies. So austerity measures make countries more likely to default on their debts, which is the opposite of the conventional wisdom, which is that the bond vigilantes force austerity measures on countries.
When I get a chance later in the summer I’m going to test the direction of causality using time series data on bond yields and the timing of austerity measures in different countries.
Brilliant idea Howard, and your logic is, as far as I can see, exactly right
That could be quite a powerful paper
You are arguing effectively that it is impossible to shrink the deficit. This may be technically true for a country like Greece, with no independent monetary policy (hence cannot monetize spending), which barely has an ability to raise taxes, and can barely pay interest on existing debt without borrowing.
But does the UK have the ability to raise taxes? Plainly, yes. Tax revenue this year is up about 10% (nominal) on last year; the VAT rise is helping there a lot. So then the questions is only, does the Treasury control spending? Plainly, yes. And the result is that that year-to-date borrowing has been only 0.5% of GDP rather than 1% of GDP in the same period of last year.
A different example would be Britain in the 1930’s, where the fiscal budget was (largely) balanced despite a huge economic slump.
Arguing that shrinking the deficit will reduce aggregate demand is one thing; arguing that shrinking the deficit is impossible is fairly strange.
But then I don’t think I did argue that
I argued we may well not want to do that
Which si quite different
“But does the UK have the ability to raise taxes? Plainly, yes. Tax revenue this year is up about 10% (nominal) on last year; the VAT rise is helping there a lot.”
But you notice mostly regressive taxation, like VAT, has gone up, not progressive taxation, in which the rich would have to start paying their whack towards the economy. This is almost certainly helping to push up the rate of inflation and is without doubt responsible for helping to suck more consumer demand out of an economy 75% reliant on services.
The deficit CAN be shrunk, but as seen in countries like Greece, at huge economic and social cost. Trying to shrink the decifit is what is causing so many problems now. While demand remains poor, the situation is just made worse as more people are thrown out of work and businesses close. That’s why a fiscal stimulus of some kind is needed, not more austerity that just maintains the spiral of depression. The deficit can be shrunk to a certain extent by introducing more progressive taxation, the rich paying around 60% income tax and paying the same rate of NI contributions everybody else pays rather than the 1% they are paying now.
The Tobin Tax and other taxes on banks and casino capitalism, such as derivatives, hedge funds and the currency markets, I believe is an area well worth exploring for raising government funds.
Not a single solitary penny needs to be cut from the public budget, being as the public was not responsible for the arrogance and stupidity of the banks and financial institutions. We’ve already affectively paid once because of the bailouts. Why the hell should we be required to pay again for a mess that was not of our making?
Richard – I was responding to Howard’s comment, though you seemed to agree with his (flawed) logic.
There is a reasonable argument that Osborne’s arguments about the “bond vigilantes” are bunk; but there were warnings on the UK fiscal position from folks like Bill Gross in early 2010. Generally, there is not a gradual shift between yields being “fine” and “not fine”; as per Italy last week, it is sudden. If Osborne’s primary responsibility as Chancellor is to protect the government’s ability to borrow, if he errs a little on the side of caution he may deserve some benefit of the doubt.
The bulk of the borrowing over the last few years has been taken up by overseas investors and by banks forced to hold more capital; I don’t think there is much evidence that longevity is driving gilt demand particularly; pension funds’ gilt holdings have not increased significantly recently.
90% of UK debt is held in the UK according to data I recall seeing not long ago
How does that stack with your argument?
And won’t banks anyway be required to hold yet more?
That seems to be right…..Austerity measures, or even the announcment of austerity measures by a government, usually create a climate of pessimism where everyone is scared to spend, even if they still can. Sales drop, government revenues based on sales drop, and so on…..
It is sort of a myth that you can punish the wage earners and the general public, and national consumption will remain about the same. Even in the US, where the austerity measures are usually applied quietly at the local level, the result is the same…..as can be seen by the budget crisis and the lack of recovery in consumption.
My question to these people would be….where do they expect the demand to come from????
I wonder if the older generations would be willing to vote for higher taxes. The reason I say this is the resistance to inheritance tax and the idea those who go into care should have to sell their homes to help finance this.
Obviously those writing in the papers are those who stand to inherit, but the older generation also seems adverse to the idea that they should support their own retirement. “I’ve paid taxes all my life, and I bought the house with what the government left me”.
My argument is that if you live in a care home then what you have done is moved house to a residence with advantages. At any other time of your life, when you do that, you use the capital from your old house to help finance the new one. Surely the whole point of the retirement nest egg is that it supports you in your retirement.
It is ironic that the very papers who say that Civil Servants should lose their pensions are the same ones that are saying that the state should support those who don’t want to use their assets to support themselves.
Many will say they want to help their children. The masses of capital that were inherited in the 80s and 90s are surely part of the reason for the house price boom continuing past the point where houses had started to become unaffordable to new buyers.
I would like to point out that my thoughts would harm me – my share of my parents house would easily clear my mortgage (unless my Dad really has left it all to the cats’ home).
You may be right, but I can’t see any way round increased inheritance tax rates
What’s needed and what people are prepared to do are two seperate things.
This is a direct lift from your tax haven report, “The UK is facing an enormous economic crisis. The economic failure caused by the recklessness of its banks has left it with a deficit in public finances that everyone agrees needs to be addressed.” So have you have now changed your mind and we can afford the deficit as the countries debt levels are actually low?
Relatively, yes
The wise man, in the face of the evidence, changes his mind
I don’t dispute the crisis the banks caused or their capacity to do it again
I am saying relatively we might be one of the best bets right now
we could be a very good one if we tackled the tax gap
What do you do when facts change? Carry on as before?