I wrote what I thought to be an entirely reasonable blog yesterday on why I think the next financial crisis will be more serious than the last, and a host of people who have never appeared in the comments section of this blog before I did so poured in to tell me how wrong I am.
To be precise, they without exception objected to the suggestion within the chart that I reproduced from Prof Daniel Mugge, who is Professor of Political Arithmetic at the University of Amsterdam, that UK gilts are overvalued. If you want to know what political arithmetic is, his explanation is available by following the last link, from which the most telling phrase in the current context may be this:
[W]hen branches of government publish evidence, either to assess past policies or to devise new ones, we demand that they not be colored already. But they inevitably are colored, consciously or otherwise. This applies most immediately to quantitative indicators, and especially to those that are so ubiquitous that we take them for granted: inflation gauges, GDP, unemployment figures, trade statistics, government debt levels. After all, measuring abstract economic quantities is never straightforward, and the choice for one formula over the other carries implications that are rarely understood beyond a narrow circle of experts and communicated to the wider public.
I have not asked Daniel if he approved of what I'd written, but we've mailed since and he raised no issue. He retweeted the blog post. I am guessing he is not taking issue. And I can guess as to why that is. What his work looks at is, amongst other things, the way false perceptions of data can be used to create misunderstanding for political advantage.
I respectfully suggest to those making comment that they are guilty of a number of things. First, they ignored most of my blog. I did not discuss overvaluation of gilts in isolation; I discussed it as part of a phenomenon of over valuation that is likely to correct. I was not, then, discussing a microeconomic phenomenon of whether or not a particular formula applied at a point in time or not but was instead considering what might happen to gilt valuation in the event of what I called a discontinuity. This idea of a discontinuity seems to be a possibility beyond the comprehension of those commenting. In their world it would seem crashes do not happen, but even if they do, they are always self correcting (hence their obsession with simultaneous liability restatement to match asset price changes). Unlike them I live in a world where crashes do occur, with consequences. It's called the real one. So do they, for the record, but they seem intent on pretending otherwise.
Second, they believe their models. As one commentator said:
Gilts are defined by nominal, coupon and redemption date. Valuation is determined by discounted cash flow against the yield curve alongside the perceived certainty that the payments will be received i.e. they will not default.
Another invited me to use a spreadsheet, which, he claimed would prove that he was right. And I have to tell him, they won't.
So reluctantly I have to explain why that is the case: I say reluctantly only because I would have thought the world would have learned this stuff by now but it seems it has not, meaning that the odds of another crisis both occurring and having worse consequences than last time move from near certainty in my estimation to absolute certainty, precisely because the lessons of 2008 have very obviously not been understood by those who think they know finance.
Those lessons were succinctly summarised by Adair Turner in his 2009 report on the financial crisis (para 1.4):
At the core of these assumptions has been the theory of efficient and rational markets. Five propositions with implications for regulatory approach have followed:
(i) Market prices are good indicators of rationally evaluated economic value.
(ii) The development of securitised credit, since based on the creation of new and more liquid markets, has improved both allocative efficiency and financial stability.
(iii) The risk characteristics of financial markets can be inferred from mathematical analysis, delivering robust quantitative measures of trading risk.
(iv) Market discipline can be used as an effective tool in constraining harmful risk taking.
(v) Financial innovation can be assumed to be beneficial since market competition would winnow out any innovations which did not deliver value added.
Each of these assumptions is now subject to extensive challenge on both theoretical and empirical grounds, with potential implications for the appropriate design of regulation and for the role of regulatory authorities.
In other words, standard capital asset pricing models do not work.
That said, I have already seen the responses on the blog saying this is not true of gilts, even if it is of other assets. The logic is that because UK gilts cannot fail (a point on which I agree) they are risk free meaning that the factors incorrectly appraised in 2008 cannot recur in the gilt markets now. Ignoring for a minute that this suggests that all commentators appear to agree with my contention on other asset values (and I am taking that as read because no one has said otherwise) let me still address the issue of gilt valuation and why that too may be incorrect.
What the commentators are assuming is that they can correctly appraise risk. That is because they think there is only risk with regard to gilt returns. This is implicit in the comment that we only need to know nominal, coupon, the redemption rate and the yield curve. In isolation, and at a point in time, that model works in isolation.
I stress though it works to produce a current value, not an actual value. Tomorrow's value may be quite different, of course, using the very same model. But I am sure those commenting use this system day in and day out to trade vast sums and extract a rent from society for doing so, believing that they are incredibly clever for doing so when all they actually do is arbitrage that daily difference in perception which their model cannot value at a point in time because it, quite literally, discounts it, which is the flaw at its very heart.
But the reality is (and why do I still have to point this out?) that we do not live in a risky world, which is what this model assumes; we live in an uncertain one, even when it comes to gilts. And that is why this model is wrong.
This difference between risk and uncertainty is fundamental, but seemingly unknown to my commentators, just as it was to Adair Turner, as he has readily admitted it was to him and most of the City pre-2008. Risk means we can attach a probability to an event. In fact, not only can we attach a probability to an event, but we can even attach a probability to when an event might happen. So, in gilt terms, the only variable that the commentators thinks of consequence is if there is an interest rate change and when, and both these can be predicted and so priced, hence their apparent certainty.
Uncertainty on the other hand means we simply do not know what will happen. A probability cannot be attached to an uncertain event. We do not know what will happen, or when, and what the consequence might be. We can guess, but we will be wrong. No amount of modelling can deal with the uncertainty: the future of uncertain events is not known.
My first contention is that a discontinuity - a disruption resulting from a financial crisis - creates uncertain consequences, even for gilts. My second - which I will come to - is that the consequences of uncertainty need time to play out. As a result, I argue gilt revaluation can be created by the type of crisis three of us predicted on Thursday.
Let me deal with two issues in turn. First, I am presuming for reasons already noted that those commenting accept that it is possible that stock market, property, personal and mortgage debt valuations on bank balance sheets, corporate debt, and derivatives based on all these things, appear over-valued at present. We can broadly argue that this is the result of misguided use of QE: I argued that this would happen in 2010 meaning I have some form in this area. In that case let's assume a crash can happen.
This is my 'discontinuity'. We do not know what will trigger this. We do not know where it will start. We do not know its scale, although I think it will be big. We cannot predict the durability of institutions in the face of it. We cannot predict their liquidity at a point of time during it. We are unable to say how long the consequences will last. And quite critically we do not know how governments will react. If those things are not a measure of uncertainty I am not sure what is and of course each has spillovers for the gilt market.
What are those spillovers? First, there could be market breakdown: liquidity failure might ensure that. We cannot know that market players will not fail, especially when their current solvency is based solely on inflated asset values that will disappear overnight.
Second, there could be forced selling of gilts: the supposedly reliable asset may be sold in the face of liquidity failures to realise cash wherever it is available.
Third, there could alternatively be a flight to safety and a massive demand for gilts, assuming that liquidity survives. So prices might irrationally rise: the excess value now is in no small part a measure of risk aversion and not just yield. This excess may increase.
But let's also be clear that, fourthly, the government may respond to this by flooding the market with gilts to maintain positive interest rates by reversing QE. It would be an act of folly, but governments are capable of those.
Fifth, things might go the other way. The government might have to (I think it will) inject cash into the economy. But it could not do QE again because there may not be enough gilts to do it with. So the gilt market may be abandoned and direct cash issuance could happen. It happened in WW1. It could happen again. And that changes the whole long term nature of the market.
Sixth there are unpredictable inflation consequences impacting yield expectations.
Seventh, interest rates could move in a number of ways.
But, eighth, just to add some fun serious tax changes could have serious impacts on asset values. Throw in a wealth tax and see what happens.
My point is, we just don't know. But the commentators ignore all this. They say we are dealing with risk when glaringly obviously in a discontinuity that need not, and almost certainly will not be the case. There model refuses to recognise that this could seriously disrupt the gilt market. Mine accepts it could. They're different models. And I say I am right because my model is evidence based: I am discussing the world that is. Their model is based on a world that clearly does not exist. That's why they're wrong.
And then, I come to my second theme, which is that contrary to the suggestion from my commentators, markets will not react immediately or rationally to any of these scenarios and the others that are possible (I am not suggesting the above list is complete). The idea that markets clear immediately is what is called 'freshwater' thinking because it is associated with Chicago. The assumption is that rational people rationally change their minds immediately when facts change because a) they know precisely what is happening and b) can process it immediately. This, of course is absurd. That cannot happen. Instead, there is a lag in processing, if it ever happens at all (the fact that I am writing this blog shows that for some this clearly has not occurred since 2008). This is 'saltwater' thinking because it is the basis for the neo-Keynesian of east coast USA universities.
Saltwater thinking is, of course, correct. But we also do not know how long correction takes, or if at all (and by raising that point I make my own position clear) But what we do know is that whilst it occurs models break down, sometimes completely. So the discontinuity has an impact, even on gilt markets, whilst reappraisal to take account of the new reality occurs.
And the only thing we know about that new reality is that gilts will be redeemed at par, which means that the only rational valuation in the face of discontinuity is something not too far from that value. But right now we are far from it. And I'd suggest that makes the current premium looks decidedly uncomfortable.
You can disagree, of course. But please don't say there is no logic to my disagreement, because there most certainly is, and unless anyone criticising it is willing to claim their clairvoyance their counter-argument based on a spreadsheet is actually utterly irrational, because making such a claim just shows what they do not admit that you do not know and what assumptions you will not embrace.
At least I admit the scale of my uncertainty. It really is time my commentators did theirs.
PS This has been written in haste in little more than 90 minutes - which is pretty good going for 2,200 words. It could be improved As a result and I may return to it to do so at some time.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Your obsession with the market value of gilts relative to the par value, and your determination to ignore coupons, is ‘strange’ at best.
And one of the above explains your claims about the impact on the Solvency position of insurance companies and pension funds in the event of a rise in gilt yields.
I’ll take that as your response. It appears that you not got one, in other words
Now stop wasting my time and go back to playing in the sandpit with Worstall
Rather than explain why you appear to think that you can ignore coupons, you simply resort to insults. Who is Worstall?
I have never once in the slightest said coupon can ever be ignored
I said you value it incorrectly
Which, just in case you are really are stupid enough not to be able to tell the difference without me spelling it our for you, is not the same thing at all
Worstall is adequately covered on the internet.
You can even read some of what he has written over the years, but you might have to think about it to evaluate its wisdom, or lack thereof, and that seems to be outside some commentators remit.
If you want to understand anything it’s no use relying on the mainstream sources.
Worstall’s weakness is a total lack of economic wisdom mixed with a surfeit of neoliberal knowledge
I really don’t know where to begin, but you again do not seem to understand basic finance. You have written a long blog trying to explain what the financial community already know, and have done so for decades – which is that we cannot predict the future.
Bond pricing models simply price a bond given today’s market conditions. It makes no assumptions based on the future. None at all bar the observable prices in the market where people will buy and sell bonds. Your argument is that because we in the financial world do not take into account “the future” our models must be wrong.
It is a given that prices will change over time, but when I buy a bond at a certain yield to maturity, I am actually going to receive that yield. Now, this is something that you will probably not understand, but that does not mean I have made or lost money. All it means is I am going to receive a series of cashflows. If the bonds go down in yield, I will have made money, and vice versa, but that has literally nothing to do with the models we use to price them.
Firstly, I challenge you to provide us with a mathematical model of this uncertainty, and therefore a better way of valuing bonds, let alone any other assets. Rather than saying it exists and we can’t quantify it, which frankly is a cop out.
Secondly, of course, we in the financial world do take rather a large account of this unknowable future. It’s called “risk”. Directly measured by the price change of a basis point move in the bonds, and then we even take into account potential disruptions in the markets through VAR and credit models. Of course, we bear in mind that these models are not perfect.
Adair Turner”s report, which you quote from, really only points out the obvious. Models of risk are only good to a certain degree, typically a 95% confidence level, and can fail. It is also worth noting that he is specifically talking about mortgage backed securities and credit markets, which have significantly less observable data than government bond markets, though you seem to have co-opted to try and prove a point.
As for this:
“And the only thing we know about that new reality is that gilts will be redeemed at par, which means that the only rational valuation in the face of discontinuity is something not too far from that value. But right now we are far from it. And I’d suggest that makes the current premium looks decidedly uncomfortable.”
Yes, Gilts redeem at par. But you and your model can’t tell us how far they should be trading from par. Of course, Daniel Mugge’s data is really only showing that the face value of bonds has diverged from the nominal value as interest rates have come down. Anyone with a basic understanding of bond maths would not be surprised by this – old stock of higher coupon bonds having a higher market value than it’s nominal value. And no-one will be surprised when this slowly reverses as interest rates rise.
Again, I ask you a question. Let us assume that you have been tasked with raising money for the government with the issue of a new 10y bond. Current yields in the secondary market are 1.30%. You can issue bonds bearing a coupon of zero, 1.30%, 2% or 5%.
Which is cheapest for the government?
So you agree (as I said) that the bond pricing you have worked so hard to defend has a sell by date of about thirty minutes (or less)
But you then say that a prediction that in the event that there is discontinuity is wrong?
Please do not waste my time again with your fatuous comments
What happens to interest rates in this ‘discontinuity’ that you keep focussing on?
You tell me
We won’t know in advance
Yes – bond prices change all the time. What’s new?
And nor can any model accurately predict the future. But we’re not trying to, and nobody has ever claimed to be able to accurately. Unless you are counting yourself. Typically the risk of loss models we use have a variety of different scenarios, with a variety of different probabilities and outcomes attached to them. You however, seem to be confident that your bond pricing model, which remains to be disclosed, can confidently predict that bond prices are wrong. Can it predict what the correct price is?
You are arguing that bonds are valued incorrectly, yet have provided no evidence for this, other that in the future things might happen. What you have said is that bonds are overvalued, relying on Daniel Mugge’s chart. This chart does not show that. It only shows that the market value of bonds has diverged from their nominal value. Which is exactly what you would expect to happen as interest rates go lower.
You explicitly say that bonds are overvalued, because their market value is higher than their nominal value.
“And the only thing we know about that new reality is that gilts will be redeemed at par, which means that the only rational valuation in the face of discontinuity is something not too far from that value. But right now we are far from it. And I’d suggest that makes the current premium looks decidedly uncomfortable.”
Anyone with the most basic understanding of bond maths knows that the market value of a bond, given by it’s cash price, means absolutely nothing as to the true value of the bond. Specifically because it depends on the coupon of the bond compared to current market yields.
Which is why I asked you the question – which bond is cheapest for the government to issue? 0%, 1.3%, 2% or 5%?
Does a 10 year Gilt with a cash price of 125 make it 25% overvalued to a 10 year Gilt with a cash price of 100?
So, you agree with me
Bonds can be seriously overvalued
And a discontinuity could exacerbate that
And yes, bonds are over valued: QE did that by shortening supply
If you don’t get that let’s forget all your other silly games, because I am wasting no more time with you
I wouldn’t bother to post again: my readers deserve comments from people who know what they’re talking about
FFS how do you expect someone to produce a mathematical model of uncertainty?
I suggest you try. It would be very useful. Maybe worth a Nobel.
Stochastic analysis, not simple maths but well established.
Alex, I hope you are right. You sound confident, but I thought I’d check.
I’ve been brushing up on my rather rusty grasp of stochastic analysis and it’s just as I thought….. Don’t understand a word of it.
Fortunately Yellen, Draghi and Carney can be guaranteed to have a thorough grasp of it so we’ll be OK.
You’ve told us that insurance companies and pension funds will be insolvent in this scenario – how can you make that claim if you don’t know what will happen to interest rates (and hence liabilities).
Secondly, if interest rates fall further, then this market value – nominal value premium that you are basing your whole argument on, would actually increase, not decrease, which makes no sense.
So the logical conclusion is that interest rates would rise.
Would happens to the solvency position of the vast majority of insurers and pension schemes in that environment…?
I said anything is possible
And interest rates do not make insurance companies insolvent
Cash flows do, caused by failed contributions in most cases
If you don’t know basics your time here is over
Right now
Steve Bland, it really is time to stop arguing and start to think. The fact that you can’t entertain an alternative view is what is going to ensure the uncertainty is a certainty. Because you are one of many and they go right to the top of the food chain in which I am unable to tell whether you are a minnow or a shark.
I think you are stuck in ‘Newtonian’ economics and it’s high time you had a look at what the ‘Einsteinian’ model has to offer.
We are living with Schrodinger’s debt. Ask yourself what will you see when you open the box.
The analogy is one I thought of using
The market has a valuation model that works if you realise, as with Newtonian physics, it has its limits
The trouble is these people do not seem to realise that
Where do I agree with you?
I am saying that you CANNOT say that bonds are overvalued simply by comparing the market price of bonds to the nominal value of bonds, as you and Daniel Mugge have done. The market price of bonds is dependent on the coupon. Which you steadfastly ignore.
The market price of a bond tells us literally nothing about it’s true value, and therefore it is impossible to say if bonds are overvalued given the information you have provided. If you say another crash is coming, then bonds are more than likely undervalued. Both can’t be true. Your non-existent model, supposedly better than the ones the market use, is also unable to provide us what the price of bonds should be.
You post above and your repeated comments on the last blog, as well as your unwillingness (or plain inability) to answer my basic bond questions show that you have no knowledge of how the bond markets work, despite your claims that you know everything about them.
You agree:
1) The market price does not tell us value, as I said
2) My model is unable to tell us what price bonds should have – as I said
3) In your last comment you said the market model cannot predict price except at a moment and I said that too
Thanks for your agreement
And I never denied coupon exists: that’s just bizarre
What I (and I think Daniel) said is it is being misvalued
It plainly is
Now you’re off here for good
Why are you banning some people who agree with you and not others?
I am banning neoliberal trolls in turn
You now
The reasons are plainly stated in the comments section
Richard
When these neoliberal trolls are trying to disrupt your truth, you know you are doing something right!
Keep up the good work,
Si
Does simply asking some ‘challenging’ questions (to which no credible answer has been received) make me a troll?
Changing your email address to get on proves you are
In fact it shows you’re clearly very experienced at this game
Richard
you refer a couple of times to your model in this latest piece. Does your model permit any quantitative valuations or is it more restrictive in only acknowledging the face value of the gilt and discounting entirly the cash flows that it will generate until its maturity on the grounds of the various disconuities you note at length?
If the discontinuities hamper a realistic full valuation of a gilt, then a gilt becomes a highly speculative holding wouldn’t you agree.
Did I say I had a model?
Or did I say that there is no model in the face of uncertainty?
Did I say there was only a nominal value? After all, I’ve not once ignored the coupon: all I have said is that the short term model for valuing the coupon may be wholly inappropriate in a discontinuity
And I have explained why
And I have indeed said a gilt is speculative in that case: I suggested cash
Why has it taken you so long to cotton on?
Richard
I should like to overlook your slightly hostile tone because you may be reacting to challenges posed by others.
You said you had a model and that you were right because your model was evidence based which is good so I was only asking you for further insights into your model if you were willing.
As an aside, what fascinates me in this discussion is the contention that UK Govt debt is possibly hard to value beyond its redemption price because of discontinuities which , I think it follows, should obviously make it less of a safe haven for investors.
Corporate bonds and then equities tend in that order to the riskier end of the spectrum of investments and so it follows that investors in UK equity markets like pension funds must have a considerable appetite for risk. Is that a fair summary?
I think they have a surprising appetite for risk that the perception of low yield whilst a monthly dollop of institutional saving has continued has created
The fact that you ban people who are trying to point out your misunderstandings is seriously embarrassing.
My only embarrassment comes from not deleting mindless followers of neoliberal trolls with the inability to think beyond some mindless formulas somewhat earlier
Richard, you might aswell talk to the cat I think.
If we are relying on idiots and the willfully purblind to keep the financial system going it’s time to get the tin hat off the top of the wardrobe.
I do rather think I wasted my time
But not quite
It was time to rehearse the old arguments again
I recommend lunch and perhaps a glass or two of a half decent red.
It is Sunday after all.
I wish I could join you.
I’ll be out with my boys
Definitely a day off
Richard
We can all agree that indeed Gilts may be overvalued if current expectations of interest rates are wrong and they were to suddenly rise, just as when we exited the ERM. But this is a risk that can have a probability assigned and assessed using established methodologies. It does not mean that Gilts are overvalued, it’s just an unexpected event. (It is also an unlikely outcome of a financial crash, as then rate expectations are likely to be lowered and gilt values rise, as they did after the EU referendum.)
You were saying that gilts were overvalued because the current market values are greater than the nominal, and that this would inevitably lead to losses, which is not the case.
Gilt have been traded through two World Wars, the Great Crash and Great Depression and a number of financial crashes, which were all pretty major shocks to the system, and these have not changed the way gilts should be value.
Of course we may have a nuclear war which wipes out half of Britain or some cataclysmic climatic catastrophe, which would cause the discontinuity you fear, but gilt prices may then be least of our worries.
This particular hill is not worth dying on.
I note your refusal to recognise what Adair Turner has appreciated
And reiterate, that’s why we will have to go through this all again
I pity the time and effort you’ve gone to, Richard, to make the one basic point, uncertainty, which has been made over and over again by plenty of others throughout history but which seems to fall on deaf ears in this particular context.
It was made vividly by Taleb in 2008 with his ‘Black Swans’ book. One of the most insightful I’ve read in the last 30 years.
https://en.wikipedia.org/wiki/Black_swan_theory
I would sum up this latest blog on this subject matter as ‘History vs Irrational exuberance’. It just goes to show that the whole charade of ‘big finance’ is based on confidence and nothing more.
But if you are addicted to risk and know that you will be bailed out – why would you change your mind? Especially if that way of life rewarded you well? I think that the risk versus uncertainty issue is the blind spot for your detractors, most certainly.
Richard, I am afraid that I am going to cause offense by suggesting that a discussion of bonds that does not consider inflation is akin to a discussion of angels dancing on the heads of pins. I am not an expert on bonds, because I think they have most of the disadvantages of equities, with none of the upside. They are likely to be more consistently overvalued, because of the market pressure of pension funds, and methods of measuring liabilities (Equities are only sometimes overvalued).
I think the redemption yield on long-dated gilts is about 1.5%
CPI is currently 2.3%
RPI is currently 3.9%
A FTSE tracker would currently yield about 3.7%.
In the medium term, I suspect inflation measures are more likely to rise than fall, also possibly in the longer term, though that is more of a toss-up.
Interest rates are almost certain to be higher in the longer term.
All of which supports your conclusion that gilts are seriously overvalued.
The stock market is almost certain to fall substantially, but a bit like the Government, it is very unlikely to go bust. Some companies will surely survive and still pay dividends. And in the long run, dividends should rise approximately with inflation.
One reason that equities are overpriced is simply because everything else is even worse. Even so, I believe that on most scenarios they are still the least bad option.
I did mention inflation – albeit not as strongly as perhaps I might
And you are right
The ‘other’ side would argue that their rate of return is inflation adjusted
What was it Old ‘Milton’ Keynes said…?
….and in the long term we will all be dead?
Footsie trackers are just that. Trackers; which have done very nicely since 2009. I think we’ll find the Market memory is longer than that of a generation of traders who have never seen a bear. You can bet they will track down just as well. And sure they will track up again for the few individuals who don’t cut their losses and are prepared to wait a generation to see their ‘investment’ crawl back to where it was.
Many will have to cut their losses because they are investing ‘money’ that doesn’t exist, but which they owe elsewhere. Tell me how that doesn’t spell a complete collapse.
Nobody can predict where the rot starts, it could be any market in any country and at any time. Maybe tomorrow maybe not for months or even years (pardon my unbridled optimism), but global interrelation of markets will ensure contagion.
Absolutely fantastic to see a serious discussion about aleatory uncertainty (ie about the probabilities involved) vs epistemological uncertainty (ie caused by a lack of knowledge about the world). A topic which should be discussed more often in my view. There are too many people being highly paid to promote clever ways of determining assumptions for models while defending the models themselves from proper questioning. This is not in the public interest but only serves the interests of the people paying them
Clearly Upsetting Neoliberal Trolls!
I seem to be
I thought that this might be an interesting article for you to read when you have time. It is titled:
Post-truth Politics, Bullshit and Bad Ideas: ‘Deficit Fetishism’ in the UK by Jonathan Hopkins and Ben Rosamond
The link is below but it is to the abstract but as a Professor, I guess you will be able to access it for free.
http://www.tandfonline.com/doi/abs/10.1080/13563467.2017.1373757?tokenDomain=eprints&tokenAccess=AkVfYGwd8DeHfhEyCQMV&forwardService=showFullText&doi=10.1080%2F13563467.2017.1373757&doi=10.1080%2F13563467.2017.1373757&journalCode=cnpe20
It’s good
Bullshit is a well defined term now
The article looks good
I have been away with little access to the web, and returned to this hurricane in a teacup; I hadn’t realised that there were quite as many neoliberal trolls still in existence. I was at sea, which fits nicely with my saltwater views.
So, speaking from the perspective of my past experience as a technical advisor to what was then the Board of Inland Revenue on the Accrued Income Scheme, I should note that the people trolling you share the misconceptions about the nature of interest which led to the existence of the Accrued Income Scheme legislation in the first place.
For those fortunate enough never to have encountered the AIS I should note that it was an anti-avoidance measure which sought to tackle the loss of income tax when gilts were sold as a capital transaction by apportioning part of the sale price as accrued interest taxable as income. The fact that the apportionment was done on a straight line basis along the coupon period demonstrated only too obviously the drafters incomprehension of what interest is and their inability to understand the value of such a gilt.
Taking a simple example: a gilt sold with a six month coupon of £1,000,000 due in 3 months time was said to include an interest element of £500,000. This was, of course, utter nonsense; no sane person is going to pay £500,000 now for the right to be paid £500,000 in three months time.
In fairness to my predecessors who had come up with this I should note that the Bank of England had also apparently failed to notice this point, and that people trading gilts saw nothing wrong with it either. I am therefore not overwhelmingly surprised by the bravura demonstrations of pearl clutching by those horrified by the very idea that they could be wrong about what their gilts are worth.
And on that happy note I propose to go in search of lunch…
Thanks
It’s high-time somebody did.
I wouldn’t call them neoliberal trolls. I would say they were people just like you and me: entrenched in their way of thinking and world view, as one would be, if that’s how they have made a living, and who are instinctively defending their position as one would, if they feel that their very value, experience and knowledge that makes them who they are today, is being threatened.
They’re all human, I suspect!
To parse the personal — the man, the father to a son, husband to a wife – away from the ideology that their thinking exemplifies (in this case — neoliberal), is difficult , but I believe necessary, if we are to have real transformative discussion. I wouldn’t be surprised if some of these commentators have no idea of what neoliberalism is or what trolling is, for that matter. They are just defending beliefs that they are invested in to the core, as we all would.
It is one of the greatest sorrows that our system seems to allow — or actually encourage – good men to labour earnestly, create proud livelihoods for themselves and their families (as we all would aspire to), but in service of such damaging ideologies (whether they know it or not). But alas, that’s why the system needs to change.
I suspect many of them know exactly what they are doing I am afraid
@Stevie
HMRC take into account accrued income under HS343.
https://www.gov.uk/government/publications/accrued-income-scheme-hs343-self-assessment-helpsheet/hs343-accrued-income-scheme-2015
You’ll notice that it takes care of the difference in the clean and dirty price of the bond when it comes to taxation.
@ Richard
I have been following this argument, and I’m not sure that labelling people neoliberal trolls has helped your cause. They all seem quite aware of how the market works, and I’m not sure bond maths can be described as “neoliberal”. I don’t think your argument, which seems to boil down to “we can’t predict the future so we can’t value bonds” holds much water, really. If you can’t value them, then how can pension funds and other investors realistically expect to invest in them, and how can they be taxed fairly? I notice in other blogs you seem very keen for the government to issue more debt.
I also see tht Daniel Mugge’s data comes from the BIS data. The same data shows Greek debt having a market valeu significantly less than it’s nominal value. Does this mean, by logical extension, that Greek debt is significantly undervalued?
First it is apparent that many of these people came from the site of Tim Worstall, an Adam Smith Institute Fellow, inclined to persistent abuse and encouraging those of like mind.
Second, I am pointing out the market works within narrow horizons. You too are ignoring the fact that this does not mean it always works. Of course we can value bonds if we assume all will continue as it is. I am saying that right now that may not be true and in that case maybe we cannot value them. What is so odd about that? This is what happens in meltdowns.
And re your comment on Greek debt, you are ignoring that Greek debt has a wholly different situation to UIK debt. Maybe you think it’s situation and that of the UK is the same and so circumstances apply equally. Clearly that is not true. Maybe you need to think about why the differences are possible and what that means instead of making what look to be rather ridiculous comments.
With respect you are a troll
You are in fact the so-called Shyam Shah now reappearing under a different name
With respect, before you shout about trolling I think you should stop trolling
Samuel
You appear not to comprehend the fact that the instructions at HS343 are exactly the same as those I set out out in my post above, and are based on the same error of principle identified in my post above.
It would help if you tried actually reading what others have written before you comment; that way it spares me having to point out your grasp of these matters is embarrassingly deficient.
I do not expect non-specialists to have the expertise of a technical advisor to the Board of Inland Revenue; that is clearly unreasonable. I do expect people to read what I have written and comment on the substance thereof. And if you really believe that the value of £500,000 now is the same as the value of £500,000 payable in three months time then you are simply reinforcing Richard’s argument.
Incidentally, doubling down on silly statements is the hallmark of a troll; perhaps if you stopped doing it and instead tackled the substance you might garner some respect. At the moment you are making a fool of yourself and wasting my time.
a strikingly homest assessment Richard. Many of them know exactly what they are doing.
Richard,
God only knows how or where you find the patience to persist with the dullards that you seem to have attracted with this subject. The relentless non-sequiturs of the one that was banging on about “coupons” were particularly tiresome.
The greater offense of your detractors was not so much in their trolling but their failure to identify a salient point and come to it concisely. To the extent that a worthy debate can be gleaned from this episode. I think that it may unfold like this:
Your detractors begin with the suggestion that, despite the recent data from Prof Mugge ( Chart 3, http://www.taxresearch.org.uk/Blog/2017/09/15/next-time-it-will-be-different-thats-because-it-will-be-much-worse/ ) bond prices are still consistent with textbook pricing models. According to your position (mine and others) the textbook explanation appears to be defensible in so far as it explains the narrow, steady gap between the nominal and market value of government debt prior to 2009, but not the erratic and increasing market value that occurs thereafter.
The trolls, having grown tired of their own obfuscations, came closer to being relevant by citing the (bleedin’ obvious) fact that Quantitative Easing and historically low interest rates are to a large extent responsible for the current aberration in bond prices. A day later they found the lucidity to suggest that the gap between nominal and market value may be relatively extreme, but it is still rational once QE and near zero interest rates are taken into account.
What they were struggling to say is that there is no “bubble market” in govt. debt. And that this is because the overvalued asset prices in a bubble market are inconsistent with their earning fundamentals and that this is (allegedly) not the case with gilts where the fundamentals are the interest rate and the ‘risk-free’ government guarantee.
In considering that proposition I would suggest that 2 thoughts come to mind:
1. A question: is this proposition actually true?
2. An insight: they and their models have comfortably come to accept the fact that the “risk-free” rate of return is now effectively, and increasingly, negative.
With regard to the question, I haven’t studied it closely (that would take more time and data) but if QE and low official interest rates are given as the sole explanation, then ostensibly, the proposition appears to be untrue not least because the data we have shows ‘the gap’ to be continually widening despite the fact that there has been no expansion of QE for quite some time. The near- zero rates have also been with us for a while and the current talk is of higher rates. So the increasing gap between market and nominal values is not entirely consistent with the given explanation. Something else is affecting them.
With regard to the risk-free rate, a move into negative territory cannot necessarily be regarded in the same way as a fall from one positive value to another. There may a critical threshold at the point where the rate of return is zero. We know in the case of deflation, for example, that a sub-zero inflation rate increases the real value of debts leading to a debt-deflation spiral (if the fall in prices persists).
I don’t know what happens when the risk-free rate persistently remains below zero and keeps falling, but that’s where the real debate begins I would imagine.
Thanks
Rather than simply reply ‘thanks’, wouldn’t it be more productive and value-adding to point out that we DON’T have negative yields on UK Gilts?!
Except we did
It is only brexit inflation that has temporarily reversed that
Do keep up
Or be deleted since you are clearly here to troll
I knew that both of those points (Gerald’s and Richard’s) might be raised which is why I’ve popped back late to see if anyone is still inhabiting this post (apparrently not).
My awareness of those two points also explains my deliberate use of the term “effectively negative” in comments that appear in this post and the one that preceded it (http://www.taxresearch.org.uk/Blog/2017/09/15/next-time-it-will-be-different-thats-because-it-will-be-much-worse/).
It was a way of avoiding a potential but nonetheless peripheral, can-of-worms. I stand by my use of the term, ‘effectively negative’ and to tidy up that loose end briefly, I first of all note that my comments referred to the data from Prof. Mugge (Chart 3, previous post). That data takes us up to late 2016 when the situation was described in these terms:
“Return on UK government bonds turns negative” (10/11/16)
http://www.bbc.com/news/business-37031793
“Fears for pensions as gilt yields turn negative” (11/8/16)
https://www.ft.com/content/c338f3c0-5ed6-11e6-a72a-bd4bf1198c63
Those were just 2 among dozens of similar reports that we were well familiar with at the time. By the way, that last one (ft.com) might appeal to you Richard. The likes of Shand, Shah and William may not appreciate it quite as much. As to the situation this year, the impact of the Brexit-driven inflation that Richard referred to, is paradoxical. It contrives a ‘higher yield’ with the affect that it has on gilt prices but the overall affect that it has on safe, low-return investments in real terms, is devastating (lower real interest rates lower real incomes etc.).
So, all things considered, still ‘effectively negative’. Cheers.
“
You are right
Of course they were effectively negative
With current inflation rates they still are
Nominal rates aren’t negative, real rates are – they are quite different things. And still nothing to do with market values versus nominal values!
You are now getting to be ridiculous
Please don’t try again
I’ll be saving you the embarrassment
Richard
I don’t want to feed the troll, but what part of what Gerald said was incorrect? This could be informative for your anti-neoliberal readers.
Thanks
SG
There are negative real interest rates
And of course that changes valuation
Therefore they do matter
He claimed otherwise
He claimed that real rates WERE negative but that nominal rates WERE not, which is surely true?
It was Marco that was suggesting that nominal rates were negative.
I think we’re into pedantry here
Nominal rates are positive
So what?
Real rates are not
And this does impact valuation
What are you trying to prove?
@A friendly voice,
Please do not misquote or misrepresent me.
You were not paying sufficient attention which surprises me in your case, being friendly and all, I am less surprised by Gerald.
I supplied these links (above) for a reason: http://www.bbc.com/news/business-37031793
https://www.ft.com/content/c338f3c0-5ed6-11e6-a72a-bd4bf1198c63
Current bond yields became negative in 2016 – not just in real terms but negative in their own right.
‘current yields’ are those that are generally referred to in the news and in market reports.
The affect that post-Brexit inflation has subsequently had on bond markets and yields is, in practical terms, no consolation whatsoever to most bond holders, especially those that may have purchased gilts at 2015/2016 prices.
Gerald Soper’s reference to “nominal yields” was an irrelevant, insincere and disingenuous red- herring.
If you want to know the difference look here:
http://www.investopedia.com/terms/b/bond-yield.asp
Marco
I am sorry you didn’t find my previous reply helpful or friendly.
The point I was making is that the fact that the nominal yields on a few government bonds turned marginally negative for a few days over a year ago is somewhat irrelevant to the current yield on UK government bonds.
Current yields on UK government bonds are not negative. Those who purchased such bonds at 2015 prices (except in a few exceptional circumstances) will have seen significant capital appreciation since that time – what consolation are they expecting? Those that hold those bonds to maturity will achieve exactly the yield they expected.
As for the comment about nominal bonds and market values – this is the whole point of this discussion, had you forgotten?!
You are not helpful
Or friendly
And a) you get facts wrong and b) you are ignoring this whole debate
For which reasons you will join those being deleted
Your behaviour exactly fits a stereotype of trolling
I’m not trying to prove anything!
You appear to want to agree with anything said by those people ‘on your side’ (even when what they saying is inaccurate) and abuse anyone who shares a different view to you, even when what they say is entirely true.
It doesn’t help you credibility with casual observers when you ignore / abuse those that are providing useful information.
Gerald didn’t suggest that real rates being negative didn’t affect valuation, he said that real rates being negative is nothing to do with the gap between market values and nominal values. Which again, is entirely true.
With respect, you’re playing very silly games
And I have a life
Or to out it another way, you’re wasting my time
Not least because of course real rates being negative impacts value
A “friendly” voice,
You weren’t making a point you were aimlessly nitpicking in attempt to sidetrack the discussion. Bond yields became negative in 2016 and if the Brexit referendum went the other way they probably still would be and eventually will be again. Such was the trend of the BIS data that we saw in the chart.
If you think that yields going from “marginally” negative to being positive-but-deeply-negative in real terms, is something to celebrate, or a worthy point of argument in the meantime, then we have nothing to discuss. At any rate your arguments are not arguments but vacuous platitudes.
For example: My point about bondholders was in direct reference to the Brexit inflation and I doubt that they would have been “expecting” to “achieve” a real rate that is as poor as it is now.
By the way, no one is ever “expecting” consolation. Consolation, when it occurs, follows a shock or disappointment. It isn’t required in the case of expected events.
And Geralds’ reference to “nominal” rates was almost funny. Simply saying that “real rates don’t affect market values” doesn’t make it true. It is a weird conjecture and that is all it is. Of course they affect market values. They already have.