The Jersey Evening Post reported yesterday that:
MINISTERS have been tasked with finding significant savings in departmental budgets to help deal with the financial impact of the Covid-19 response — with one minister saying they had been asked to see if there was scope for 20% cuts.
For the people of Jersey this is profoundly worrying. In effect, Jersey is announcing that it is heading for full-on austerity.
Is that necessary? In Jersey's case many people would say that maybe it is. After all, it has no monetary sovereignty. It has to use the pound. And, of course, it has no central bank of its own. So, in effect, it is a jurisdiction with the economic characteristics of a sub-national government. That makes it look like a council in the UK, for example.
This fact, coupled with what I have described as the long-term black hole in its finances, which has long been covered by rising stock markets that have given it the opportunity to claim that it can cover its long-term pension costs when this is uncertain, could be said to make its position very difficult indeed.
However, a person in Jersey asked me if anything could be done to prevent this austerity, which will undoubtedly impose significant cost on the people of that place when, at the same time, Jersey will continue to function as a tax haven servicing the world's wealthiest people who wish to avoid their obligations to society. And the obvious answer is that something could be done.
Unless the government of Jersey really does believe that it is economy is in an irreversible decline then its demand for crippling austerity does appear to be dogmatic rather than necessary. After all, there is no reason why Jersey cannot borrow to cover the costs of an utterly unforeseen nature that the coronavirus crisis has imposed upon it.
My recommendation to Jersey would be to look at the issue of a very long-dated bond. Something up to 50 years would be my suggestion. I doubt it could do a perpetual, but it could explore it.The bond would need to be of significant amount: it looks as though Jersey's anticipated costs are of at least £200 million. A margin should be built in. At least £300 million might be raised then. And, it would need to pay a reasonable rate of interest. Something exceeding those available on the UK's National Savings and Investments's offerings would seem to be necessary to attract a consumer interest in this offering, and I happen to think at that sum that a consumer offering might make a lot of sense. Something between 1.25% and 1.5% would do, and would almost certainly attract attention, but if 2% was offered the money would come flooding in, and the marginal cost difference is small. Partner with someone like Hargreaves Landsdown and not only would the marketing based be available, but so would the aftermarket.
The consequences would be very apparent in Jersey. Firstly, it would have a debt that did not require repayment in the lifetime of most people in that place. And let's be candid, it would be rolled over after 50 years in any event. And second, even if the interest rate was 2%, the annual interest would only be £4 million, which as an alternative to trying to find budget cuts of £150 million or more makes complete sense.
So, why is Jersey choosing austerity rather than borrowing? There are three possibilities.
One is it hasn't considered debt, because it has not used it before.
The second is that it really does not believe it could repay: there really is a black hole. Refusing to borrow would be the surest indication of that.
And third, it would rather impose austerity than do so, even though the option of preserving essential services exists.
I'm not suggesting which of those is true. But what is undoubtedly true is that Jersey is not considering all its options in the face of an unprecedented crisis. And that seems both quite remarkable and deeply worrying, whilst the precedent that it sets of conservative thinkers turning to austerity as their knee-jerk reaction to this situation is deeply worrying. It suggests that it very likely that this is what we might face in the UK as well.
Debt, when used and explained appropriately, is not an issue for governments. I have explained why this morning. Jersey needs to take note, and very soon.
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“Don’t doubt that austerity is an option”
I don’t doubt it for a moment. The ruling and monied class were totally insulated from the last round of Austerity so they believe it to be both necessary (because they don’t understand) and painless because it misses them. There won’t be one person in a thousand that associates the inadequate response to Covid 19 here with health service and public sector cuts of the past decade. (Nor the parlous crippling of the tax gathering service as mentioned elsewhere today).
I don’t think anyone in a position of power cares about the pain of others.
Interesting.
You think that when an entity issues a bond it chooses the rate of interest it pays on it?
The BoE is nit any old entity
And in its case, yes
QE and central bank I reserves guarantee it
You miss the whole point that the gov’t is unlike anything else
Not sure what the BoE has to do with anything, but no, you are still wrong.
Issuing entities, whatever they may be, can set the coupon rate, but as anyone with any understanding of the bond maths knows, that does not set the amount of interest paid. In that respect, governments are exactly like any other issuer. Bonds are only worth what someone will pay for them.
It belies a lack of understanding when you say that Jersey could issue bonds with a certain interest rate.
Jersey can issue a bond with a rate
I promise you
People do, all the time
Of course they gauge it to the market at that moment – as I suggested
But you’re really very wrong
Promises are meaningless when they are based on nonsense. And I’m afraid you are definitely talking nonsense.
Jersey can issue a bond with a particular coupon. Whatever coupon they desire.
If Jersey issues three bonds today, all of the same maturity but one paying 0%, one paying 2% and one paying 10% coupons, which will cost Jersey the most?
Simple question with a very simple answer. One I doubt you will be able to provide me with given what you have said betrays a complete lack of understanding of how bonds price and work.
Oh, you’re one of those silly game players
And yes I know the theory
But you are ignoring so many issues i clearly refer to in the blog I really cannot be bothered to play your game
I’m not sure you do know the theory, as you call it. There is no theory about it, for a start. Just relatively simple maths.
It looks like you are just avoiding the question. Either because you don’t know the answer or by giving the answer it shows your error. Either is not a good look.
You could of course have just answered the question. I can do it in a single word, not even a full sentence.
I asked you a specific question about a specific point in your blog. Not about all of it. But if this point is anything to go on, the rest of it is probably just as wrong.
Let’s face it. To claim that a government, or any bond issuer for that matter, can just choose the rate of interest they pay on their bonds is just clueless.
So clueless that the BoE does do it?
Says it does it
And actually achieves it?
That wrong, eh?
Why do I not bother with your maths? Because I prefer to deal with reality
Now very politely, go and play with your models
The BoE does what? You are just rambling now.
The maths IS the reality. There is no theory at all regarding how bonds are priced because it is known. A law if you like.
That is the reality yet you clearly don’t understand it and prefer to just make things up as it suits you. One would have thought a so-called economics expert understands basic finance, interest rate pricing and bond maths.
There is basic maths
And then there are those who can change the parameters of the equation
You are ignoring that what I am saying is that there are those who can change the parameters of the equation
And that is what I am interested in, and not your pedantry
Whilst reminding you that there were, off course, those who said that 2008 could not occur because formulas did not permit it
If you can’t understand my argument it’s best not to try to engage with it
Yes, there is basic maths. Something you seem unable to manage in this case. You can’t “change” the equation just because you say so.
In this case – how bonds are priced – you most definitely can’t. Something you clearly don’t understand.
You are saying there are those who can change the parameters of the equation. By this I suppose you mean great thinkers such as yourself.
Don’t you think though, that it might be useful to have some basic knowledge of what you are talking about before you set about changing things? By not knowing the subject you are pontificating on, don’t you think the chance of your solutions being wrong or simply very poor are much higher?
And it is pretty clear you don’t understand basic bond maths or finance. Especially given your need to refer to 2008 as an example. Really, tell me which formula went wrong in 2008?
You could of course just answer the very easy question I asked you earlier, if nothing else just to prove that you do actually have some knowledge of basic finance.
A discounted cash flow equation is not fact
Not is it economics
It is an equation that assumes perfect knowledge
I suggest you read Adair Turner in 2009 on that and his condemnation of the CAPM
CAPM was a false prophecy
And if you have not noticed it, 0 if your formula is so right the price should never change
It does
So your claim is false
And the reason why it changes? Because the government can change the price
In other words, very politely, you’[re a rather ill informed commentator peddling lies
You and your mates won’t be wasting my time again
Discounted cash flows are exactly what they say on the tin. Taking a future cashflow and discounting it by today’s interest rates to give you a present value. At a given time for a given discount rate that present value is factual.
What you don’t seem to understand, other than the idea of discounting itself, is that those present values change as interest rates change. They are not set in stone. It is just a mechanism for making valuations of future cashflows, which is quite useful. What would you do instead? Guess?
Taking CAPM as your example for a formula that “got it wrong” is also pretty silly. It gives you the expected return of an asset. Not the absolute or gauranteed return. Which in real terms just means you can compare one security to another in risk terms, but it doesn’t tell you anything about the future or the fair value of the security.
But now we get to the answer we have all been waiting for. You would issue 0% bonds because they are they cheapest.
And of course, you are wrong. They are all cost the issuer exactly the same amount. Exactly.
Why is this? Let us for this example say the bonds are all 10 year maturities, and the extant yield is 2%.
The 2% bond will issue at par, 100, and will have a yield of 2% to match it’s coupon of 2%.
The 10% coupon bond will have a much higher price thanks to it’s high coupon. So for every 100 face value at issue, the issuer will receive a much higher amount up front, to compensate for having to pay for the lower coupons. It will also have a yield of 2%, meaning the issuer will still be paying an effective 2% cost of interest.
The zero coupon bond, because it pays no coupons at all, will issue below par. Known as a discount bond. So to raise the same amount as the other bonds more will have to be issued. And guess what, the yield will also be 2%, meaning the interest cost to the issuer will be the same.
And nowhere did I say the price could never change. Of course it will, every day. Nothing to do with the government at all. it is the market that sets the price, through the natural action of buying and selling. No issuer can set the interest rate they want to pay. They can set the coupon rate, but that is immaterial as the coupons are irrelevant to the yield of a bond, which is the effective interest rate the issuer will pay.
Thus proving that you don’t understand basic bond maths and the most elementary mechanics of fixed income finance.
In other words, very politely, you are a rather ill informed so-called expert, peddling lies.
So, let’s summarise this
There is a formula that tells you nothing because the interest rate changes
And who controls that rate change in the modern world?
The government…
As I said, all along
Meaning a rate can be set
Your future contributions will automatically be treated as spam: you added precisely nothing to understanding here
Hi Richard, thanks for all your hard work.
I notice that Guernsey has in my opinion handled the crisis better that Jersey, it now lifted all the restrictions except opening up the borders to all and sundry, also I see they are looking at borrowing £500 million to get things going again.
Unusual
Guernsey usually copies Jersey’s mistakes
Could someone tell me why all the trolls who appear here seem always, without exception to be some kind of self-styled bond traders, but with the special capabilities of a Feynman? None such ever existed. They confuse procedure with insight [(just for example, the maths of DCF is so basic: 1/(1+r), it scarcely counts as maths].
It is unfortunatley becoming routine, and extremely boring, if I may say. After about their third foray, I start to think of a kind of shifty Derek ‘Del Boy’ Trotter flogging me a dead parrot (I think I mixed up something, there ……). I wonder if there is a boiler-room of trolling pseudo-bond traders, being sent out out regular intervals, just to annoy Richard, and look foolish to everyone else; safe only in the knowledge that nobody knows who they are (one tell-tale; they always use a part-name or pseudonym)?
Mr Parry is of course ecepted from my general complaint, and my apologies to him for any distress caused!
Ah, but the moment you can explain yourself with a letter in a formula you know you lose most of the population. Add a power to the n and then almost any deception can follow