Duncan’s Economic Blog

Being Terrified by Bond Yields

Posted in Uncategorized by duncanseconomicblog on August 19, 2011

Disclaimer: For the first time in two and years of blogging I have been driven to swearing in a blog post. Apologies but I lack the words to express what’s happening.

A short post but there really isn’t a great deal to say.

We have falling equity prices, falling commodity prices, record low bond yields across UK, Germany and the US and the worst hit shares are financials (where rumors of problems in the European banking system are once again circulating) and those most exposed to global growth.

This is a growth scare – and a big one.

And George Osborne is still taking comfort in low yields on government debt and declaring Britain a ‘safe haven’.

I’m afraid a bond yield of 2.3% on 10 year UK government debt isn’t the market saying ‘well done you, nice deficit reduction plan you’ve got there mate’ it’s the market screaming ‘for Christ’s sake, everything is fucked and we’re terrified about vanishing growth’.

Markets, as we know, can be irrationally optimistic but they can of course also be irrationally pessimistic. Let’s hope that’s what’s happening now.

I fear though that Paul Krugman is right.

18 Responses

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  1. Dave Holden said, on August 19, 2011 at 11:08 am

    Paul Krugman is for more QE, in that I think he is seriously wrong. But then I don’t think he understands how the banking system works.

    What we have is a private sector deleveraging from the biggest private sector debt binge in history*. This has given us insolvent TBTF banks continually bailed out by now (in some cases) questionably solvent governments.

    If there is to be no debt destruction or restructuring then I suspect Richard Koo is probably correct in his recent letter to the Economist.

    http://www.economist.com/node/21526289

    * Resulting from a broken banking system that not only allows but positively incentivises unsustainable credit creation.

  2. Interpreting economic numbers said, on August 19, 2011 at 12:16 pm

    […] Well, yes, but bond yields of 15% and rising (Greece maybe?) or 6% (Italy, Spain) or just rising bond yields (France) are also indicators that: it’s the market screaming ‘for Christ’s sake, everything is fucked […]

  3. Redshift said, on August 19, 2011 at 12:46 pm

    I’m no economist but what I don’t understand is why QE seems to be for governments the most obvious form of stimulus.

    Why don’t governments directly spend on areas that will deliver a social good – like building council houses, investing in green manufacturing, etc rather than using seemingly directionless mechanisms like QE?

    To me it seems like commitment to neo-liberal economic ideology over the lessons of history but do you have any better explanation?

    • duncanseconomicblog said, on August 19, 2011 at 1:25 pm

      Partially because of (sometimes misplaced) worries about bond market reactions, sometimes on ideological grounds

    • Gareth said, on August 19, 2011 at 1:59 pm

      Because QE is free, and running a deficit is not free (you pay for it with future taxes). So why should QE *not* be the first choice?

      If the central bank is doing its job properly, it should be setting the level of demand in the economy “correctly” already. If you attempt to use fiscal policy to move the level of demand somewhere different, either the Bank will not allow it (and will e.g. tighten MP faster), or they are incompetent. 8/9 of the economists on the MPC voted that the level of demand in the economy was about right, in August. Are they all incompetent?

      BTW, we don’t live in a planned economy, where the government sets a “direction” for the economy, and everybody else jumps to it. Thank god.

      • duncanseconomicblog said, on August 19, 2011 at 2:06 pm

        Although CBs can surely get it very wrong.

        BOE was late to cut rates in 2008, ECB actually hiked in July 2008, plus the recent ECB moves don’t fill me with confidence.

        Or we can go back to Bernanke’s ‘the Fed made the Depression worse’ (monetarist) argument.

        On the current MPC I have a lot of time for Posen.

        • Gareth said, on August 19, 2011 at 2:35 pm

          Sure, agree totally with all that (and also on being scared by the gilt yields). The ECB are off the reservation and should tried for crimes against humanity😦

          Argument remains the same: first choice is have the central banks do the right thing; you are stuffed otherwise. If the ECB insist on blowing up Europe and reducing demand for exports, we’ll have to ease MP ato make up for that. Same is true of other European countries where bond yields are signalling depression, even without ongoing fiscal tightening – e.g. Sweden.

      • Redshift said, on August 19, 2011 at 2:46 pm

        Firstly, I’m not suggesting a planned economy but an active state. I’m not sure you’re the person who is going to give me a useful answer if that is your reaction to what was a pretty harmless (if ignorant) question.

        Secondly, whilst my understanding of economics might be somewhat limited what is patently clear about the UK economy is that the level of demand in the economy is not correct and that it should be taken somewhere different. Interest rates are on a record low anyway, so I’d have thought intervention through fiscal policy would be appropriate – afterall, the fiscal policy of the government has massively reduced demand through over-zealous spending cuts.

        I appreciate that this article is about the crisis in the Eurozone but my question is more about the nature of QE, something that beyond ‘(electronically) printing money and buying bonds to stimulate lending and thus growth’ I don’t really understand.

    • Dave Holden said, on August 20, 2011 at 10:47 am

      As I understand it both Krugman and Posen support QE, John Hussman on the other hand puts well what’s wrong with QE

      http://www.hussman.net/wmc/wmc110815.htm


      Without question, one of the notions buoying Wall Street optimism here is the hope that the Fed will pull another rabbit out of its hat by initiating QE3. That’s a nice sentiment, but it does overlook one minor detail. QE2 didn’t work.

      Actually, that’s not quite fair. The Federal Reserve was indeed successful at provoking a speculative frenzy in the financial markets, which has now been completely wiped out. The Fed was also successful in leveraging its balance sheet by more than 55-to-1 (more than Bear Stearns, Lehman, Fannie Mae, Freddie Mac, or even Long-Term Capital Management ever achieved), and driving the monetary base to more than 18 cents for every dollar of GDP – a level that requires short-term interest rates to remain below about 3 basis points in order to maintain price stability ( see Charles Plosser and the 50% Contraction in the Fed’s Balance Sheet ). The Fed was indeed successful in provoking a wave of commodity hoarding that affected global supplies and injured the poorest of the poor – particularly in developing countries. The Fed was successful in setting off a very predictable decline in the value of the U.S. dollar. The Fed was successful in punishing savers and the risk averse, and driving investors to reach for yield in risky investments that they would normally avoid were it not for the absence of yield. The Fed was successful in provoking those with strong balance sheets to pay down existing higher interest-rate debt, and in creating an incentive for those with weak balance sheets to issue more of it at low rates, resulting in a simultaneous deterioration of credit quality and compensation for risk in the financial system. The Fed was successful at boosting the trading profits of the banks that serve as primary dealers, by announcing precisely which securities it would be buying prior to Treasury auctions, and buying them on the open market a few days later from the dealers that acquired them. The Fed was successful in creating a portfolio of low yielding securities that will be almost impossible to disgorge without capital losses unless the Fed holds them to maturity. On proper reflection, the list of the Fed’s successes from QE2 is nothing short of stunning.

      It is beyond comprehension why anyone would wish for more of this recklessness. “

    • Dave Holden said, on August 20, 2011 at 11:34 am

      @Redshift, I’m not an economist either but in may ways most economist have forgone the right to claim superior knowledge given the complete failure of their models in recent years.

      Steve Keen is currently putting his Behavioural Economics lectures up at http://www.youtube.com/user/ProfSteveKeen. It’s shocking how much of neoclassical economics is bogus.

      “Why don’t governments directly spend on areas that will deliver a social good – like building council houses, investing in green manufacturing, etc rather than using seemingly directionless mechanisms like QE? ”

      Euro countries have their own particular problems because they don’t have control of their currency but in the case of the UK I think it’s because QE is neither borrowing more money nor is it seen as printing money, I think people describe it as an asset swap aimed at affecting interest rates. Both of these points however I’ve seen questioned by people much more knowledgeable than me on the subject and it’s clear that, certainly QE2 implement by the Fed was inflationary as it caused a bubble in commodity prices hitting business and consumers where it hurts.

      For governments to spend directly into the economy they would have to either borrow or print the money. I think the main argument against this is that in the first instance you are increasing your debt levels and secondly its inflationary which in turn would effect borrowing rates. I think Krugman is on firmer ground here in arguing that certainly in the short term this is less of an issue than the lack of growth.

      The other argument against direct spending is that governments are notoriously bad at allocating assets and there is a risk of malinvestment and cronyism. In the case of the UK I agree with you building more houses would be a very good investment however I suspect in the back of some peoples mind is what that would do to house prices further undermining the value of a lot of banks assets..

  4. jomiku said, on August 19, 2011 at 1:40 pm

    I think much of the anger at Krugman is because he has been right. People don’t like to admit they’re wrong. Some of the worst offenders are the brightest people: they become locked into their world views and intellectual structures of belief. And then there are the ideologues, meaning sometimes the overtly religious and other times those who say they proceed from first principles – notably Austrian School followers – but who are literally unable to see they’re only trying to impose a theology.

    My comment on the post is this: we are a short-sighted race. Lots of business people argued for or at least went along with austerity measures: they would benefit from less regulation, perhaps lower taxes (excluding the VAT rise) and from vague promises of better times and they loved the idea of reducing social service structures for people they think are undeserving or which they see as waste. They bought into it. They discounted the many warnings about how this would affect economies. Why do people not listen? In this case, you had ideology about government coupled with ideology about how economics should work, but the main reason a person listens is they’re predisposed to hear what you’re saying.

    Why would people be predisposed to listen to the same people who created the financial crisis? To the same people whose models said it couldn’t happen? To the same people who were creating huge debts? (I know it’s somewhat different in the UK because you switched from Labour to Tory, but how much of the financial sector votes Labour anyway?) I’d say the reason is pretty simple: you can’t admit you’re wrong and so you buy the next piece of shite they sell you because you need to believe this piece of shite is better than the last. The alternative would be admitting people like Paul Krugman are right, which after nearly 3 years of 0 rates should be obvious but isn’t. They would have to admit they’re wrong, that their beliefs are wrong.

    Historians ask questions like this all the time. Why didn’t Germany surrender? Why would the South fight on through 1864 when the only effect was death and more destruction to the South? Scientists deal with this all the time, especially in biology. Two of the three GOP leading presidential candidates don’t believe in evolution, which outside the realm of political nonsense is frankly astounding.

    So shortsighted business people who bought into austerity will now find their own businesses will suffer because they couldn’t believe austerity would hurt the economies. One of my favorite Picasso’s is a wall hanging in the Barnes Collection. It’s a man sitting in a bed with a cigarette as a figure behind him cuts the man’s throat. It’s a joke: smoking in bed will kill you. But people do.

    • gastro george said, on August 19, 2011 at 6:16 pm

      Excellent post, jomiku. What we have right now is that those 90+% of economists and businessmen who have bought into the theology are in a state of denial. These are men (and they are mainly men) who no longer have any answers, because their model doesn’t work – and that is one big reason for the current panic. You have people going into broadcasting studios helplessly saying that there are no policies left – which is patently untrue. It’s just that they have no policies left.

      From other posts:
      “Because QE is free, and running a deficit is not free (you pay for it with future taxes). So why should QE *not* be the first choice?”

      Because it doesn’t do anything, apart from indirectly propping up asset prices?

      And the idea that the deficit is paid for by future taxes is an act of fortune-telling.

      ” 8/9 of the economists on the MPC voted that the level of demand in the economy was about right, in August. Are they all incompetent?”

      See above.

      “…what is patently clear about the UK economy is that the level of demand in the economy is not correct …”

      Absolutely.

      “Why don’t governments directly spend on areas that will deliver a social good – like building council houses, investing in green manufacturing, etc rather than using seemingly directionless mechanisms like QE?”

      Absolutely. If the government should spend, it should spend money that will contribute to the local economy – spend it on those that will then spend it locally, rather than squirrel it away.

  5. Alex said, on August 19, 2011 at 2:12 pm

    Not quite. The markets are saying:

    “You are not fucked, but your lunch is on a plane to India or China and it’s not coming back so get used to it.”

    You remember those people telling you that all kids had to go to university to get a job, well India and China have those same graduates and they work for a third of the price of Western kids but with the same added value.

    So while your engineers, IT staff and factory workers have got used to the downward pressure of foeign wages, now Western bureaucrats and state employees need to do the same.

    A state employed surgeon thinks he is worth 200 grand fixing the hips of old women who have never paid a days tax or social security. Think again. Nothing wrong with the operations, just don’t expect to be paid so much when everyone else has their pay determined by China.

  6. […] Duncan Weldon is terrified by bond yields: We have falling equity prices, falling commodity prices, record low bond yields across UK, Germany and the US and the worst hit shares are financials (where rumors of problems in the European banking system are once again circulating) and those most exposed to global growth. […]

  7. […] same people whose models said it couldn’t happen. To the same people who were creating huge Debts. (I know it’s somewhat different in the UK because you switched from Labour to Tory, but how […]

  8. […] that unemployment is inevitable, or that all consumption is now welfare reducing. Still others that the Chinese are our rightful masters – submit! although poor old Europe runs a trade surplus. And of course these aren’t the only […]


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