Alasdair Macleod – 3 March 2010
This last week will probably go down in history as the time markets stopped taking governments on trust. The importance of this statement should not be underestimated: it is the switch from markets accepting that policies such as quantitative easing are appropriate to economic circumstances, to a realisation that they have led governments into a debt trap, from which there is no escape. The evidence of this momentous change is in sterling’s devaluation, and events have now moved on from a little local difficulty for Greece.
The fact that markets are now driving the agenda comes as a blow for both Keynesians and monetarists, who doubtless believe that given time their remedies will work. That this is based on no more than pure faith was admitted by Roger Bootle in the Daily Telegraph, where he writes a Monday column, and I quote:
“Although on many issues I am from the ‘Right’, I am an out and out Keynesian. That means that I do not believe that the markets are always right and that indeed sometimes they can behave downright stupidly. Moreover, there is a problem of collective action that competing individuals and institutions cannot solve. So there is a key role for the state in managing the economic system.[i]”
So there you have it: he’s got belief; he’s got religion. He qualifies it by saying that markets can behave downright stupidly, without offering any evidence. Presumably he draws on his experience, which will be entirely post-Keynes, so like all today’s economists he has never seen free markets. It is from these people that governments draw their advice; advice that has led us into collective insolvency.
The debt trap did not take long to spring. The UK printed its entire budget deficit and more as an exceptional measure during 2009. It is staggering to think that net investment in gilts by domestic and foreign buyers was zero, and it raises the question as to whether this was because of a deliberate act of monetary policy or the buyers were not there. Whatever the truth, markets are now refusing to accept QE prestidigitation twice. The Government now has to fund another £140bn for fiscal 2010/11 on its own forecasts, which incorporates 3.25% growth in GDP. Now that there are signs of this growth faltering, it will be considerably in excess of this. Where is the money to come from?
Domestically, it is not there, because the yields are not attractive enough to generate savings; and the international investment pot which is contracting is now risk-averse. If the Bank of England raises rates to encourage demand for gilts, the deficit spirals out of control due to the deflationary impact and the added financing burden. Alternatively, if the bank is seen to rely on QE for more than a minor part of the borrowing requirement, the currency will collapse. This is the classic debt trap.
It is not just Britain with sterling, and the PIGS with the euro facing a credibility problem. Various commentators in America from Bernanke downwards are drawing our attention away from the Euro to the dollar and California, or any other of the many states in difficulty. For paper currencies, it is a strategy of all sinking together and hoping no one in the parallel world of reality will notice.
There is no other Plan B, and the global authorities are now loosing control of bullion prices. How they can now make good on the promise to rescue failing banks is not clear, and not much has to happen for a bad situation to turn much worse. Even if there was a volte-face by the Bootles of this world, it is too late to save the situation. The markets are at long last reasserting themselves.
[i] The Telegraph article is here.