Recent financial news has highlighted a paradox: as the US finds its credit rating downgraded, the extra it has to pay on its bonds to convince private investors to buy them have fallen. Yields of government debt – meaning the overall rate of return available on government bonds – have fallen, making it cheaper for the US government to borrow than before. A similar phenomenon exists in the UK: as the economy heads towards another recession, investors are keener to hold government bonds than before the ‘double dip’ recession debate began. In fact, they are so keen to do so that yields on UK government bonds have fallen to a historical low (a hat tip to Lee Jones for the graphic).
An obvious question to ask is why this is happening. Do private investors have secret information about the US and UK economies making their bonds particularly attractive? Not at all. The movement of bond yields reflects a change in sentiment amongst investors about the future of stock markets across North America, Europe and Asia. Investors increasingly think – based on bad economic data and ongoing crises – that stock markets will be bearish (losing value) for a long time to come. In comparison with that, government bonds seem like a reasonable investment. What are driving down yields are the poor growth prospects of OECD countries. In Switzerland, investors are fighting to hold government bonds whilst in Japan many are turning to gold instead of bonds, melting down individual gold holdings (jewellery, even teeth) to resell the gold as a way of profiting from surging gold prices. As ever, investors want to put their money where they will get a good return. If the stock market isn’t performing, the money will go elsewhere. Into government bonds, into gold, and anywhere else where there is a decent return.
Another question is whether falling yields are a good thing or not. They are announced in the language of doom and gloom but presumably it’s a good thing for those governments who can now borrow at a lower rate. Compared to the borrowing problems of Italy, Greece and Spain, who are having to pay interest rates of up to 6% if they want to finance their borrowing on the international markets, the US and the UK can borrow cheaply. Doesn’t that mean that they can spend their way out of the current downturn?
There are a number of problems with this. The first is that the lower yields are only part of what is otherwise a very gloomy picture. That government bonds may start outperforming equities is a trend associated with Japan over the last 20 years, prompting a debate amongst journalists, economists and analysts about the likelihood of ‘Japanisation’ of Western economies. In general, lower yields will not do anything to solve the underlying problems of an anaemic private sector. As is widely reported, a difference between today and the crisis in 2008 is that credit markets have not dried up and big companies are sitting on large amounts of cash which they have accumulated in recent years. But they are not investing it in a new round of capital accumulation.
A second problem is about what governments should do if their yields are lower. This may undercut those arguing for the necessity of more austerity but even here the argument is increasingly nuanced. IMF head, Christine Lagarde, recently argued publicly for mid-to-long term government debt reduction coupled with short-term fiscal stimulus. The Financial Times recommended over the weekend that in place of universal fiscal retrenchment we should opt for an internationally coordinated move that includes fiscal tightening for some but not for all. It has finally dawned on policymakers that if everyone is cutting their spending, then the economy will bomb. But this takes us to an issue that we’ve discussed before on the Current Moment – the pros and cons of government spending. The technicalities are vast, as are the different options. The existing approach of quantative easing by the Federal Reserve in the US hasn’t worked. More controversial moves, such as job creation programs, have not been tried yet. There are many things governments can do to try to stimulate the economy but these will ultimately be determined by political factors. The options chosen by governments will reflect the balance of forces in society. The stock market downturn may make borrowing cheaper for some governments, but it will not change these balance of forces.
In and of themselves, the changes we are seeing – falling yields, falling equity prices, fluctuating exchange rates – only become good or bad when placed within a wider analysis of the political economy of the current moment. Lower yields may seem to give some governments more options but given the state of play politically today it is unlikely that any of the more radical options will be chosen.