What Would a Conservative Do?
links for 2010-07-01

Can't Anybody Play This Game? Diagnosing Our Economic Ills

Why oh why can't we have a better press corps?

The leader in the Economist:

Global economic policy: Austerity alarm | The Economist: supporters of the shift to austerity believe it is both essential and appropriate: deficit spending cannot go on for ever, and by boosting firms’ and households’ confidence and lowering the risk premium on government debt, well-designed fiscal consolidation can actually boost growth. Jean-Claude Trichet, president of the European Central Bank, argues that fiscal thrift will increase private spending by reducing uncertainty about government tax policy and debt.... Mr Krugman’s crude Keynesianism underplays the link between firms’ and households’ behaviour and their expectations of future tax and spending policy. For example, firms across the rich world are hoarding cash. Their reluctance to invest may have more to do with regulatory, financial and fiscal uncertainty than weak consumer demand.... If governments address those worries, businesspeople may start spending.

If businessmen fear regulatory, financial, and fiscal uncertainty, then--since businessmen are also investors--investors fear regulatory, financial, and fiscal uncertainty. Fiscal uncertainty raises interest rates on government debt: you don't know how depreciated the currency you will be paid back in is, or what the tax rate on your interest and principal will be, and so you demand a high interest rate before you lend to the government. Similarly with regulatory and financial uncertainty: they both make moving purchasing power from the present in the future by lending to the government risky.

Whenever businessmen fear regulatory, financial, and fiscal uncertainty, investors fear it too. When investors fear regulatory, financial, and fiscal uncertainty, the interest rates governments must offer in order to induce investors to accept their debt are high.

The leader-writers in the Economist could have called their own Buttonwood to ask about interest rates. But they didn't.

So let's do it ourselves: Hey! Buttonwood! What about interest rates?

Buttonwood replies:

Banks, credit and bond markets: Pincer movement: WHILE the big equity market falls may grab the headlines, there is a lot going on in the bond and money markets. Risk aversion has sent the 10-year Treasury bond yield below 3%. And the Federal Reserve's apparent commitment to keep short rates near zero for an extended period has had a dramatic effect on the two-year bond, where the yield is anchored to short rates. The yield is now just 0.6%. Meanwhile, continued concern about the health of the banking sector, heightened by the imminent withdrawal of one-year funding from the European Central Bank, has caused a jump in Libor, the rate at which banks borrow and lend from each other. As the graph shows, the three month dollar Libor is almost as high as the two year bond yield and the six-month rate is above it...

Investors don't fear the government to any unusual extent. Rather, they appear willing to trust it to maintain the value of the currency and not to impose confiscatory taxes on investors.

That simply doesn't fit claims of unusual regulatory, financial, and fiscal uncertainty.