Markets. Why they are important.

[Alouiseg]

I've posted this elsewhere on a different thread but it's cropping up all over the place.

In all capitalist and free market democracies the government is kept in check by the bond market. When society requires new hospitals, schools, roads or an increase in its social welfare payments then the bond market decides whether and by how much they have to available to spend.

When you vote Labour because they will provide greater amounts in your benefits each month, or promise pay hikes for your school teachers and nurses or even fix the potholes in the roads they raise the money borrowing from the bond market, which is comprised of worldwide and domestic investors, banks, hedge funds, speculators and traders. If this collective group, known as the bond market decide that the government is spending beyond its means, or continually making poor decisions then it insists on receiving a larger return on its investment to compensate for the increased risk of default.

In the case of Greece, who were charged 15% interest on their Drachma borrowings to then be allowed to borrow at the German rate of 4% when they adopted the Euro, they did not re finance their debt and borrow to invest wisely they started a spending binge to such an extent that the country is now unable to borrow enough money to meet its due obligations without the joint aid of a $960'000'000'000 bailout from the USA, UK (yes its costing us £15'000'000'000) and Europe.

The UK, under "New" Labour have borrowed more than Greece. It is only the fact that we are not in the Euro and still control our own currency and interest rates and its is still likely that the fiscally prudent Conservatives will gain power that the yield charged to our government borrowings has remained fairly low albeit has risen significantly since the hung parliament.

If Labour retain power then it is extremely likely that the bond market vigilantes will punish this by demanding a much higher yield on our enormous New Labour borrowings. We currently pay in excess of £60'000'000'000 in interest alone which would triple if we were on a par with Greece. Sterling, which already fell 1.50 points against the dollar and 0.90 points against the Euro merely because Gordon Brown resigned making it more likely that Clegg could deal with Labour, would collapse in an inflation fueling rout. Imagine if Labour retained power... £1 to $1 and £1 to E0.50 ? Inflation inflation inflation.

This article expresses the problem for me, especially this bit;

"These bodies that see public debt as a burning issue today foresaw no problems with the unsustainable private debts of the banks investing in sub-prime holdings a few years ago. "The vast majority of the analysts at Moody's [one of the leading ratings agencies, and seen as the most likely to move on the UK's debt rating] are honest individuals who try hard to do their jobs," Eric Kolchinsky, a former managing director at Moody's told a US Senate subcommittee on investigations a few weeks ago. "However, the incentives in the market for rating agency services favoured, and still favour, short-term profits over credit quality."

There's a reason for this. These agencies are primarily funded by the banks that they are supposed to be rating, creating what several former officials testified was a fundamental conflict of interest. In the words of Upton Sinclair, "It is difficult to get a man to understand something when his job depends on not understanding it."

So the very sector we bailed out with public money, run by incompetent people who are once again paying themselves bonuses, is now threatening to destabilise the next government unless it fires thousands of low-paid workers, cuts their wages and withdraws the services to millions of mostly poor people.

It's as though you borrowed money against your home to save a wayward relative from penury only to have them roll up a week later in a brand new Porsche and tell you to cut your food bill or they'll repossess the property."

www.guardian.co.uk/commentisfree/2010/may/10/people-markets-democracy-capitalism

Ok.

So we have established that Gordon borrowed too much.

My next question is what did he spend it on?

On market regulation, I work for a financial institution, and I am totally for it. There needs to be better regulation, unfortunately the FSA has been particularly slack over the last few years. It is a pain - the Fed is much more active (though obviously they could have done more), and it does make things easier, particularly if you're in the position of having to say "no" to deals and transactions. If you can say "no - there will be legal and regulatory repurcussions", and there actually are, it is much better.

Thanks Alouiseg, I for one really appreciate the time it must have taken you to write that.

On whilst we're on the subject of Greece can we just remind ourselves that the main problem in Greece has been corruption - money has been borrowed against the government but not spent in the way promised. Much of the money is currently absent from the Greek account books.

British debt is being invested in the country and can be accounted for.

It's a bit like the difference between a business borrowing money to buy machinery and take on new staff, and borrowing money to have a massive piss up.

But it doesn't matter what you spent the money on, you still have to pay it back.

But your ability to pay it back depends on what you did with it. Your assuring your creditors that you spent it on what was agreed when you borrowed it protects your credit rating - see above post about Greece.

Of course it does. But the government didn't spend money on income generating investments. Hospitals and schools are undisputedly good for the country but they don't earn an income. (Obviously a well educated and healthy workforce will earn an income one day, but that will be in the long term, not within the next 2 to 5 years.)

Well it does really depend what you spent it on. In the same way that if I blow my pay on a diamond ring I don't really have anything to show for it. If I spend it on an OU course, then I may be able to get a better job with better pay because of that.

If GB spent the cash on schools then it is an investment in the future.

Income generating investments are not the only way of stimulating an economy. Anyway the government did spend money on income generating investments when they bailed the banks out and when they converted some of the country's gold reserves into invested currency reserves.

Moodys, the rating agency, said yesterday that it wil wait to see who eventually ends up in te UK coalition Govt and what budget it publishes before deciding whether to downgrade the UK Govt debt.

If they did downgraded, interest rates throughout the economy would immediately rise. That woudl affect us all and immediately.

It seems from the news that the Lab-Lib alliance is now definitely off and the Gilt market is still rising on the basis the Lib-Con alliance will happen. That is good for the economy and all of us and our children who will have to eventually pay the money back.

Sometimes speculators and markets do things we like as smallwhitecat rightly says.

Hasn't Gordon Brown spent a lot of it on hiring people/paying benefits, so that now for the first time more than 50% of the country gets their money from the government, leaving less than 50% to work in the private sector... something which is the long run is unsustainable? Figures may not be right, this is something DH was blabbing on about the other night while I was watching rather an exciting episode of Lost!

Beachcomber - agree with you about Greece and that is probably why the bond Market is reasonably relaxed about the UK at the moment.

Mme.Lindt - Glad you liked the Paul Mason blog. I follow him on Twitter and bore impress my dh with his every tweet!

FWIW - I also don't think the bond markets should decide the UK government. But because we owe them so much, the interest rates we pay (which they set) will impact us significantly

Lymond that is my understanding too, that a lot of it has been wasted rather than invested in infrastructure.

I think there is clear confusion here on the role of the markets and the role of government.

So I'd like to address the points made by Policy and Mme Lindt about the government being effectively held to ransom by the markets.

Government borrows money from the markets. It pays interest. The rate of interest will go up (and we will have to pay more interest and have less to spend on education, health, benefits etc) to the extent that the UK is viewed as a bad credit risk

Bond yields vary according to the length of time, the currency and the credit rating. So AAA is a high investment grade which will attract a low rate of interest. Greece's bonds were trading at a yield of around 40% at the height of the crisis.

The fact is that the Labour government has been less fiscally prudent, we are in a significant amount of debt and our credit rating is vulnerable. Another Labour government - with no solid plans for how to address the deficit - would have had an impact in the international markets.

No-one is holding you, the electorate to ransom. It's merely that your vote has consequences.

If the UK had shrunk the public sector wage bill and borrowed to build, say, a fantastic broadband and rail network that I really would have been happy about.

Borrowing to invest is what markets like but borrowing to spend they don't.

Quatt - you summed up what I was thinking.

It's not as if the markets are telling us what to do, just that they will react to our actions.

There's no point us shaking a fist at them, any more than a sailor shaking his at a storm. It is what it is.

As to what Gordon spent it on, he spent it on:

1. Massive increases in health spending - the figure I saw was 300% in real terms

1. Wars and stuff

1. Lots on education - not seen the like for like figures

The Market and people who claim to represent The Market are two different things.

The Market is a complex system made up of all the participants - this includes all of us though in most cases by proxy. It can't have emotions, opinions, morals or be regulated anymore than the sea can.

What we does have all those things is the participants in the markets. This is why economic theories are important. Not because they are true but because people believe in them, so if you know that certain people will do certain things as they hold certain beliefs you can make money from them.

And a fair bit did go on bailing out the banks. Though hopefull we will see a return on this.

Quatt, it's not so much (right now) that the market is holding us to ransom. It's that people are running around saying that the markets are holding us to ransom (ie 'the markets will punish us if there's no deal soon!') and trying to use that line, as MmeL says, to force the democratic process. AFAIK the markets have been relatively sanguine.

policywonk- I love this "'I wanted the Tories to win, I had the champagne in and everything, and I am beyond furious'"

I've been thinking that all kinds of people have been running around saying "It's MORALLY wrong that I didn't get the result I wanted. So someone should give it to me" ;)

Interesting post Quattro.

I agree that we are not being held to ransom by the markets, but pressure is being applied to affect a swift deal, using the markets as an excuse.

Policywonk - That's one of the things I meant to say. There is NOONE who can speak for the Markets. Everyone who purports to do so is doing it to support their position in the Market. To encourage something to happen that they want to happen or to make people THINK that they want a particular thing to happen.

The problem with regulation is that you can't regulate markets. You can only regulate the participants in the market - so the results of regulation are very unpredictable. This doesn't mean you shouldn't try.