Sunday 10 February 2013

UK, US, Australian + the PIGS Government 10 Year Government Bond Yields – February 2012 update

10 Year UK, US and Australian Government Bond Yields 
Click to enlarge

 Click to enlarge

I haven’t published these datasets for 20 months now because as far as the UK is concerned it’s really been status quo.  The UK Government have continued to run a budget deficit that isn’t sustainable.  There isn’t any of the promised austerity because government spending is actually rising.  This combined has resulted in the UK National Debt reaching around £1.13 trillion today.  That’s £18,021 of Debt for every man, woman and child in the UK.  Less than half of the population work in the UK, 29.17 million people working against a population of 62.64 million, so comparing the debt to this group means a debt of £38,699 for every worker. 

Government forecasts project the debt continuing to grow quickly with it reaching £1.5 trillion by 2016.  Meanwhile in parallel the Bank of England has “bought” £375 billion (33%) of that debt through the Quantitative Easing (QE) programme.  This has had the effect of forcing UK bond yields down to historic lows when under the scenario described in the first paragraph yields should have risen which would have forced the government to take action rather than masking the problem.  Now it’s important to remember that for bonds already in circulation that as yields fall prices rise and that’s what we’ve been seeing happening for a number of years now.  It is however important to remember that the opposite can also happen.  Should that happen not only would the cost of borrowing for the Government rise but also other debts like mortgages would also rise.  That would reduce affordability and would in my opinion reduce house prices (and other asset prices) helping the value argument here.  Instead of asset price deflation we’re seeing just about every asset type either holding or increasing in nominal value including housing, shares and hard assets like gold which to me seems to be making the problem we have even worse.  

I’m therefore watching government debt yields closely and what its showing is that since August 2012 those yields have been rising despite the Bank of England announcing another £50 billion of QE in July 2012.  This is not showing in mortgage rates yet because the Treasury and Bank of England are distorting the market independently there with the Funding for Lending Scheme. 

To me it seems like a lot of plates are now spinning in the air.  Will they be able to keep them spinning until the recovery arrives?  Now I’m not one of the highly paid Economists or Bankers that have come up with all of the schemes to save us all from the pain I believe we should have had but from where we are today I can’t see how what we have embarked upon will ever result in a recovery.  I believe we still need the asset price crash and subsequent debt write offs that should have occurred before we can move on.  Here’s the only way I can see it playing out from here:
  • Option 1 is the option that I think the Bank of England and Government will take because they’ll try and stave off the inevitable until the very end to try and keep asset prices high.  This means the Bank of England will continue to buy bonds in an attempt to keep yields down through QE until at some point the markets realise that the level of QE is so large that the debt can never be sold back to the market.  This will leave the Band of England with no choice but to start to monetise the debt.  This will quickly devalue the currency, result in large levels of bond selling, rising interest rates, uncontrolled inflation and subsequent asset price deflation.
  • Option 2 is the option where the Bank of England doesn’t continue to QE because it’s futile.  This would then mean the main buyer of UK debt leaves the market which should result in rising rates, controlled inflation (possibly even deflation) and subsequent asset price deflation.

Under both scenarios we see the asset price deflation that we should have seen when the recession first started.  We see the very bad recession (it will probably be eventually worse than it would have been had it been allowed to play out the first time around) which we should have had which will include the writing off of plenty of bad debts and a lot of asset price deflation.  We can then begin to grow again instead of the dead economy we have seen for a number of years now.  All the powers that be have done in my opinion is to stave off the inevitable and thus prolong the pain.  The only difference between the scenarios is that one will also leave us with an inflation problem.

Does anybody have a more positive scenario to share?

As always do your own research.


  • All yields are month end except February which is the 08 February yield


  1. Option 3

    UK tax rises and spending cuts continue and economic growth gets to a "normal" level of 2% around 2015-2016

    By somewhere between 2017-2020 government spending - government revenue becomes negative and the government can start to retire debt without having to issue more debt to fund it (right now I think the government spends about 6-7% more than it gets in

    I think, from memory, by 2017 or 2018 government borrowing would be around 100% of DGP under this scenario

    In the meantime, government schemes like QE and funding for lending continue to keep the interest on debt for consumers, companies and the goverment artificially low in order to maintain job creation in the private sector, although many of the jobs created make a limited contribution to GDP or the tax base of the country

    To make the correction in government income versus expenditure most central and local government functions apart from health and education would need to have cut their spending by about 40% in real terms over 10 year since 2007

    In the mean time, the UK current account deficit will be funded from foreign investment flows to buy assets in the UK (the current account defecit is about 3-4% of DGP per annum right now I think)

    I don't think this is some random policy I came up with in my head, it seems to be the current government's policy

    The first major weakness in this policy to my mind seems to be the dependance on foreigners to continue to buy financial assets (including government bonds) in a country with such poor economic fundamentals

    The second major weakness is how can the economy reach 2% GDP growth overall when the public sector part (which is half of the economy) is generally contracting. Basically this means that the private sector part of the economy has to grow at nearly 4% per annum (which as far as I'm aware it has never done on a long term basis)

    1. Hi Anonymous

      As you say Option 3 is current Government belief. Ok maybe not belief but what they say to us. It's a belief which just doen't seem real to me.

      Let's look at just one elephant in the room. Mortgages are currently unsustainably low due to QE and the FLS. Banks are back giving 95% mortgages again based on these ultra low rates allowing people to continue to become massively indebted.

      A recovery would mean that the QE and FLS can stop and maybe some of that debt can be sold back into the market. That means interest rates rising and all those home "owners" with their huge mortgages dependent on those unsustainably low rates caused by the FLS/QE distortion are in big trouble. House prices fall and we're back to what should have happened in the first place.

      For it to work what they need is earnings growing at a rate greater than inflation. In the globalised world we now live where when one countries wages become too high they are offshored to a lower cost country I just can't see wages increasing at a rate equal to inflation let alone above it. This will then put further pressure on indebted people as day to day essentials take a greater and greater portion of earnings leaving even less money for debt repayment.

      Your last two paragraphs clearly show you also don't believe government policy. How do you really think it will play out?


    2. Option 3 is exactly what worked after the UK had larger debts after the second world war

      This was called "financial repression"

      The difference is that from 1945-1970s there were strict exchange rate and capital control rules in the UK (and the rest of the world)

      I think sterling was even backed by gold reserves

      Those aspects are quite different now

      So we'll see I guess


  2. Alternatively: Mervyn King retires, Osborne changes the BoE's inflation target to either core inflation (CPI constant taxes - energy, food and drinks) or the level of nominal GDP. The MPC begins to issue forward guidance on policy rates.

    This provides certainty to investors and companies, private sector investment begins to rise in anticipation of increased future demand.

    Nominal GDP starts to rise. Asset prices and tax receipts increase, the deficit falls. Net debt to GDP ratio (a nominal variable) begins to stabilize.

    The extent to which this recession, and ongoing depression in the UK, is due to tight monetary policy from the MPC is really not widely understood. If Carney does half of what he's discussed, the economy could do relatively well over the next five years.

    Note that since Osborne announced Carney's appointment on 26th of Nov, a FTSE 100 ACC tracker has returned 8.2%. In the same period five year inflation (RPI) expectations (based on the Gilt market) have risen from 2.46% to 3.22%. Thus the Gilt market shows no evidence of an impending major increase in inflation. If you truly believe there will be very high levels of inflation over the next decade, short conventional gilts, and buy index linked gilts.

    Option 2 is exactly what happened in Japan 1991. Their economy crashed, again as a result of inappropriately tight monetary policy (which you appear to advocate). Today the Nikkei 225 is just over a quarter of its peak value. It's also exactly what happened in the Great Depression in the US in 1929, see Friedman and Schwartz (1963). Depressions, such as the US 1929-1933, Japan 1991-1997, and the UK 2008-2013 are always and everywhere a symptom of tight monetary policy.

    In every case, investors' returns have been decimated. Given this, why aren't investors demanding looser monetary policy?

    So I'm still a bit confused by your aversion to easier monetary policy. As an investor, which would you prefer, a real return of 10% and inflation of 10% or a real return of -10% and inflation at 2%?

  3. Hi asdasdasd

    Thanks for an alternative view. Certainly some good thoughts in there. Your observation re FTSE price rises combined with an expected rise in inflation upon the appointment of Carney was most interesting.

    Do you see the QE and FLS crutch ever being able to be removed? I'm still struggling to see how we can ever take them away as the interest rate rises would destroy asset prices (particularly housing).


  4. Hi,

    Thanks for the reply!

    If the economy is growing and unemployment is down to a reasonable level (5-6%) and inflation remains above 2%, then sure QE and FLS can be gradually withdrawn and the base rate increased.

    But to tighten monetary policy before the economy has fully recovered could be catastrophic for both workers and investors. As you say there would be asset price falls (houses and stocks) and increases in unemployment and wage cuts.

    Modest levels of inflation is far less harmful than economic depression. For example, a percentage point increase inflation is associated with less than half the fall in welfare associated with a percentage point increase in unemployment, see Di Tella, MacColloch and Oswald (2000):

    What would cause you to demand the MPC do more to support the economy?

    Either way the modest rise in expected inflation and asset price increase after Carney's announcement is a just a correlation, there's no way of knowing what would have occurred if someone else was chosen to be Governor of the Bank of England. Don't read too much into this, between Jan-05 and Aug-08 average Gilt market five year inflation expectations inflation were 2.98%, see:

    Oh, I should have said, fantastic blog, very interesting posts (including this one), it puts most of Fleet street to shame.

    Funnily enough by far the best commentary on monetary policy in the UK is another anonymous blog:

    Simon Wren-Lewis is also pretty good:

    1. Hi asdasdasd

      Thanks for the detailed response and thanks for links to the two blogs. I wasn't aware of those two and have added them to my reading list.


    2. All well and good...except austerity seems it might actually work in the Eurozone periphery

      Contrast Ireland's growing economy coming close to exiting its IMF program and Portugal's exports to non-EU countries being up 20% to non-Eurozone countries with the UK's woeful economic performance

      Admittedly these countries are now able to grow because their economies crashed hard because public spending was cut very sharply and taxes rose, but they did enact supply side reforms

      In the UK by contrast, no meaningful public spending cuts + no real tax rises + no real supply side reforms = no growth