Fiscal default is nigh, insist the doomsayers: repent and retrench before it is too late. Yet I have a question: do we believe that markets are unable to price anything right, even the public debt of the world’s largest advanced countries, the best understood and most liquid assets in the world? I suggest not. Markets are saying something important.
On Monday, the yield on 10-year government bonds was 1.1 per cent in Japan, 2.6 per cent in Germany, 3 per cent in the US and 3.3 per cent in the UK (see chart). Based on yields on index-linked securities, real interest rates on borrowing by these governments are very low (1.2 per cent, or less, in the US, Germany and UK). Investors are saying that they view the risk of depression and deflation as greater than that of default and inflation.
This is the moral: if you want to know what the bond market thinks, do not listen to the words spoken by any of its participants. Watch what it does instead.
Government borrowing has been consistently cheaper since the end of 2008 than it was in the couple of years before the crunch. And the recent fall can hardly be attributed to the new anti-deficit government: it dates back to the start of the Greek crisis and extends beyond the UK.
A caveat is that, as those of you with memories stretching back two or three years may suspect, the prices that markets allocate are not always right.