Pricing political stability

Government borrowing costs have little to do with a country’s debt level but quite a lot to do with its perceived stability. That is why a country like Japan, whose debt as a proportion of GDP is one of the highest in the world, pays interest at 0.03 percent on its bonds. Oil rich countries like Russia, Venezuela and Nigeria, with much lower levels of debt, pay significantly higher rates of interest; 7.5 percent for Russia, over 10 percent for Venezuela and a staggering 16 percent for Nigeria.

Countries with governments that might do something bonkers are perceived as a much greater risk than those with populations that pay their taxes and elect moderate governments. Stable and boring countries are a lot less risky. Most stable and boring of all are the Swiss who charge investors a small fee for lending money to their government.


Source: Trading Economics

But occasionally, even countries perceived to be strong and stable do something a bit crazy, like elect a volatile and clearly incompetent president. It is unlikely that Donald Trump will be able to do any lasting damage. The checks and balances of the American state will see to that. The cost of servicing US government debt is still therefore relatively low when compared to much of the rest of the world. Nevertheless, the fact that they could put someone like Mr Trump in the White House at all makes Americans seem that bit less reliable than they once were. Consequently, compared to other safe-bet countries, US borrowing costs have crept up.

Historically, though, all government bond yields are low. In uncertain times, people look for safe places to park their money. Government bonds provide such safe places and the more people there are who want to lend money to a government, the less that governments has to pay to borrow. Therefore, though it may look perverse, as UK government debt has risen, the interest rates on that debt have fallen. Both are, to an extent, consequences of the recession. Government borrowing went up but so did the search for safe assets.

Chart by Economics Help

Should we, then, be worried about Moody’s downgrading the UK government’s credit rating? In the short-term probably not. Ratings don’t seem to make much immediate difference to government borrowing costs.

Nevertheless, Moody’s assessment of the UK was scathing:

Moody’s believes that the UK government’s decision to leave the EU Single Market and customs union as of 29 March 2019 will be negative for the country’s medium-term economic growth prospects. Aside from the direct impact on the UK’s credit profile, the loss of economic strength will further exacerbate pressures on fiscal consolidation.

Growth has slowed in recent months, with average quarterly growth of just 0.26% in the first two quarters, versus an average of 0.6% over the 2014-2016 period. Private consumption has slowed sharply and business investment has been weak since 2016, most likely linked to the Brexit-related uncertainty. While future years may see some recovery, Moody’s expects growth of just 1% in 2018 following 1.5% this year and 2.25% on average in recent years.

More importantly for the UK’s credit profile, Moody’s does not expect growth to recover to its historic trend rate over the coming years. The UK is a relatively open economy, and the EU is by far its largest trading partner. Research by the National Institute of Economic and Social Research (NIESR) suggests that leaving the Single Market will result in substantially lower trade in goods and services with the EU. In a similar vein, both the NIESR and the Bank of England estimate that private investment will be materially lower in the coming years than in a non-Brexit scenario.

Moody’s is no longer confident that the UK government will be able to secure a replacement free trade agreement with the EU which substantially mitigates the negative economic impact of Brexit. While the government seeks a “deep and comprehensive free trade agreement” with the EU, even such a best-case scenario would not award the same access to the EU Single Market that the UK currently enjoys. It would likely impose additional costs, raise the regulatory and administrative burden on UK businesses and put at risk the close-knit supply chains that link the UK and the EU. Also, free trade arrangements do not as a standard cover trade in services — which account for close to 40% of the UK’s exports to the EU and 80% of Gross Value Added in the economy — given the prevalence of non-tariff trade restrictions and the need to align regulations and standards. In Moody’s view, the differences of outlook between the UK and the EU suggest that the most likely outcome is now a rather more limited free trade agreement which may exclude services: the UK’s desire to pursue its own regulatory policies and to avoid the jurisdiction of the European Court of Justice will make finding an agreement on services challenging. Moreover, any free trade agreement will likely take years to negotiate, prolonging the current uncertainty for businesses.

Aside from the direct impact on the UK’s credit profile, weakening growth prospects are likely to exacerbate the government’s evident fiscal challenges. And this is likely to be happening during a period in which policymakers will be increasingly distracted by the twin challenges of sustaining a domestic political consensus on how to operationalise Brexit and reaching agreement with EU counterparts.

In other words, Brexit has made a bad situation worse. Although the rate the UK pays on its borrowing is low, it now has a lot more debt relative to GDP than it has had for several decades. Even small rises in the costs of refinancing that debt will put extra pressure on public finances.

As I said before the Scottish referendum, there is a lot to be said for living in a 300 year-old country with a reputation for political stability. Voting to leave the EU dented that reputation. The government’s poor handling of the aftermath and the antics of some of our government ministers haven’t done anything to repair the situation. Sure, it’s still unlikely that a British government will do anything completely mad but we don’t look as strong and stable as we once did. Over time, the cost of government borrowing is likely to reflect that.

It is ironic, then, that some of the politicians who told us in 2010 that if we didn’t control the public debt the bond markets would slaughter us, are the same politicians who have brought us to this pass. Some of them want us to go further and quit the EU without paying anything. They tell us that electing Jeremy Corbyn would make the UK like Venezuela. Yet unilaterally repudiating an international treaty would be more Venezuelish than anything a UK government has done in decades. It would be a sure-fire way of making us look like a basket-case.

The rest of the world thinks we are a bit crazy but, for now, seems to be giving the UK the benefit of the doubt. The Brexit vote was an uncharacteristic outburst from a usually sober and rational nation. Despite the ridiculous posturing of some of our politicians, people still believe that something sensible will be sorted out eventually. But the closer we get to the Brexit deadline without any meaningful progress, the more risky the country will start to look. Being volatile, bonkers and a bit maverick might look like fun but there is a price to be paid for it.

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22 Responses to Pricing political stability

  1. tom says:

    A really important dimension: both the political and the economic cost of our lowered reputation – for the reasons made clear by Moody’s and your piece – will be long-lasting and significant. God knows how bond markets price these kinds of effect, and I don’t have much faith in the price they arrive at, but it will cost us.

    • gunnerbear says:

      Ahh, yes Moody’s…one of the agencies that utterly failed in their job to price risk in the run up to the Crash…..f**k ’em.

  2. Perry525 says:

    As a Sovereign country, issuing our own currency, there is no limit to the amount of money the Government can create. For example, Quantitative Easing. The Labour government rescued the banks, the Liberal/Conservatives and later the Conservatives all continued/continue to create money from the Magic Money Tree. There is no real reason to create Government Bonds or to pay interest on existing Bonds, except, that the very rich need somewhere safe to put their money.

    • Dipper says:

      well, yes. We can wipe out UK government debt with a press of a printing machine button, and we have been doing a bit of that. The problem comes afterwards. Would anyone take a currency seriously when the owners of that currency show such a cavalier attitude to its worth? If I was a company that traded with the UK I think I’d want to be paid in US Dollars. Or Euros.

  3. Jim says:

    FFS! Leaving the EU to become like the majority of world nations that are not part of supra-national proto super States is not like the the UK becoming Venezuela. You Remain obsessed lot really need to have a long hard look in the mirror, and get a grip on reality. Most countries aren’t in the EU, or even the EEA, and last time I looked countries like Australia, Canada, Chile, Switzerland, Japan and India aren’t descending into social chaos. Yet apparently the UK becoming an independent sovereign State like them is the end of the world.

  4. Dipper says:

    “They tell us that electing Jeremy Corbyn would make the UK like Venezuela”.

    It isn’t Conservatives who say that electing Jeremy Corbyn would make the UK like Venezuela. It is Jeremy Corbyn who says that electing Jeremy Corbyn would make the UK like Venezuela.

  5. Dipper says:

    As usual, this analysis relies on Brexit being a radical shift against a settled status quo. That status quo that we were offered at the Referendum has been steadily unwinding ever since; Verhofstadt and Juncker have made it repeatedly and loudly clear they wish to see the end of nationhood within the EU and hence the end of the UK as an independent sovereign nation. Verhofstadt has launched a plan to undermine UK citizenship by offering an alternate EU citizenship creating a ready made fifth column in the UK with an interest in destruction of the nation state. These people are not lunatic fringe politicians, they are dead centre of current European thinking.

    It isn’t us Leavers who are overthrowing 300 years of political stability, it is you Remainers.

    Oh, and would the Moody’s you are taking so seriously now be the same Moody’s in this article? https://www.theguardian.com/business/2017/jan/14/moodys-864m-penalty-for-ratings-in-run-up-to-2008-financial-crisis

    • Moyenda says:

      Perhaps the divergence between the cogent wings of the Leaver and Remainer camps could be (simplistically) characterised as both claiming to advance the interests of the British people but the Remainers emphasising the ‘people’ part of that formula where the Leavers emphasise the ‘British’ part. This split is manifested in the Remainers’ emphasis of economic arguments where the Leavers prefer to talk politics. Your reply here is a case in point: deepening EU integration may be a radical shift from nation-state politics, but undoing the integration that we have is undeniably a radical shift from EU economics.

      I suggest that many Remainers are more concerned about living in an economically prosperous country than in one where their directly elected politicians make all the laws. Whatever you think of the long-term economic prospects of the EU and Britain (I’m with Mervyn King here – I don’t know) it seems pretty evident that the short to medium term economic effects of Brexit will be harmful. We are an economy adapted to and optimised for an environment that we seem set to leave – adapting ourselves to the new environment will take time and resources. To some extent it’s gonna hurt. This is one half of the point made in Rick’s post. The other half is that the management of the process, whatever the end, is important, and that economically significant entities are starting to lose confidence in the UK’s ability to manage Brexit in a manner that minimises the harm that it produces. (Ratings agencies are economically significant, even if they’re sometimes wrong.)

      The best way for Leavers to win the argument on Brexit is, therefore, not to bang on about issues of sovereignty and our lucky escape from the EU superstate but rather to describe the mechanisms through which we will address the real economic challenges resulting from Brexit. Sadly such descriptions seem few and far between (I’d be very pleased to be directed to some) and the competence and coherence of the people negotiating for us is in doubt (the EU appointed a professional negotiator; we plumped for David Davis). When Remainers point out the economic threats to the country, what’s needed is a reply as to how those economic threats will be addressed, not bogeyman stories about the EU and integration. Norway and Switzerland have close, economically beneficial relationships with the EU without fearing for national disintegration. Can we? If, so how? If not, why not?

      • Dipper says:

        It is not possible to talk about Leaving the EU without taking about sovereignty. Sovereignty underlies most of the arguments for leaving. The events since the referendum have reinforced the arguments for leaving with the European Commission becoming increasingly powerful and increasingly confident about making the case for removal of key policy making options from national governments and instead giving them to the European Parliament and the President of the commission.

        For the economy. It is important not to look at the headline projections and numbers and GDP per persons (not that these have any real meaning in a post Brexit world) but instead consider the life of a regular person. The EU has as its central projection a 25% increase in the population of the UK between 2013 and 2050/60. Roughly equal to the population of the Netherlands arriving. In that world, how can an ordinary person get the training they need to develop worthwhile skills in the face of mass importation of skills, and how will they ever afford a house of their own when there is such a pressure on housing? Only by controlling immigration can a national government create the environment in which ordinary Britons can build a prosperous life of their own. Sovereignty means a UK government that has the freedom and capability to be ambitious for its population, not one that is constantly being told to comply with policies that are in the interests of the rest of Europe. The government has recently announced an increase in the number of training places for Doctors and Nurses, so we are already winning.

        As for the negotiations, it is another Remainer myth that if only we had the right negotiating approach and people we could get a good deal. We are negotiating with the Commission – an organisation that does not think the British government should exist in anything like its current form and that regards Brexit as an existential challenge. We have about as much chance of getting an acceptable agreement out of them as Catalonia does from the Spanish government. We are simply spinning our wheels waiting for the inevitable demand to capitulate on all points (ECJ, FOM, money) or be cast out into the wilderness. Frankly the sooner we walk away the sooner we can get on with building a life in the rest of the world that has high economic growth and accepts our right to self-determination.

        • Moyenda says:

          So, simplifying again:
          1 – You’re pessimistic about the possibility of negotiating an acceptable agreement that maintains some of the benefits of EU membership – (I’d say the devil here lies in how you define “acceptable”‘. Presumably nothing comparable to any of the less-than-full membership models already in existence cut the mustard?) ; and
          2 – While accepting that the economic effects of leaving the EU will be harmful in the near term and at the macro scale (?), you believe that the longer term outlook for the man on the street will be improved by our leaving – this largely by way of reducing competition from migrant labour for training, jobs and resources.
          Is this fair?

          If so I’m still inclined to believe that it would be easier to achieve a satisfactory diplomatic adjustment than it will be to achieve the economic adjustments needed to make Brexit a success. Achieving a compromise on controlling immigration, beefing up the ’emergency brake’, for instance, would be difficult and costly, but I fear that the initial and continuing costs of complicating economic relations with out European neighbours will be more costly still. Afterall, countries like Switzerland and Norway have made arrangements to participate in the economic club, with the associated recurring charges (roughly equivalent to the UK on a per capita basis in the case of Norway), because participation remains a net benefit.

          The notion that we’ll trade on the world stage ‘just like any other sovereign country’ concerns me too as we’re not any other sovereign country – no country is – we’re a specific nation and we have a specific geography and history that influences the economic conditions under which we’re likely to succeed. It seems to me that, more often than not, close relations with the EU – our geographical neighbours and economic peers – enhances our strengths and mitigates against our weaknesses in ways not replicable through enhanced trading relations with other countries.

          As for the man on the street, he’s got a tough gig. With increasing automation on the one hand and globalisation on the other and the broader economic system favouring wealth over work it’s looking to be a difficult time for regular people. Immigration, from an economic perspective (there are legitimate social concerns here), is among the lesser of their worries. The effect of immigration on wages is sensibly addressed here: https://www.niesr.ac.uk/blog/how-small-small-impact-immigration-uk-wages and I’d suggest the current housing crisis is at least as much about poor policy decisions as about people. I’m wary of predictions but the notion that the UK will attract an immigrant population the size of the Netherlands is presumably predicated on an assumption that the UK economy will grow sufficiently to support that population. They’re not coming for the weather.

          While you might welcome the precipitous decline in EU nurses applying to work in the UK that provides the backdrop of the ‘win’ of increased training places for UK nurses (not everybody does), we need to remember that there has also been a 20% reduction in the number of applications to study nursing, this attributed to the removal of the bursary (which has also, incidentally, made offering new training places much cheaper). Providing funding for schemes like the nurse bursary requires a successful economy.

          Like I say, I don’t really know how things are going to pan out, but I do feel that the difficulties of working with the EU pale in comparison with the difficulties of plotting a wholly separate course and that the economic risks of divergence outweigh the political risks of cooperation. So much of economics seems to be about the compound effects of small advantages and disadvantages. But you’re right that if Leaver sentiment is unable to accept any offer that the EU can make, we need to start thinking about how to manage the fall-out pronto. Again, I haven’t heard many ideas and I’m going to need more than ‘the fall in immigration will fix it’ to feel reassured.

        • George Carty says:

          The reason why house prices are so high in the UK is because of a policy started by Thatcher’s government (and continued under Blair and Cameron) of using house price inflation to buy baby boomer votes. And it was the very baby boomers who benefited from this policy who voted for Brexit in droves, not the younger generations who were victimized by it. The way in which the Express and the Daily Mail encouraged this generation to go on a MEWing-funded spending spree, and then diverted the blame for the resulting unaffordable housing onto immigrants, reminds me of how in World War II many of the most enthusiastic Jew-killers in the Baltic States (Estonia/Latvia/Lithuania) were men who had collaborated with the Soviet occupation, and who thought that they could somehow atone for this treason by killing Jews under the aegis of the Nazis!

          The problem of young people being left on the employment scrapheap because employers can just poach already-experienced workers from the Continent is also real, but again isn’t a major motivation behind the Brexit vote (which as mentioned before was very much a revolt of the old). And surely there are ways to deal with this that don’t involve actual immigration control: couldn’t big companies be required by law to train young Brits who want such jobs?

          It seems clear to me from your posts that you see Brexit primarily as a means of controlling the size of the UK’s population. If many other Leavers feel the same, it would probably be another reason why Brexit was supported primarily by the old: not only are pensioners (as rentiers) likely to feel insulated from the negative economic consequences of Brexit, but they are more likely to be concerned about population size as they naturally crave peaceful, quiet rural areas. I suspect this is also why you seem to be blasé about the ruinous economic consequences of a “no deal” Brexit, because you perhaps hope that this would result in mass emigration from the UK. (However you obviously haven’t considered where the surplus Brits would go once FoM ends – maybe the fascination many Leavers have with Australia, New Zealand is all about Lebensraum rather than trade?)

          And as for the negotiations, it is liberal Leavers (you’re clearly a hardliner not a liberal) who think that “if only we had the right negotiating approach and people we could get a good (Brexit) deal”! Remainers are under no illusions on that score, which is why they voted Remain in the first place!

          • Dipper says:

            there are a number of reasons why house prices are high, one of which is extremely low interest rates. But yes I do see one reason for leaving the EU is controlling the size of the UKs population. The EU projection is to increase the size of the UK population by the size of two Londons. If built as two cities, that would give England the three biggest cities in the UK. I have never heard any Remainer discuss where they would put these cities.

            Your point about requiring companies to train UK workers is an interesting one. This kind of argument crops up a lot, and is done by many countries on the continent – e.g. I was reading today that it is very hard to get an academic job in Catalonia if you are not Catalan. My view is that to survive as a nation in the EU we would have to develop a kind of immune response, being asked to treat Europeans as second class citizens in some discriminatory way. This happens in many other European countries, and I very much did not want that happening here. If we are to survive as a diverse open society then in some way you have to control access to that society or else it just ends up being crushed.

            Before the referendum I was informed of some analysis that had been done for the board of a leading UK financial institution that said there was little long-term economic difference between being in and out. Suddenly after the vote the media was full of people claiming imminent economic disaster unless we effectively remained in the EU, I don’t believe a word of this. It is all highly partisan rubbish from people justifying their point of view. There need only be a short-term issue as we re-adjust to a new world of relationships.

            There is a quasi-racism in the Remainer world. A group of people who sit in judgement on others and say these people can do no better, are fit only for a life on benefits, are not genetically capable of doing difficult things. These untermensch can only survive if we import superior Europeans to do all the difficult stuff. Frankly I am sick of hearing this stuff. constant denigration of groups of people because of the behaviour of one individual that in the most famous case turned out in court to be incorrect. I’m still waiting to hear Juncker’s apology to the people of Harlow.

            I’m not responsible for what young people think, and am not going to change my thinking because of them.

          • Dipper says:

            … the three biggest cities in the EU, not the UK.

          • George Carty says:

            Dipper, could you point me to:
            a) the European Commission report whose 2050 population projections you often refer to, and
            b) the report for the financial institution which claims that Brexit would have little economic impact in the long term?

            My impression was that even leavers such as Patrick Minford admit that Brexit will pretty much wipe out what is left of the UK’s manufacturing industry (although for some unfathomable reason they don’t seem to have a problem with that).

            On classist bigotry among Remainers, yes I am aware of it – although rather than claiming that the underclass is intrinsically inferior, they more usually castigate them for being unwilling to move where the work is. This kind of unwillingness to respect local social ties though is certainly not a Remainer monopoly – wasn’t Norman Tebbit (of “on yer bike” infamy) a Leaver?

            Personally, I suspect that extreme classism is about as prevalent among Remainers as extreme racism is among Leavers.

          • Dipper says:

            they’ve moved it around and changed a few of the numbers but it is now here
            http://ec.europa.eu/eurostat/data/database?node_code=proj
            you have to pick around the populations projections bits.When I had a look at the numbers and used the CIA fact book for births and deaths the UK population increase was around just under 50% population growth and just over 50% immigration, so we have to build one of these cities anyway.

            Jeremy Corbyn’s million homes in five years was about the right rate of growth from my calculations, but you have to keep that up over about five parliaments. Being Corbyn, he has no plan beyond simply saying he will build the homes; no identified sites, no legal shortcuts, no idea where he will get the builders and tradesmen from in a country with record low unemployment. It is to all intents and purposes impossible to build anything like a million homes in five years as you will just spend five years in public inquiries and legal challenges, and probably the next five years arguing with the building trade, which just illustrates the pickle we are in.

          • Dipper says:

            … and I suspect the unwillingness to work more or move is because of relying on working tax credits. WTC mean a marginal rate of taxation of over 90%, and if you move you run the risk of not remaining in the system. There doesn’t seem much point in moving around the country for considerable risk and little financial benefit.

        • gunnerbear says:

          Yep…see out the process and then walk away. The EU are going to give us nothing – they can’t because if the EU does….the EU is dead.

    • AdrianD says:

      @Dipper – you’re absolutely right regarding the flat out corruption of Moody’s and the other ratings agencies.

      For Rick to mention Moody’s and Japan in the same piece without mentioning the former’s laughable history of rating the latter is something of an oversight.

      You’re also right on the dubiousness of the assumption that a remain vote may have left us with something like the status quo. I’d add that all the remainer analysis I’ve seen makes the optimistic/heroic/ludicrous assumption that there’s not going to be another GFC in the next decade – let alone the next three years. When it happens we’ll be much better placed to survive the storm if capital controls an option – something that they will never be inside the EU.

  6. Keith says:

    Good piece. We and other countries seem determined to repeat the mistakes of the 1930s. Narrow minded nationalism, racism, xenophobia and the mistaken policy of beggar my neighbour. As we learned then blaming the other fellow and trying to shift the effects of failing capitalism onto other nations leads to war and genocide.

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  8. gunnerbear says:

    @George Carty,

    Yes, if Minford gets his way – zero tariffs, totally open trade borders and the like, then UK manufacturing is for the chop but I know of more than a few leavers who think the man is scum and only wants UK manufacturing smashed because he hates the people in it because they don’t vote the same way as he does.

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