There is no such thing as a free lunch – bond yields, debt and economic growth

The problems faced by the peripheral countries of the eurozone have, for the first time in many years, propelled the oft cited bond yield figures into the national conscience. George Osborne, the Chancellor of the UK, has played a role in this as he is fervently claiming that the low yields enjoyed by the UK is a sign that the markets feel secure in investing. Can Osborne claim this for the UK or are there more factors at work?

If we look at the peripheral countries, especially Greece, then we have seen bond yields shoot up. These countries have found it increasingly difficult to borrow on the global financial markets as the perceived risk of the government being able to service the debt is high. As a consequence the price of bonds has plummeted and the yield increases. Put simply, if the risk is higher then the investor wants a higher return on his investment.

According to this logic, Osborne is using the argument that the perceived risk of the UK government being able to service its debt is low and so the yield is low. He is calling us a ‘safe haven’.

Unfortunately for him and us, this is not the end of the story.

Confidence (both consumer and producer) in the UK economy is not as high as he is touting. Stock markets around the world, including the FTSE, have had billions of pounds wiped as investors can’t see their returns on investment being high.

Why? They do not feel that the economy will grow in the short- or medium-term. The markets are showing a clear sign that the current economic policies will not stimulate growth – this austerity-growth story is being repeated across the developed nations.

So without economic growth forecasted, why are yields still low? The answer is that we should not view sovereign bonds in isolation as they are a reflection of the attractiveness of equities available within that country. As a result, the stock/share price is inversely related to the bond price which in turn is inversely related to the yield. So, when share prices decrease, the bond price increases and the bond yield decreases.

In this instance, when the market is willing to invest in a 10 year bond at 2.3% even with high inflation it shows that investors do not want to commit any money to any other equities. This surely highlights the problem – investors are not investing in the ‘real economy’ as productive assets. They are only lending the government.

If investors are not investing in the economy but in the state, does this not give the state scope to invest instead? To drive economic growth there needs to be a commitment to business creation, regional growth, jobs and production – if investors won’t and the state doesn’t, who does that leave?

Clearly the government feels that reducing the national debt level is the key priority. There are a myriad of ways to do this (including a Keynesian approach to government spending or tax decreases) but this government is using inflation to its benefit.

The Bank of England does not see growth being very high and as such has kept interest rates low (in order to stimulate investment as opposed to saving). This is in spite of high inflation – if inflation is predicted to be high over a long period of time then the central bank will increase the base rate to cool the economy down.

So, with the priority of reducing the debt, the government could use the low bond yields (2.3%) and the high inflation rate (5%) to make it easier to pay down the debt i.e. the value of the debt decreases as real interest rates are negative.

The concern is that while an austere government uses this method to reduce the debt, it comes at the expense of important economic factors such as jobs, training, skills, regeneration as well as key personal issues of self-worth, confidence and personal development, to name a few.

Ignoring these issues in the short run to simply decrease the debt level will come at the expense of the economy in the medium to long run.

There is no such thing as a free lunch and it is particularly true here.

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One thought on “There is no such thing as a free lunch – bond yields, debt and economic growth

  1. Pingback: The UK economy needs a kick-start | Comment Today

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