James Carville, adviser to President Bill Clinton, once said that were he reincarnated, he would choose to return as the bond market: he could then intimidate anyone.
There is little doubt of the reality of such intimidation. In its manifesto for the 2010 UK general election, the Conservative party listed a series of “economic benchmarks for Britain”. Top of the list: “We will safeguard Britain’s credit rating.” The following year, President Nicolas Sarkozy was reported to have told aides “if France loses its triple A rating, I’m dead”. A few days later France lost that status; a few months later, Mr Sarkozy was out of office.
A sovereign credit rating supposedly reflects the likelihood that a country will default on its government debt. But is Britain or France likely to default? And should their governments care what Moody’s, Standard & Poor’s or bond traders think, anyway?
When that Tory manifesto was written in 2010, government interest costs were about 2 per cent of national income – the lowest figure for 100 years. Since then, the percentage has risen slightly but by less than the amount of outstanding debt. The average interest rate has fallen because current rates are below historic ones and the refinancing of maturing debt lowers the overall cost. And these figures overstate the true cost of borrowing, since much of the higher-yielding debt is owned, through the Bank of England, by the government itself.
In the past, the UK government has serviced interest costs that were, in relative terms, more than three times what they are today, without the faintest suggestion of default. (I pass over the embarrassing question of liabilities to the US incurred during the first world war, some of which were conveniently overlooked during the negotiations over German reparations. I also pass over the risk that a future government might acquiesce in accelerating inflation, a real risk but not the one described in the credit rating.)
The prospect that the British government will renege on its bonds is probably even lower than that for other major economies. America’s dysfunctional congressional budgetary process means that a technical default is a possibility, even though the capacity of the US to repay its creditors is infinite. Japan has a formidably high ratio of debt to gross domestic product, while Germany and France have relinquished control over their money supply to the European Central Bank. Britain has a powerful executive, a more manageable debt level and a printing press.
The detached observer would conclude that the UK government failing to repay its sterling obligations is a risk commensurable with the prospect of a meteorite falling on one’s head and much less than the likelihood of being struck by lightning. It is simply not the sort of thing a sensible person would worry about, absent political earthquakes or global conflict; and then there would be plenty of other things to fret about first.
The observable reality is that today the British – and other advanced country governments – can borrow for 50 years at an interest rate of about zero in real terms, the lowest in centuries. Any government worried about future financing needs should issue as much debt as possible at very long maturities – and issue it to the market rather than the central bank.
Even if there are few good reasons why anyone should anticipate a UK default, traders and rating agencies might persuade each other that such an event is imminent. But if you have the resources and powers available to the government, this kind of irrationality is as much an opportunity as a problem. Since the government is not in fact going to default, it can print whatever money is needed to repurchase the supposedly risky debt, refinancing it when traders finally get the message. These are the very policies the Bank of England is pursuing now – but in a context in which there would be an expectation of financial profit rather than of loss.
So how do bond markets acquire their power to intimidate? Politicians spend too much time talking to people who take a daily interest in the bond market, and come to believe that their obsessions are important. Britain’s economic performance should be judged by benchmarks relating to employment, productivity, growth and innovation, not credit ratings.