WHEN markets turn, their speed and ferociousness can be awe-inspiring. Take the equity markets: in just 23 working days, the FTSE 100 has lost 846 points, collapsing from 6,875 on 22 May to 6,029.10 yesterday. Or take bonds: when the Fed made its statement about tapering last Wednesday, yields on US 10-year Treasuries were about 2.2 per cent, which was already up 0.05 percentage points or so on the trough of the previous day. The scale of the increase since then has been astonishing. Ten-year yields hit 2.61 per cent yesterday, a massive 0.41 percentage points rise in just four working days.
Given that yields move inversely to capital values, the losses to investors, central banks and institutions that are forced to own them for regulatory reasons have been eye-watering. In Brazil, for example, the price of 30-year dollar bonds is down by 26 per cent since the start of last months. As Andrew Lilico of Europe Economics notes, the rise in UK 10-year gilts has now reversed the entire drop since the start of QE2 in October 2011. Panic is setting in, with the Vix fear index up 75 per cent from its 17 May low. Financial institutions that hold a lot of supposedly safe government bonds will end up nursing huge losses, which won’t be helpful to the financial system. The idiocy of regulations that force people to buy over-valued assets at their peak continues to amaze. Far from being a safe asset, a collapsing government bond is a nightmare. Sure, it will almost certainly pay out what its issuers promised, but the capital loss can easily end up overwhelming everything else.
We should cautiously welcome the fact that markets have started down the long road towards valuing bonds more sensibly. Let’s hope that the movements of the past few weeks aren’t reversed again by central bank interventions. But by one estimate the rise in US yields will shave off 0.3 per cent from GDP growth. Deflating the bond bubble is a vital prerequisite to building a more sustainable economy but it will be horribly painful.
GETTING IT RIGHT
Readers have been writing in to urge me to add names to my list of UK-based monetarists, Austrian and other economists, City analysts and politicians who foresaw the crash.
New entrants to my economic walk of fame include Lord (Howard) Flight, the Tory peer, City grandee and former front bencher who was disgracefully treated by his party (he warned of a coming crunch in his 2005 shadow budget), Jonathan Ruffer of the eponymous fund management firm, and Bernard Connolly, a brilliant economist who worked for AIG at the time but was ignored by his company (he now works for Hamiltonian Associates). Writing in The Chaos Makers in 1997, Fred Harrison of the Georgist-leaning Land Research Trust, made an eerily accurate prediction: “By 2007 Britain and most of the other industrially advanced economies will be in the throes of frenzied activity in the land market to equal what happened in 1988/9. Land prices will be near their 18-year peak, driven by an exponential growth rate, on the verge of the collapse that will presage the global depression of 2010.” I’m not a Georgist and disagree with many of that philosophy’s tenets, but this was pretty spot on. There were, of course, many others in the UK; they are rarely mentioned, partly to buttress the self-serving myth that “nobody predicted the crisis”. True, most of those I listed today or yesterday did not forecast the exact way in which the crisis ended up manifesting itself, including the implosion of CDOs and the sub-prime fiasco – the one who got closest was probably Connolly – but all kept warning of the bubble, of inflated asset prices, of excessively loose money and credit and that it would all end in tears. If you think of others in the UK, do email or tweet me the names (and preferably include a link to their actual predictions).
Follow me on Twitter: @allisterheath