Short-term politics trump long-term economics. That’s the message in the beating administered to the pound yesterday.
The implications for the United States are rather depressing.
The pound got killed yesterday (March 1), falling almost four cents against the U.S. dollar and dropping below the $1.50 level that has provided major support.
The reason? New polls that show that the Conservative Party lead in the next election, expected in May, has just about evaporated and that the country faces the real prospect of a hung parliament with no party in an overall majority.
The financial markets had been willing to cut the pound some slack despite a big current budget deficit and an economy where growth lags both the euro economies of the continent and the United States because of the belief that a Conservative Party victory would result in immediate spending cuts. But that relative optimism is in short supply now that the currently ruling Labor Party is within 2 percentage points in the polls. Experienced election observers say that the electoral system in the United Kingdom could well leave the Conservatives short of a majority even if the party wins the election,
The price of 10-year government bonds, called gilts, has not only plunged but is now trading below comparable Italian and Spanish 10-year bonds.
The yield on 10-year gilts is now 0.976 percentage points above the yield on the benchmark German 10-year bonds, called bunds.
That’s not especially surprising given that the German budget and economy are both in better shape than their U.K. counterparts.
But the rout in the pound has pushed the yield premium on gilts above the 0.827 percentage point premium on Italian 10-year bonds and the 0.725 percentage point premium on Spanish 10-year bonds.
From a long-term perspective that’s perverse.
Both the Spanish and Italian economies face huge long-term competitive problems. Rising wages and lagging productivity have left both countries priced out of export markets for much of their production. Given the near-paralysis in Italian politics and the power of regional governments and labor unions in Spain to prevent any significant spending or wage cuts, the long-term situation in those countries is far worse than it is in the United Kingdom.
In that country what is sometimes called the parliamentary dictatorship gives any party with a majority in the House of Commons the ability to do pretty much what it pleases without a challenge from the almost powerless House of Lords or from judicial review.
That is, the long-term fix in the United Kingdom, is much easier than in Italy or Spain (or Greece for that matter.)
Which is why the prospect of a hung parliament, which would prevent the drastic action that the United Kingdom needs and which its parliamentary system makes possible, has so spooked the financial markets.
None of which should make U.S. taxpayers or investors very comfortable.
In the budget just proposed the Obama administration has punted the problem of reducing the budget deficit into fiscal 2012 at the earliest. The political odds now are that the 2010 mid-term election will reduce (at least) the Democratic majority in both houses of Congress.
Anybody think that will make Congress less dysfunctional?
The jockeying for position in the 2010 mid-terms has brought all serious legislation to a virtual standstill and the stakes just go up after those elections as the parties position themselves for the presidential race in 2012.
I know that many readers and political pundits extol the virtues of gridlock in Washington. I doubt, however, that the international bond markets feel the same way. They sure don’t when it comes to the pound. I don’t see why bond and currency traders would be kinder to the U.S. dollar.
Who in Washington is not a career politician? Meaning they wern’t holding some political office before they got elected.
Here’s an idea Jim: The more change in D.C. the more bills and bonds I will buy. We’re starting to see real Americans get elected over career politicians. The tide is changing. Washington is being cleansed. I’ll throw a (long island iced) Tea Party when Pelosi gets tossed.
I bet there are plenty of patriotic Americans who would love to buy American bonds again. We don’t trust them so we don’t buy them. If we trusted our government then we could trust their debt.
I’d love to own government debt over current paltry bank c.d.’s and money market accounts.
“Anytime the Deomocratic party loses power, government becomes less dysfunctional. Gridlock is better than damage repair. You asked.”
Do you have examples or are you just making this up? IMO, the most functional government we’ve had in 20 years was when the Dems lost legislative power and Bill Clinton triangulated under guidance from Dick Norris. Is that what you mean?
The subtitle for this posting should be “Want to See the Future of US, Watch the Fall of UK”
So, how would have the USA been able to borrow all this money without it looking so difficult for the USA to pay it back? As I recal, Jim extoled how massive defficit spending can help (i.e. wwII). But it looks like we’ve deficit spent for so long that MORE spending won’t yield the same gains.
Anytime the Deomocratic party loses power, government becomes less dysfunctional. Gridlock is better than damage repair. You asked.
Gridlock might not be good for the US dollar, but I doubt the massive extra spending that would have happened without it is good for it either.
DJ,
I can’t believe the bond markets took Olli Rehn’s comments as some sort of progress. He said NOTHING! His comments amounted to “we’re looking at the problem now”.
Even IF the EU comes up with a plan, what happens if another country gets near the ledge of bankruptcy? The EU isn’t exactly overflowing with extra money.
Background to Jims post:
http://www.bloomberg.com/apps/news?pid=20601087&sid=a8fpFclDj7Ek&pos=3
Highlights :
The pound weakened against 15 of its 16 most-traded counterparts. The U.K. Conservatives’ lead over Prime Minister Gordon Brown’s Labour Party narrowed to five percentage points in a poll published late yesterday, adding to signs Britain may have its first minority government since 1974.
“The longstanding fear we’ve had is that speculators will target the U.K. at some point, given the perilous state of public finances,” Jim Reid, a strategist at Deutsche Bank AG in London, wrote in a research note. “The currency is slowly but surely taking the strain, but this and gilt yields are certainly worth keeping an eye on as we approach a pivotal election.”
Greek Debt Gains
Greek government bonds rose for a third day after Amadeu Altafaj, spokesman for EU Economic and Monetary Affairs Commissioner Olli Rehn, said in Brussels that officials are “looking forward to see measures that can give us a clear idea on the gap and how to cover that gap.”
The Greek government will announce as much as 4.8 billion euros ($6.5 billion) of additional deficit cuts tomorrow
The 10-year Greek bond yield declined 9 basis points to 6.18 percent and touched a two-week low of 6.08 percent.
Jim,
The ONLY way to get the U.S. government to leave the economy alone long enough to let it heal IS gridlock.
As for the UK, they need to reverse course, not just gridlock.
Seems like the place to be these days is in the futures markets….