Fiscal default is nigh, insist the doomsayers: repent and retrench before it is too late. Yet I have a question: do we believe that markets are unable to price anything right, even the public debt of the world's largest advanced countries, the best understood and most liquid assets in the world? I suggest not. Markets are saying something important.
On Monday, the yield on 10-year government bonds was 1.1 per cent in Japan, 2.6 per cent in Germany, 3 per cent in the US and 3.3 per cent in the UK (see chart). Based on yields on index-linked securities, real interest rates on borrowing by these governments are very low (1.2 per cent, or less, in the US, Germany and UK). Investors are saying that they view the risk of depression and deflation as greater than that of default and inflation.
Why should it be so easy to fund such huge fiscal deficits even after central banks have stopped their buying of government bonds? In response, here is a calculation that can be derived from the figures for fiscal and current account balances in the latest Economic Outlook from the Organisation for Economic Co-operation and Development: the private sector – households and corporations – of advanced countries is forecast to run an excess of income over spending this year of 7 per cent of gross domestic product. In round numbers, this is $3,000bn. In the US and eurozone, the implied private surplus is about $1,000bn, in each case. In Japan, it is around $500bn. In the UK, it is $200bn.