which may confuse some people, but shouldn’t.    Here is the graph of the June Gilt future since March:

As this story indicates, yields are now at a very low level.

Good news?  Well, no.  A naive, political interpretation of this would be: the Conservative government has impressed the market that it has borrowing under control.  Control = less debt issued = less supply = higher price.   But as Tyler and others on this blog would rush to point out, that it not the story today.  For if this were the cause, we would also expect higher equity prices, which all things being equal benefit from such circumstances.  Instead, the FTSE is down 2% or more. Instead, there has been a rush – again – from ‘risk’ assets to those regarded as unrisky.

The missing word – as ever – is demand.  The demand we are talking about is the demand expected in the economy, that rewards money put at risk in things like equity.  All the signals from the markets are that -despite yesterday’s ‘dreadful’ figures – the market as a whole is happy receiving just 3.7% for its money for a long period.   And the only interpretation of that is that the market is expecting fewer great opportunities to earn its money the honest way – out there in the world of enterprise – than it was before.

Read the Economist’s blog, if the UK is getting high inflation, it may be the only major currency bloc to achieve this.  (See their account of the US trends and also Krugman.)  And given what problems deflation may cause, you may want to ask whether or not our policy – even if unintentional – is in fact better.  Indeed, if targeting high nominal growth is what we need – as I called for in Credit Where It’s Due – then maybe Merv is doing it, just by mistake. …

Rather than trying you with my amateurish interpretations, Scott Sumner has done a fantastic, educational and counterintuitive job here.  Has the euro got weaker in the last few days?  If only – it has got stronger – just the dollar has got stronger still. With commodities and equities falling, and ‘money-ish’ things like gilts rising, what we are seeing is money itself gaining in value.  Money demand up means money is tight, which in Sumner’s system is what causes recessions …. Read it!


4 thoughts on “The day after the inflation shock, the gilt rockets …

  1. Surely Giles, inflation has two elements – a cost push and a demand pull. Investment decisions by businesses react differently to the two elements. Cost push would discourage firms dusting off the put aside investment projects that Chris Dillow refers to. Demand pull would encourage those projects to be undertaken because of their opposite effects on profitability.

    Haven’t we got cost push (we have devalued and raw material prices are rising) and deflation on the demand element?

    By continuing to concentrate on targeting interest rates (especially when they are near to zero) and not the supply of money, monetary policy is still far too tight. You don’t have to read Sumner but just look at the money supply figures.

    The only way to both increase the supply of money (when the private sector can’t/won’t undertake net borrowing) and increase demand is Government expenditure financed by bank lending to the public sector.

    Change in M = PSBR + Change in Bank Loans to the non-bank private sector – change in non-bank private sector loans to the public sector.

    Why does everyopne ignore the DCE equation and its obvious relevance to policy?

    1. Giles

      Hope you don’t mind me harping back to this but thought you might be interested by a reply by Ben Lord to comments made to his post following George’s letter to Cameron here: http://www.bondvigilantes.co.uk/blog/2010/05/18/1274198880000.html

      It reads: “My argument, which I maintain, is not that inflation is good. It isn’t. And as fixed income managers it is probably the single biggest focus and concern we have at all times. As for the suggestion though that ‘inflation is ALWAYS the real enemy’, well I have to say I disagree here. There is good inflation, which comes from rising and high aggregate demand causing prices to rise, and there is bad inflation caused by rising costs of goods and services being pushed on an economy. If I had to categorise the UK’s inflation along these lines, I would posit that at the moment we are being subjected to cost-push inflation (bad), but that medium term we are going to be subjected to demand-pull disinflation. I believe that in the medium term we will see disinflation (not deflation, in passing) winning out in the UK. Why? Higher taxes will stem aggregate demand, the public sector will see wage freezes and (at last!) some shrinking in size, which again will negatively affect demand in the economy and thereby, simply, apply downward pricing pressure. And I haven’t even mentioned the output gap yet, which again only strengthens my conviction, but it appears most of our readers don’t buy into this argument.”


  2. Thing you’ve got it pretty much spot on Giles….no-one is really worried about a little inflation at the moment, what with everything else going on.

    There are massive stops going through….huge flows of hedge fund capital out of equities and into cash and bonds. EUR 9.5bn went through EURCHF yesterday sparking massive interventions by the SNB, and am hearing the GBPCHF has seen massive intervention today.

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