Why do we care what markets think?
"In reality we all know who will be running the UK for the next couple of years: the bond market." Gary Jenkins, Evolution Securities, 10 May 2010.
"I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a 400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody." James Carville, Clinton special adviser, 25 February 1993.
Every time I talk about how the markets are reacting, or might react, to the British hung parliament, there are always some viewers and blog readers who object: why do we care what the markets think?
I understand their frustration. I think journalism is sometimes over-obsessed with what the markets "think", even when it comes to ordinary business and economics stories, let alone politics.
But let me explain why the markets are - in this situation - important, and define more clearly which markets are important.
First, I am not really talking about the stock market. The stock market is a voting machine (and in the long term a weighing machine) for judging the profitability of companies.
If it were that alone I would discount it altogether in this situation: however because it exists in a global market, the price of UK equities can reflect the market's view of what is going to happen to sterling.
If you think the pound is going to fall and remain low, you hold fewer shares in British companies.
Next, the foreign exchange markets. Forex is a 24-hour market, into which many speculators and day traders have piled, but it plays an obviously vital role as a barometer of investors' expectations of economic growth, inflation and the public finances.
However, since you have had a government and central bank in Britain happy to acquiesce in a 25% fall of sterling since this crisis began, I would not be rushing around headless at the odd dip in sterling.
Sterling will only become the speculators' target once the fundamentals become unpredictable, as in Greece.
It is the bond markets that are important in this crisis, and for the obvious reason that the UK government has to go, repeatedly, to them and borrow money. It is doing so today to the tune of £2bn.
There is - and read my lips - no danger that the UK will default on its debts; or that the international debt markets would suddenly close to the UK. The danger is that those who buy the bonds start to demand a higher interest rate, to the point at which it becomes dysfunctional to finance Britain's £1 trillion debt, and it pushes the interest rate on everything more risky upwards.
(Jargon buster of the day: The effective interest rate on a government bond is called a yield: as the bond's price falls, the yield rises.)
There is a clear material difference between the bond markets and stocks, currencies and derivatives. The bond markets lend money to the government and thus their reaction to what the government is doing has to be logical, ruthless and unsentimental.
So who are these here bond markets? Well, fundamentally, it is you.
Pension funds hold large amounts of government bonds because the interest on them provides a steady and predictable income and they are not liable to fluctuate in price.
Hence the bond markets tend to be dominated by people from pension fund managers: Threadneedle, Norwich Union, Standard Life, for example, as well as the "fixed income" desks of the banks which make money out of buying and selling the bonds.
If bond buyers aggressively punish governments who do not look like they have realistic budgets, or who overstate growth, or who - as in Greece - cook the books, that is because they do not want to have to write you a letter saying "sorry we lost the money you put aside for your pension".
Indeed, such is the culture of caution, that a one or two per cent loss in this profession can be a career-ending moment.
Now it is still going to rankle with you that these bond markets have the power to make or break governments, to insist on what electorates sometimes want to reject.
That "markets" and "bonds" seem to have power over "voters" and "governments".
But I want to invoke in their explanation an economist not often quoted on Newsnight:
"The commodity form... is nothing but the definite social relation between men themselves which assumes here, for them, the fantastic form of a relation between things."
Yes, the original Doctor Doom, Herr Marx of 1 Modena Villas, Camden, put his finger on it. (Capital Vol 1, p165). He pointed out that, in a market economy, people's own "movement within society has for them the form of a movement made by things, and these things far from being under their control in fact control them". (p167)
He lamented the fact, but he also understood it: "market forces", which appear to be uncontrollable by human beings and look more like a force of nature, are just the products of human action, mediated by an economic system.
What gives the bond markets their ruthless character is, you could argue, the ruthless determination of millions of middle class retirees to buy a cottage in the country, a Labrador and globetrot like grey nomads the archaeological wonders of the world. To not have their savings lost by incompetent fund managers.
Oh, and the fact that we all want credit cards and mortgages - because these two basic financial instruments also require the bond markets to exist. Ditto all manner of public bodies, such as local councils, housing associations etc, which access the bond markets.
There is the related question of Credit Ratings Agencies (CRAs). Those who know this market are expecting the CRA guys to start tapping the bezels of their Jaeger-LeCoutre chronographs quite soon in quiet indication that they need some kind of certainty about what is going to happen.
Some bond market professionals I know pay scant regard to the CRAs and there is a legitimate argument that you could run a bond market without them. What they have tended to do is issue signals that become qualitative inflection points: as with Lehman, in the world of the CRA it is always going swimmingly until its not, and the first downward notch usually signals rapid decline.
The CRAs got the credit boom badly wrong; were caught red handed distorting their own findings under pressure from the mortgage-backed securities industry. For this reason they are being doubly hawkish over sovereign debt: at the first sign the UK has no coherent or credible plan to reduce the deficit, they will downgrade.
Indeed there is a theory high up in the investment banking industry that only a downgrade will create the kind of government that can address Britain's debt problem.
Now to the specifics of today. A Lib-Lab government, say analysts and BNP Paribas, would "almost guarantee" a downgrade. Let's see.
The current British government has a deficit reduction plan. It is quite tough, front-loaded but suffers from two related problems.
The first is it might be over-optimistic, based on growth figures the markets (i.e. the guys employed by you to look after your money) do not believe. Second, it is absent any detail for about four-fifths of the cuts envisaged. Nobody can judge whether the plan is achievable until they know whether it means massive pay cuts for civil servants, the loss of the strategic nuclear deterrent, a massive sell off of state assets, etc.
The Conservatives have a tougher plan on paper, with cuts starting this year and a more aggressive deficit reduction curve (but still; like Labour and the Libdems, only getting debt below 40% of GDP by 2031).
The problems: first the Conservatives seem to have moved back from trying to ring-fence the budget process within a coalition government. Vince Cable has reportedly been offered a "quasi chancellorship" and Tory sources believe they have already "split the difference" over this year's £6bn cuts.
Anybody who hoped or feared the Tories would bring in a draconian, ideologically driven, socially confrontational budget can forget it in a Lib-Con coalition whose theme tune is being composed by Philip Blond and Oliver Letwin.
As for the Lab-Lib coalition: the worry in the markets - on top of the budget plans being softer than the Tories' - is that Lab-Lib does not deliver certainty, stability or credibility.
What they fear from all parties was demonstrated when it emerged last night that the Conservatives have agreed to the £10,000 tax floor demand of the Libdems, which should cost £17bn. We do not know where that would come from, though as one wag in the Newsnight office pointed out, they could always scrap Trident.
The markets thought that, even with a hung parliament, we would get a stable coalition of the Lib-Tory type, or a confidence and supply based Tory government.
Now - over a weekend - a lot of things have become uncertain. Because the deals are being done behind closed doors, with participants emerging only with concessions and not painful economic remedies, the fear in the bond markets will probably have to be addressed head on, in the form of restatements of commitments to cuts, tax increases and growth.
One final note: there is a lot of opposition to public service cuts. The New Economics Foundation makes the case that £50bn of the deficit could be addressed through closing tax loopholes. Others point out that selling off RBS and Lloyds Group could raise tens of billions. But in the end, if you want to keep going year in, year out, to the pension funds to borrow money, you have to show a long term plan consisting of some cuts, some tax rises and above all some growth.
To summarise, the difference between the bond markets and the stock markets is that, with stocks you are taking a bet on a race. With bonds, if you place a big enough bet, you can influence the outcome of the race.
That is why we should care about what they are doing.