Hamish McRae: Don't question the markets' logic. Be grateful for it

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The Independent Online

The world is unfair and the sovereign bond markets are most certainly so. Take the rate for 10-year debt on the markets yesterday. Here in the UK our government could borrow at just under 2.2 per cent. France, which has a smaller deficit, though slightly higher debt levels, would have to pay more than 3.5 per cent. Germany, with an even smaller deficit but debts still larger than the UK, can borrow at 1.9 per cent. And the US, which has the highest deficit of any major country in the world and, as we have seen this week, an utter inability to agree on how to cut it, can borrow at 1.95 per cent. All these countries have the same top credit rating, AAA (though the US lost its rating from one of the three agencies), yet the rates they are charged are quite different. Rum, isn't it?

The fact that the UK not only has kept its top rating but can borrow from the markets so cheaply will be used by the Coalition as a key justification for sticking as far as possible to its deficit-cutting plan, despite lower-than-expected growth. As of yesterday, we were still on track for this financial year's target deficit of £122bn, but the Office for Budgetary Responsibility may forecast some deterioration when its report is published next Tuesday along with the Chancellor's Autumn Statement.

It always seems to me silly to crawl over the last decimal point of forecasts when the uncertainties are so massive, but a sensible rule of thumb would be to expect the return to structural balance to be pushed back a year to 2015/16, or even 2016/17. If that were to happen, we would be into the early part of the next Parliament rather than getting things done and dusted this one. Plan B is still arguably Plan A, but Plan A done somewhat more slowly. Would the UK under those circumstances still retain its AAA rating and, more important, its ability to borrow at these very low rates? The key to this lies in the psychology of the bond markets.

Germany is trusted because for more than 60 years it has followed a path of fiscal orthodoxy. It even managed to carry the burden of absorbing East Germany while keeping borrowings more or less under control. If the eurozone survives, Germany remains its anchor. If it breaks up, lenders would presumably get Deutschemark-denominated debt instead, which would be fine, too. The US is trusted despite everything because of the size of the economy, the country's relatively favourable demographic profile (more people to service the debt) and its ability to print the dollars if need be.

France is less trusted than Germany for reasons that are not clear. I think these come down to doubts about how its debts might fare were the eurozone to break up. France's record since the Second World War was of periodic franc devaluations, though it showed more discipline from the 1990s onwards. The explanation, atavistic though it seems, is that the world's savers think there is a bit too much of the Latin and not enough of the Teutonic in the French make-up.

But then, on the past record, the UK has not been a paragon of fiscal or monetary virtue either. We have the highest rate of inflation among the major developed countries and the second-largest deficit. We have devalued several times since 1945 and had to call in the IMF in 1976. In the final days of the last government, our gilt yields were becoming wobbly. We are helped by having our own currency, for we can print the stuff it we have to. Yet it is to the huge credit of the Coalition – and the praise really should be shared between both parties – that it has hung on to this status. Fingers crossed we can keep it.

The little nudge that makes you buy one thing, not another

The latest issue of the Royal Economic Society's The Economic Journal carries a series of articles on how advertisers use, or abuse, search engines to sell more stuff. Of five studies, the one that really struck me was about strategies for paying for prominence.

It looked at three ways sellers could boost their profits. First, they could simply pay to promote them. But that is expensive and someone has to pay for that – that someone eventually being the buyer. So, the more you pay, the more prominent your product but also the worse value you provide. Would-be buyers cotton on to that, but where companies can differentiate on perceived quality, maybe the strategy works.

The second way is to compete purely on price. Since search engines can speedily show the lowest prices, this drives down the prices for all. The cheapest company does get much of the business but all buyers benefit.

The third strategy is to use the fact that the seller already has a customer relationship to buy prominence. Say you want a mortgage. You might start by looking at a provider you know, perhaps the bank with which you have a current account, and then only after that would you see what else was on offer. So the strategy there would be to entice customers with a subsidised initial product (say "free" banking) and then make the profit from selling the mortgage. We all know companies do this, but it is interesting that even with powerful search engines, the strategy still apparently works.

h.mcrae@independent.co.uk

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