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Bond Outlook July 28 2010

Did European governments have any choice in opting for austerity? We think not, as confidence must be maintained not just in financial markets generally but in sovereign bonds as zero-risk.

Bond Outlook [by bridport & cie, July 28th 2010]

The FT debate about austerity versus deficit spending continues and is again a useful starting point for our Weekly. Skidelsky and Kennedy argue powerfully in favour of the Keynesian position that government spending is the route out of recession. They emphasise a nuance in that such spending must be directed towards infrastructure renewal and expansion.

Last week we wrote of the significance of confidence in encouraging expansion. The euro crisis has acted as a siren call, as arguments about what Keynes would advise become irrelevant if confidence is absent, and especially if its absence is due precisely to government deficits. It almost hurts to admit it, but the ratings agencies have helped make the point in their talk of the possible downgrading of large European economies. They pushed European governments to realise the absolute necessity of rebuilding confidence and that government bonds must be perceived as risk free.

So far European governments seem to be succeeding. They have even taken the first timid steps towards establishing a political structure in favour of more centralised control, notably with the creation of the European Financial Stability Facility.

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