The Senior Lecturer tries to explain and still gets it wrong.

So, the claim is that there’s uncertainty in the market, not just risk, who in buggery knows what’s going to happen and so he’s right!

At which point he says this:

And the only thing we know about that new reality is that gilts will be redeemed at par, which means that the only rational valuation in the face of discontinuity is something not too far from that value. But right now we are far from it. And I’d suggest that makes the current premium looks decidedly uncomfortable.

No, he’s still not getting it at all.

The original observation was, recall:

And Daniel had a great slide showing how much greater the market value of UK government debt is than its nominal value. The excess is about £500 billion right now – all of which has, by definition, to unwind before these debts are repaid.

Well, what is the cause of that valuation above par? That a goodly chunk of the gilts in issue were issued when base rates were substantially higher than they are now. They thus carry coupons substantially higher than those newly issued. Those newly issued trade at around par, of course. Those with a decade or more to run at a higher than yield coupon obviously trade above par, so that their yields are comparable to other gilts. The amount they do so being a function of that gap between the coupon and market yield and the time to maturity.

As examples, and only examples of the maths, if current yields are at 0%, and we have two bonds both of 10 years remaining maturity, one at a 5% coupon and one at 10%, then the 5% will trade at half the premium to par as the 10% one. That’s to ignore NPV of course but that only changes the numbers, not the basic logic.

This has nothing at all to do with risk or uncertainty. As long as we agree that gilts are going to get paid their coupon and principal on time – which the Senior Lecturer does, specifically – then this price difference is going to remain. Bonds with coupons above market yield will be valued above par, that above par valuation collapsing as they receive their interest payments over time and come closer to maturity.

This is nothing to do with salt or fresh water economics, laissez faire or New Keynesianism, nothing at all to do with risk or uncertainty. It’s the simple maths of the bond markets.

Run through the maths yourself. We have two bonds in issue, again just examples.

Newly issued 5 year bond with coupon of 0% (just to keep the math easy) when market yield is 0%. The only payment anyone will receive from this is the par value, £100. If interest rates really are zero then this is worth £100.

OK, We’ve also a 30 year bond with 5 years left to maturity with a coupon of 5%. That is going to pay the £100 par value at the same time as the first bond, so whatever value we ascribe to that principal is going to be exactly the same. But it is also going to pay out £25 in interest, £5 each year.

We really do generally think that £125 is worth more than £100. Our credit risk is exactly the same here, our estimations of risk and uncertainty exactly the same. And we really do think that £125 is worth more than £100. Thus the second bond trades at a premium to par, at a premium to the lower coupon bond of the same maturity.

This just isn’t some grand mistake of neoliberalism, this is just accounting – heck, it’s just arithmetic.

And remember folks, it’s the Senior Lecturer who teaches economics in the British University, not me.

Ask yourself this question. Can you think of any way, any way at all, where a bond with a 5% coupon is not worth more than one with a 0% coupon? Note that both bonds have the same maturity date, are from the same issuer, have exactly the same terms and conditions, the only difference is their coupon.

One further question – how far up yourself do you have to be to insist that you’ve not made a booboo but instead it is the rest of the world’s neoliberalism to blame?

(I would also recommend the comments over there. He’s not a happy bunny)

14 thoughts on “The Senior Lecturer tries to explain and still gets it wrong.”

  1. I reiterate, the man is one of the biggest chunterting asshats around. Probably the biggest – but we don’t know that for sure as we can’t predict the future, which is all his latest post really amounts to.

    Because, obviously, all the people in financial markets haven’t worked out that they don’t have crystal balls already. Only a man in his shed in Ely has.

  2. “One further question – how far up yourself do you have to be to insist that you’ve not made a booboo but instead it is the rest of the world’s neoliberalism to blame?”

    How much is a lecturers salary?

  3. I have just read an article on the story of the explosion in a mine 150 years ago which killed over 380 coal miners. Other disasters mentioned in passing involved the deaths of hundreds more.

    At times like this I think how lucky the miners were that St. Margaret saved them from such tragedies.

  4. I see he is now banning people who prove that he doesn’t know anything about this, or, more probably, has recognised he’s made a bollox and thus bans everyone.

  5. If we all wrote to the vice Chancellor of City tech, pointing to his blog and his obvious lack of knowledge. There is also a threat to whatever reputation the college enjoys plus also a risk that students might sue for being so poorly taught, despite the fees they have paid. Such claims have foundered in the past but surely no legal system would support Snippa

  6. If there was certainty, what would be the risk?

    Go down any coal mine in Australia, AndrewC, and you”ll hear many Welsh, Scottish, Yorkshire and Geordie accents. Although coal mining is still hazardous, the biggest risk to coal mine workers is driving for 2 or more hours to and from the mine at the beginning and end of their tours, especially for those who drive home after completing a 12 hour shift instead of having a couple of hours kip beforehand. Single vehicle accidents are quite common in Queensland.

  7. @MoreBud

    If closing down mines in the UK has led to Scots going to Australia we have even more to thank St Margaret for.

    With apologies to cheerful English loving Scots, of which I am sure there must be some.

  8. It used to be said that the definition of ‘mine’ was a hole in the ground with a Cornishman at the bottom of it.

    Meanwhile, almost all the coal in Australia is surface mined, though there are a few deep mines left:
    https://en.wikipedia.org/wiki/Coal_in_Australia

    Mrs T had very little to do with the closure of deep mines in the UK, though she did create the conditions under which closure was possible. The real cause was the advance of international surface transport (shipping) to the point where surface mined coal in the US and Australia could be imported to Europe more cheaply than deep-mined coal could be dug out. If you believe it was all the fault of the evil Fatcha, you’ll have to explain why most of the deep mines in (e.g.) the Ruhr closed at much the same time.

    For those desperate to work in dirty, dangerous conditions, I believe there are still deep mines in Poland. Polish rates of pay, of course.

  9. @ AndrewC
    380 miners is small beer
    More coal miners have been killed in China since the Communists tool over than from all nuclear (military or civilian) causes since the dawn of time – yes, I am deliberately including Hiroshima and Nagasaki as well as Chernobyl and Fukushima and Three Mile Island and Windscale.

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