Tag Archives: interest rates

Exorcising animal spirits out of Keynes, by Paul Jorion

Exorcising animal spirits out of Keynes

Paul Jorion, Stewardship of finance chair, Vrije Universiteit Brussel

To be published in a forthcoming issue of the European Journal of Social Theory: special issue on “Rethinking Capitalism”, 2014

Might be referred to as “European Journal of Social Theory (forthcoming): http://www.pauljorion.com/blog_en/?p=1229″


Torn between the duties associated with the capacities of academic, banker and statesman, Maynard Keynes was in a constant hurry. He glossed over the missing parts of the economic theories he devised by referring to various unfathomable ‘psychological mechanisms’. It is claimed here that interest rates set at the level defined by the marginal yield of capital, a hypothesis Keynes envisaged cursorily but only to assert it leading to ‘circular reasoning’.

Keynes never considered the power balance between lenders and borrowers to be relevant in setting the level of market rates. However, resorting here as a blueprint to the economic arrangement known as sharecropping, power balance between involved parties is shown to be at the core of a fitting explanation.


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The Spanish risk premium

There were two bond issues today, one in Spain, the other in Denmark, which allow us to carry out an interesting little calculation of the risk premium required of Spain when it borrows on the capital markets.

A short while ago the Spanish Treasury department issued more than 3 billion Euros of debt for 12- 18 month securities.

Because we must always look on the bright side of life, it was pointed out that for an offer of only 3 billion there was a demand up to 8 billion – which is always nice to know, but not of tremendous interest since what is really important today (in the context of yields exceeding 7% for 10 year Spanish debt) is the coupon demanded by potential lenders in order for them to do without their capital for a year, or a year and a half. And in this respect, the situation is a lot less rosy: Spain has had to agree to 5.074% for a year and 5.107% for 18 months. It’s very steep, and not only if you compare it, for example, with what the capital markets are asking of Germany at the moment, but also with regard to what this very same Spain was being asked for only a little more than a month ago. On the 14th May, to be exact, Spain was borrowing over one year at 2.985% and for 18 months at 3.302%.

An increase in the risk premium, therefore, over one month and 5 days, for a one year Spanish bond (by 2.089%) and for an 18 month bond (by 1.805%). That’s steep enough in itself. It bodes very badly for what is likely to happen on Thursday, when Spain will attempt to issue two, three and five year debts for a total of 2 to 3 billion Euros. The potential demand will be (I can already guarantee it) around 5 billion Euros, which will be presented as a positive piece of news (that too I can guarantee), but what will be really interesting to know, is at what rate, including with what risk premium, the capital markets, in their magnanimity, will be prepared to lend to Spain?

Now to dishearten the Spaniards a little more: the Danish have also issued debt today, two year debt, for a lower amount, of course, of 1.55 Billion Crowns, something in the order of 208 million Euros. What coupon did the lenders get as compensation for their two years of deprivation? -0.08%. In case you missed it, I’ll repeat that in words: minus zero point zero eight per cent.

In order to lend over two years without risk (that’s what lending to Denmark amounts to at the moment), the capital markets are prepared, at the current time, to pay out of their own pockets. That speaks volumes, my friends, of the confidence there is in the Eurozone!

Ok, just to finish off, here is the little calculation as promised. If the rate without risk today for two year debt is at 0.08%, the risk premium over one year is (as a minimum, because it’s over a shorter period of time) 5.074% + 0.08% = 5.154%, and for 18 months (at least) 5.07% + 0.08% = 5.187%.

Have a nice day all the same!