A number of people making comments on this blog have agreed with Paul Krugman that the relatively low bond rates right now "prove" that new monetary creation and an explosion of government spending bring no inflationary pressure. Thus, they claim, the concerns of people that the current "stimulus" efforts will lead to inflation are unwarranted.
I have asked a number of friends who are economists to comment. As I receive them, I will include them in this post.
Professeur des Universités
Faculté de Droit, d'Économie et de Gestion
If I understand this point correctly, higher deficits need not be monetized (or not much) because of the current drop of T-bill rates. Therefore, the danger of inflation is limited. Well, this argument presupposes that it is always possible for political institutions such as the Fed to stabilize TB rates at the current low levels, or even decrease them. But this is wishful thinking. In the past 20 months, the US Treasury, along with the German treasury and a few others, have benefited from the fact that investors have been losing confidence in all other market participants. Therefore, their TB rates have declined while the rates of all others have increased, or are starting to increase. However, this group of beneficiaries shrinks by the day.
Pressure is mounting for rates to go up, for three reasons: (1) there are more and more countries that have to pay higher rates, which will create pressure on T-bills and bonds precisely if and when the general situation seems to stabilize; (2) the supply of T-bills and bonds could dramatically increase if and when the general situation deteriorates, because the US and the German governments have started to act as financial problem-solvers of last resort; and (3) the return on investments in the "natural monies" gold and silver is outpacing the meager return offered by T-bills, and this at much lower risk. These facts are so glaringly obvious that even mainstream banks such as the Landesbank of Baden-Württemberg in Germany, Société Générale in France, or UBS in Switzerland are now hammering this point, to the benefit of their clients. See the latest installment of this wave of financial enlightenment.
As soon as the rates of US T-bills and of bonds start increasing to a moderate crisis level of, say, 10 percent, all government budgets will be belly-up. Then the only remaining alternative will be between (I) US and German government default, entailing a deflationary meltdown of world financial markets, and (II) monetizing T-bills and bonds, which will very quickly bring us on the road of world hyperinflation.
Tuesday, June 29, 2010
Commentary on Current Bond Rates
Posted by William L. Anderson at 10:48 AM
Labels: Inflation, Interest Rates
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Actually, I don't think it has been a number of people making comments about the low bond rates. Just me. And I appreciate the focus on this topic, and think this could make a very interesting blog post. Your response is topical, as 10 yr rates close well inside of 3%, and the 2 yr. is at an all time low. With all do respect to Guido Hülsmann, I disagree with much of his response, and it's clear he does not understand the US monetary system.
"As soon as the rates of US T-bills and of bonds start increasing to a moderate crisis level of, say, 10 percent, all government budgets will be belly-up"
The US government has funded itself at rates > 10% before, and never went 'belly up'. Why is 10% the magic number? The reality is, as I have said before, the US government is never revenue constrained since it is the monopoly issuer of a non convertible currency, and has 100% of it's liabilities denominated in USD. So to meet its liabilities, all the US government has to do is print more money. There is zero credit risk in US treasury securities, so yields are mostly influenced by inflation expectations. So to say the US government can go belly up is 100% false. We can have a ton of other risks, but default/solvency is not a risk.
"monetizing T-bills and bonds, which will very quickly bring us on the road of world hyperinflation."
The last 2 years have proven this to be incorrect for two reasons. First, monetizing government debt is actually deflationary. All government debt monetization is an asset swap, swapping an interest bearing asset for a non interest bearing asset. This is deflationary. Second, when balance sheets are as over levered as they currently are, it does not matter how much money you throw at the economy, credit will continue to be destroyed, and will not find its way into the economy. This is obvious when you examine aggregate credit data. This was one of the many great mistakes by the Fed. They threw liquidity at a solvency problem, and all that occurred was banks got bailed out and lined their pockets, while the general population continues to suffer. Under different circumstances I would agree increased borrowing/printing would cause higher inflation (i.e. the 70's), but not during a severe balance sheet recession such as this one.
"Pressure is mounting for rates to go up, for three reasons: "
I respectfully disagree with all points, and would be willing to wager 10 yr. rates break through 2.5% before returning to 3.5%. (1) other countries paying higher rates has little impact on US treasury rates. US treasury's are credit risk free, while most other countries are not since they do not control their currency. The most obvious example is the gold standard like system of the EU. US rates will continue to track inflation expectations. Run a quick correlation of US government funding costs and inflation post the gold standard era to better see my point. (2) supply has no long term impact on treasury rates. The last two years show this as debt issuance exploded but yields dropped due to lower inflation expectations. Supply will always be met since the banking system is never reserve constrained. (3) I would rather avoid a discussion on gold, but my quick thoughts are gold is much, much, much riskier than t-bills, and is not a replacement for money. Gold investors will get burned, just like any other bubble. I will also say I generally take research reports such as this with a grain of salt. I have been in this business too long to take advice from the same banks that created CDO's and other financial engineered products. In fact, I would say this report is just another sign of a gold bubble forming.
So, with all that said, to claim the US government can go belly up, and that hyperinflation is just around the corner, to me, lacks an understanding of the balance sheet issues the US economy is experiencing, and the understanding of how a monetary system such as the US's functions.
Perhaps you could expand on your statement "there is zero credit risk in US treasury securities". As I see significant risk that the dollars one receives down the road in payment of debt will purchase significantly less than the dollars loaned to the US treasury.
T-bills are riskless, huh? All other problems with that aside, what happens when banks start expanding loans on top of their now rich reserves at the Fed? Aside from the potential for a default, I'd say the risk is pretty high that your real return is going to be negative.
And for the last time, Anonymous, the interest rate at which government must borrow is more important now than ever. Why, you ask? Because the Treasury rolls over its mostly short-term debt and so it will all need to be refinanced at those higher rates... government debt is never "paid down". With higher interest rates and greater than ever levels of debt across the board, the ability to make payments is going to a burden like never before.
I believe Peter Schiff destroyed this "low rate" fallacy in a debate with Galbraith a while back. He noted that the ONLY reason that rates were low was because most of the borrowing is being done in the short term market. If the governmnet went out to the long term market, rates would jack up.
Why? Well, it's rather simple. The short term market is safer for lenders because there is little risk of U.S. default in the next 6 months, 2 years, etc.. But in the long term market, the perspective has to change and the unsustainable welfare/warfare state must be taken into account by lenders. It really doesn't matter what Anonymous thinks about the U.S.'s long term ability to pay its obligations. It matters what lenders think.
Of course, the obvious problem with staying in the short term market is that debt service is much higher. At some point, the US will not be able to service the short term debt. When is that point? I don't know, just as you can't exactly predict when a debt ridden company will be unable to service their debt. Other outside factors may speed up or slow down this date, but it will come.
When it does come, as Hulsmann poitns out, the Fed will either have to monetize debt, causing hyperinflation or raise rates, causing another contraction.
Austrian economist Gary North walked through this entire scenario in an article called "The Five Flations" a while back. He proposes that the Fed will have to raise rates, because allowing hyperinflation will wipe out the largest banks completely and they can not allow that. Their role is to protect the largest banks.
My guess is that the Fed will monetize the debt at first, briefly, as long as the amount stays low, causing Mass Inflation (10$-20%.) This will only delay the inevitable, when the Fed gives the government the middle finger and says you're on your own.
Then the welfare state will riot, just like in Greece, as their handouts are cut off.
Jason H: Read the next clause of what Anonymous said: "... so yields are mostly influenced by inflation expectations. " Again, if one doesn't understand that US (or UK, or Japan, or Australia etc) -- but not German, French or Greek government securities have zero credit risk one understands very little about modern finance.
Monetizing debt causes hyperinflation? Japan has monetized trillions of $ worth - and still faces deflation. As Anonymous points out, monetizing debt is - obviously - less inflationary than refinancing it - there simply is no need to refinance as Brent thinks there is, and no prospect of horror scenarios as above.
And y'know, as Krugman sorta points out - the omniscient :) bond market does know all this, which is why interest rates (and inflationary expectations) are quite low, and (hyper)inflation is not around the corner, or even the next few corners after that.
Japan has had a stable monetary base from 1992-2009.
1. The M2 money supply barely rose.
2. The Bank of Japan did not inflate the currency in order to overcome systemic price deflation, which did not exist.
3. Consumer prices in Japan fell little, 1992–2009: no more than 1% per annum in most years, if at all.
4. The Bank of Japan pursued a policy that kept prices close to stable.
In light of all that, your comment is silly. It's rather obvious why Japan never had hyperinflation. They didn't have an expansion of the money supply.
The Bank of Japan DID accomplish a stable price level. Unfortunately they did so at the expense of 20 years of economic growth.
And of course, I can't forget to mention that Japan's expansionary credit in the 70's and 80's created the stock market and housing bubble that collapsed circa 1992.
So, how does the example of Japan's experience, particularly concerning the supply of money, remotely resemble America's?
@ Brent and Jason h
One last time, since the US government has a free floating, non convertible currency and all its liabilities are denominated in USD, it will never default because they can just print more money to meet principle and interest payments. The ability to make payments is 100% guaranteed. T-bills are CREDIT riskless. Inflation eroding returns is NOT the same as default. My principle may be worth less in real terms, but I'm getting it back as long as I hold to maturity.
"And for the last time, Anonymous, the interest rate at which government must borrow is more important now than ever."
True, which is why deficit hawks fearing the bond market turning on them are clueless to how the bond market and monetary system work. They are ignorant fear mongers...a bad combination. They bond market should be feared; for INFLATION reasons, not CREDIT.
"what happens when banks start expanding loans on top of their now rich reserves at the Fed?"
Two things. 1) excess reserves are due to the Fed's expanded balance sheet. Why is the Fed balance sheet so big? Liquidity facilities and asset purchases because the inter bank market broke down. The excess reserves were not created to stimulate lending..they were created to bail out the banks. Those reserves can not, and will not make there way into the economy. The banking system is never reserve constrained, so why would excess reserves find their way into credit markets now, during a time when credit is being destroyed? 2) but let's assume they do (they won't, but I'll run with it for a moment) why would credit expand when every consumer, bank, and most governments are shrinking their balance sheets? Credit demand is being destroyed by the day, so no chance those reserves will find their way into the economy. This is a balance sheet recession, not an inventory correction. Huge difference.
Peter Schiff destroyed nothing. In fact, if you took a few minutes and looked at the specifics of auctions, the treasury has been extending it's maturities.
"It really doesn't matter what Anonymous thinks about the U.S.'s long term ability to pay its obligations. It matters what lenders think."
Well, your exactly right, it doesn't matter what anonymous thinks. But what matters less than what I think is what Peter Schiff thinks (just Google his investing track record) and what lenders to the US government think. The US government does not have lenders. Bond issuance is just another means to control inflation and the money supply. Keep in mind, public deficits must always equal net private savings.
"I don't know, just as you can't exactly predict when a debt ridden company will be unable to service their debt"
Actually, I can predict when a debt ridden company will be unable to service its debt. Credit analysts to this all the time. But to compare the US government to a company just shows you don't understand the monetary system. The US government balance sheet is nothing like a company's.
And sorry David, your comments on Japan are not only silly, but factually inaccurate.
What is really sad/amazing is folks are willing to buy into the horror stories and fear mongering, and take little time to learn how the system works. I guess fear mongering is easier to rationalize and fits a political view point. But how can we have a serious conversation about the massive problems our economy has, when people don't even understand how the money system works? Sorry, but if you truly believe that the US government can go belly up, and hyperinflation is around any corner, then you don't have anything to add to the conversation. Facts are facts, and data is data.
Another Anonymous - thanks for the comments. Glad to see at least one other person on this blog gets it. I was hoping Prof. Anderson would throw in his thoughts as well.
Anon so you if inflation results in a negative return on your bond, say you lose 50% in real terms. You don't treat that the same as a debtor defaulting and only paying 50% of the loan. Both are essentially the same.
could you please suggest a book that could educate myself and the masses about the wizardry of our monetary system?
Yes facts are facts.
Look it up!
Everything I said about Japan is 100% correct.
Go to Google
Type in Japan M2 1992-2009
@ anonymous, Understanding Modern Money is a good start.
When you take a break from that book, you can look up the price and money supply data for Japan from 1992-2009 and get back to me, OK?
I found the name of the theory that the original Anonymous is arguing.
He'll come back and pretend it wasn't him that said I was wrong about Japan. It was some other Anonymous guy. If he wanted to engage in debate, he would leave his name.
Anyway, maybe he'll get back to us one day on consumer prices in Japan and the money supply, but I doubt it.
Or maybe he looked it up, and now he is on his way to becoming an Austrian. See, I did good for this world.
Haha David, well Austrians certainly need a sense of humor. Especially when hearing side splitters like money printing to pay debt is deflationary and money printing to pay debt is not a form of default and lest we forget the US has free floating, non convertible currency.
"One last time, since the US government has a free floating, non convertible currency and all its liabilities are denominated in USD, it will never default because they can just print more money to meet principle and interest payments."
Why did I suspect this was the reasoning that was going to be cited? This is just preposterous... why not then just have the Fed print up all $14 trillion in current debt liabilities tomorrow? After all, then we'd kill two birds with one stone. Hell, while we're at it, why not print up all the money needed to repay every American's private debt liabilities?
"T-bills are CREDIT riskless. Inflation eroding returns is NOT the same as default. My principle may be worth less in real terms, but I'm getting it back as long as I hold to maturity."
To repeat what I suggested above, this is just preposterous. Yes, it isn't a technical default. Obviously. But it is a default in real terms. Everyone is going to be really upset (and poorer). Economically, we'd be better off admitting we're financially exhausted and set a new course starting immediately, as opposed to trying to string it out by papering over our problems.
You betcha! It's funny, because you can always easily find the Austrian answer. Robert Murphy in a recent Mises circle talk pointed out that the reason Keynesians can't see the inflation is because they don't understand where the price level SHOULD be. They didn't let the prices fall ALL THE WAY. They intervened. So prices look stable, but they are obviously much higher than they should be. That is inflation.
Well, I guess it would be obvious to anyone who has a dynamic capital theory at his disposal and understands the structure of production.
"Yes, it isn't a technical default. Obviously. But it is a default in real terms. Everyone is going to be really upset (and poorer)."
Glad to see you finally realized inflation is not default. Now look at the situation from the government's perspective, and not as an investor.
@ David - I'm ignoring your Japanese comments because it is off topic, but I'll be happy to address it when you answer my original question back in SS is a Ponzi scheme post (which is why Prof. Anderson created this blog post). Explain to me why despite massive increases in government debt, massive money printing, and a massive expansion of the Fed balance sheet, interest rates continue to fall? Why is the 2 yr. rate at an all time low? Since you think you are such a Japanese expert, why are Japanese long rates so low? Prof. Anderson tried to address this question with a response from Guido Hülsmann. To his credit, at least he attempted to answer the question. Of course, the always easy to find Austrian answer does not exist for this question, because it flies in the face of everything they believe to be true. The simple fact is excess reserves, money printing, and deficits do not always cause inflation. They, nor you, just can't, nor won't, understand why inflation does not exist today, because you do not understand how the monetary system works.
Nope. Not playing your game. I already answered that above anyway.
Look up Japan and get back to me.
Besides, it's got to be awful embarrasing, after trolling this blog proudly beating your chest about how you're the only one who knows how the modern monetary system works, that you don't even know how monetary policy was conducted in the most important two decade recession since the GD.
(sorry for the run-on sentence.)
Then again, not to be so mean, but you should read Bagehot. He learned all the tricks and fancy ideas behind modern monetary theory, agreed that "in theory" they were possible - which we contest but beside the point - but in practice, central banks never operate that way.
Just google The Bagehot Problem or if you have time read Lombard Street.
Anyway, what you posit as fancy new modern era central banking is nothing new and you'll find that out if you do the research.
Thanks for the laughs.
Uh, at what point did I 'posit fancy new modern era central banking?' Try paying attention to what I have written, and to what's happening in the market, then, if you have enough intellectual curiosity to read something by someone not associated with Mises or Austrian ideology, you would realize this 'fancy new modern era of central banking' has it's roots in the 30's. And guess who one of it's greats studied under? One of your hero's, Hayek. If you understand free banking (do you?), then all this may make sense to you. It wasn't until my studies on free banking that the monetary system of a free floating, non convertible currency started to make sense. And as for Japan, you're right, money supply did not increase. But are you denying debt to GDP exploded in Japan? Are you denying they massively printed money? So where is the hyperinflation? Why did money supply not grow? I mean, the US is pursuing the same policies, but you write hyperinflation will wipe out the banks? Huh? So why hasn't Japan defaulted? Why does Japan still have the ability to issue government securities? FYI - money supply in the US is shrinking.
PS - I'm done with this post. All this started with Prof. Anderson comparing SS to a Ponzi scheme, which of course is nonsense. He then created what I thought was going to be a very interesting blog trying stimulate conversation on why rates are so low despite increased borrowing/money printing. Not surprising, the ignorant have destroyed any stimulating debate, and while I did not expect most to understand how the monetary system worked, I did expect the responses to remain above the 3rd grade level.
PPS - I have little interest in educating or debating anyone on how the monetary system works. My motivation is based off the complete silliness of people believing we need to fire a bunch of school teachers and police officers in the name of fiscal austerity because the government is going to default. If you want to fire teachers because you think they are useless and poison the minds of our youth, that’s fine. Say that. But to claim we are going to bankrupt the government if we don't implement austerity now, now, now is complete ignorance and total nonsense.
I'm glad to see you go, totally humiliated. It's obvious you are terrified to check out the monetary policy of the Bank of Japan from 1992-2009, even though a quick Google search will return the information that I posted above, verifying that you are wrong.
Good-bye and thanks for the laughs.
I would be very interested in your response to the following points raised by anon:
"And as for Japan, you're right, money supply did not increase. But are you denying debt to GDP exploded in Japan? Are you denying they massively printed money? So where is the hyperinflation? Why did money supply not grow? I mean, the US is pursuing the same policies, but you write hyperinflation will wipe out the banks? Huh? So why hasn't Japan defaulted? Why does Japan still have the ability to issue government securities? FYI - money supply in the US is shrinking."
PS. I think he's wrong that money supply (M2) is shrinking. Growing slowly? Yes. But shrinking? No.
BC (& all),
I don't mean to take David's thunder (though I guess I am), but this link might be of interest.
The FED has increased the US Monetary Base a lot more than Japan's central bank did. I don't think it's fair to compare what has happened in Japan to what could happen in the U.S.
The excess reserves being held by U.S. banks is unprecedented.
To be concerned about future serious inflation, or perhaps hyperinflation, in the U.S. is not 'silly'.
His original assertion was that Japan's Bank did the same thing as the Fed. Of course, that's false. Sure, they printed money. Every central bank does, but I believe 2001 was their largest expansion in M1 and that was about 40%, 9 years after the Nikkei plummeted? No comparison. A much more sophisticated argument would have been Krugman's (that the Bank of Japan inflated too little), because it takes research to uncover the other interventions (like the Bank of Japan purchasing equities outright in an attempt to prop up the stock market) and it lets Krugman ignore the source of the boom in the first place (low rates).
I write on the Motley Fool Investing website under the psuedonyms "whereaminow" and "David in Qatar". I have answered these questions before so I will just start by pointing you here:
And in regards to Japan, I highly recommend Thomas Woods' book Meltdown which details the series of interventions in the Japanese economy from 1992-2009. (That's just one chapter. The whole book is phenomenal.)
Mr. Anonymous seems to think the US government is either God or the government of the entire world, which doesn't need to held accountable by other countries or its own citizens, simply because the Dollar is the default reserve currency of most countries. That's why he would make outrageous statements such as "the US government is not revenue constrained" or "Taxation is just a means to control inflation". While accusing others of not understanding modern money, he betrays a gross ignorance about society and the nature of government.
sorry, but anyone that thinks money supply is not falling, does not know how to read a chart.
And sorry Richard, money supply is not the same as excess reserves. The banking system is never reserve constrained (loans create more reserves - basic reserve accounting) so an excess of reserves will not cause inflation, much less hyperinflation. This is a fundamental misunderstanding of the banking system.
That's a great point, and it also explains why people who make similar arguments get so furious when other governments devalue their own currencies or threaten dropping the dollar as a reserve. "How dare they" the apologists exclaim! "China is a trade cheater flooding our country with cheap products!"
It takes a tremendous amount of ignorance to believe in government, and a great deal of cognitive dissonance to defend it.
NO ONE thinks excess reserves SITTING in a vault causes inflation.
They won't sit there forever. That's the point. If you can't understand that simple premise, that's not our fault.
Feel free to make the argument that they will be withdrawn magically when the time is right! Because people given money always give it back. And even though they had no idea the crash was coming (Go to YouTube and search for "Bernanke in Denial", they will know exactly when to recall the reserves :)
Well hot darn!
Tom: Anonymous's statements "the US government is not revenue constrained" or "Taxation is just a means to control inflation", are not outrageous, they are true, by definition, of any nonconvertible, floating, fiat currency, like that of the USA, Japan, the UK, Australia or Canada. Here is a 1945-46 paper by the governor of the New York Fed and inventor of income tax withholding, Beardsley Ruml -
TAXES FOR REVENUE ARE OBSOLETE- http://home.hiwaay.net/~becraft/RUMLTAXES.html
Warren Mosler's short new book might be helpful in ridding false preconceptions - http://www.moslereconomics.com/wp-content/powerpoints/7DIF.pdf .
Of course, Tom, I never said such things about the US government. In fact, all I have said applies to the UK, Canada, Australia, or any country that has a free floating, non convertable currency with all it's liabilities in it's own currency. And unless you are on some barter system with your trade partners, and don't pay taxes, you and David have the same confidence in the government I do. And if you aren't paying taxes well hot darn you sure are smarter than all of us.
Mr. Anonymous and Another Anonymous:
Taxation as an important means to redistribute wealth in a society was pointed out by Beardsley Ruml himself. You might think that is not necessary, most people think otherwise, even if they disagree on to what extent.
As far as as "revenue-constrained" is concerned, you are merely trying to argue the semantics. The fact remains that any government, with free-floating, non-convertible currency or not, cannot keep creating money to spend without creating commensurate amount of wealth. Otherwise, it will be called to task by its "creditors" (entities that own its money if you preferred), i.e., other countries and its own citizens (or bondholders). I believe the classical terminology of "revenue", "deficit", and "debt" serve this purpose just fine. Changing the terminology and confusing the picture doesn't make Warren Mosler any smarter than Larry Summers, even though he himself seems to think so.
Tom, I agree, Ruml lists some other purposes of taxation, but I think at the level we are talking about here, disinflation is the primary one.
What terminology has been changed? To me, one attraction of the chartalist viewpoint is that it uses standard terminology and describes the nominal / financial situation with it more carefully than other approaches. This makes it easier to distinguish real world and nominal/financial facts, and avoid saying nonsensical things like the US is running out of $, or that bond sales finance deficits, or that government deficits are a bad thing and surpluses are a good thing. The reverse is the case and for centuries deficits have been the norm in the USA.
What money is being used for matters a great deal of course, but using it to create full employment by employing idle resources for public projects, etc and thereby create wealth has historically worked well, and is not inflationary at times like now. It would be a lot better than many present uses, like a network of military bases to support insane wars.
Being smarter than Larry Summers is not imho an uncommon intellectual distinction.
Tom-I never said the government can just keep creating money. The overriding point is INFLATION is the ultimate check on spending/printing, not credit quality.
The overriding point is INFLATION is the ultimate check on spending/printing
On what planet? The threat of rising prices has never once stopped a government from using the printing press.
What, we are having an argument about money supply on an Austrian Economics blog and people are referencing M3? Why not TMS?
Why won't the creator of this blog come in here and take on Anon. Seems like Anon's like a Ronin itching for a fight from samurai in residence, and the samurai is nowhere to be found. Someone get him down her to defend himself instead of having his acolytes do it.
Or maybe Anon can go to Mises.org forums for a debate. Lost of Phd level economists that will gladly give you a go.
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