Ferguson or Krugman, Which One Is Right?

You may be aware of a disagreement between Paul Krugman and Niall Ferguson (not to be confused with Turd Ferguson) about what the rise in treasury yields actually means.

Krugman believes it is evidence of confidence about the future and normalcy in terms of market function.

Ferguson believes the market is pricing (what should be) the realization that the US is headed for big trouble as it is printing money, issuing debt and effectively monetizing some of that debt.

Dan Gross chimes in here with links galore if you want to get the whole story.

There are a lot of moving parts to this and for now all anyone can have is an opinion. We won't know the answer for a while yet. Between the two camps (Gross calls them Krugmanites and Fergusonians) is probably where the true answer lies.

As far as confidence and normalcy the pure panic that existed does appear to have subsided. By this I mean confidence that the market can just function (not a directional call for where things are going). Hopefully people remember that there was rampant fear that markets would not function ever again, there were a couple of spasms in this regard of course but we have moved out of the panic stage. I'm not sure how the Fergusionians could argue otherwise as they could be right about the US being in big trouble but the market could easily function the way it should in the face of that outcome.

I suppose there could be a return to that sort of panic but the world is far more educated about things like counterparty risk, the magnitude and danger of the leverage employed and everything else. We can debate whether these things have been fixed or not but if everyone now knows much more than they did before March 2008 then I'm not sure panic in the context we are discussing is possible.

Krugman believes the rise in treasury rates is evidence that investors are willing to go for more return than a few basis points from treasuries, Gross notes how much Brazilian and Indian stock markets have rallied. Again this is a point that is hard to argue because again the US could erode (or implode?) as other markets do well. Money is flowing into other asset classes--not to say it won't all correct aggressively one more time but it is tough to argue that money has not moved from US treasuries to other things.

As for the logic behind the Fergusonian camp I'm not sure how anyone can argue that the US has become a much more attractive investment destination in the last couple of years (to be clear I haven't read anywhere that Krugman has said this). If the US is much less attractive than it was because of all the reasons that you can think of, then rates would seem to have to go up a lot, although not necessarily to 1981 levels. I suppose this could be wrong but I don't see how they do anything but go up.

There is an element to this of captive buyers. One way to look at this is that China has to buy US debt in order to protect its current investment. That is at least partially true and I would have to imagine that China getting out of its US investment would require both strategic and logistical planning and some sort of management of the consequence to them when the US can't buy as much stuff from them. No matter your conclusion on this it is a very unhealthy relationship with bad consequences for both parties.

It should be obvious that I am not too concerned with trying to solve this debate as I am concerned for what this means for growing/protecting the portfolio. US treasuries are down a lot but still expensive so anything beyond short term (don't even have any short term though) would be off the table. It seems to me that to think uncomfortably high price inflation (I am not in the hyperinflation camp) won't happen is to believe that the Fed and Treasury will know exactly when to reverse everything which seems unlikely given how reactive they have been all along. Additionally it seems very unlikely that the Obama administration will err on the side of belt tightening.

As I read the Krugman/Ferguson debate they can each be correct on certain things but I am leaning toward the Fergusonian side of the debate because it is closer to what I have expected would happen (not to the same magnitude) and because I see very little need to "protect" against a happy outcome.

The pictures, by the way, are from a NY Times interactive feature about the history of GM. I found the contrast of the two vehicles to be striking. Up top is a 1926 Vauxhall 30-98 OE Type and the second picture is obviously a Hummer.

Comments

[zaphod42:]

Conclusion? The two camps are not mutually exclusive.

Jun 08 12:57 PM

[conceptwizard:]

It really does not matter who takes home the title of economic guru. More emphasis needs to be put on solving the issues at hand.

Everyone should agree:

Worldwide Depression is now considered on the table where it was on the back burner before. The policies put in place of the Obama administration are not having the desired effect on the economic drivers. Monetary policy of the Treasury and Fed are causing issues on mortgage rates and long term treasuries.
Ben Bernanke said it plain that without "major" changes we are going to have complete system failure. This is cause for major concern.
Federal Reserve Board Chairman Ben Bernanke demanded that Congress and the Obama administration map out a program of austerity measures to bring down record budget deficits. Bernanke made clear that the heart of this program should be sharp cuts in social spending, including basic entitlement programs such as Social Security and Medicare.

Even as he called for plans to slash social programs, Bernanke said that the economic “recovery,” which he predicted would begin later this year, would be preceded by a continued surge in unemployment that would last for a protracted period. Acknowledging that nearly 6 million jobs in the US have been lost since the beginning of 2008, he said “sizable job losses and further increases in unemployment are likely over the next few months.”

Even when the economy stops shrinking—currently at an annual rate of 6 percent—“businesses are likely to be cautious about hiring, and the unemployment rate is likely to rise for a time,” he said.

Noting projections of rising outlays for these entitlement programs as millions of baby boomers retire, he said “we will not be able to continue borrowing indefinitely to meet these demands.” Speaking of “difficult choices,” he said, “Congress, the administration and the American people must confront how large a share of the nation’s economic resources to devote to federal government programs, including entitlement programs.”

Ben Bernanke is saying an L shaped depression is currently underway, these statements do not mean "V" or "U" or "W" they mean "L".

Jun 08 01:15 PM

[Whippet:]

Nice comment, conceptwizard. Despite Helicopter Ben's cries for slashed spending, what's in the news? Healthcare. Taxing individuals for benefits. Forcing employers to offer coverage. Adding the uninsured, unemployed to government employee plans. Also, China proposing the idea of floating yuan-payable debt to us. Ben can't print enough Benjamins. As the dollar declines, we will be forced to borrow a stronger fiat by the only nations who will offer us debt, and at an increased rate as our national credit rating will fall. We will be faced with a choice of maintaining entitlements or slashing them almost entirely. A lot of pain now, or crushing pain later.

Jun 08 01:26 PM

[Henry Buttal:]

I am with Ferguson on this one. It would seem the ultimate determination will be seen this summer as we see the appetite for new U.S. Treasury issues.

If the Krugman camp is right, the Obama rock tour will create a consistent demand for the issues, as the U.S. will be seen as beacon of safety, truth and love in a world gone mad. Offerings will be oversubcribed, the interest rates will be low, the damage to future generations from interest carry will be ameliorated. Personally, I think Krugman is wearing his "enchanted" media persona on this one, not his economic thinking cap.

If Ferguson is right, an auction or two will fail, and effective interest rates will have to rise, drawing in needed money from other credit areas. This won't be good, and can likely only be forstalled by realistic expenditure constraints that don't seem to be part of the current administrations dialogue.

Jun 08 01:38 PM

[Dave Wrixon:]

Krugman has as much chance of being right as Bush has of solving global warming.

Jun 08 03:56 PM

[Thomas J. G...:]

Roger brings up an important point. "Which" reason for rising interest rates is really important. If it's all getting better and q42008 was just a bad dream, that's one thing. If the smart money correctly sees that unacceptable inflation and higher interest rates are in our future, that's very different. Both these scenarios describe a situation where interest rates are rising. Most people don't hold all stocks or all bonds. I would argue if Krugman is right stocks will stay where they are or go up. If Ferguson is right, stocks will decrease.

Jun 08 04:46 PM

[E Nuff Sed:]

I am firmly on Krugmans camp. Quick action by Ben Bernanke (incl. Hank Paulson) saved us going down the toilet. Clearly the bond prices are signalling normalcy and money is flowing into risky assets with higher return.
finance.yahoo.com/echa...=^TYX#chart1:symbol=^t...
The chart above clearly shows how abnormal the situation was during the last two quarters.

Jun 08 10:56 PM

[E Nuff Sed:]

Sorry - try this
tinyurl.com/n52ukc

Jun 08 11:02 PM

[Quaker:]

Neither Bernanke or Obama's "plans" had anything whatsover to do with the US economy. The primary purpose was to insure that the same 12 guys who run the world on Friday run it on Monday.

These "economic debates" are like having a wife that's a slut and debating how much she loves you. The majority of money created between 2000 and 2007 were not created by the fed, it was created by trade deficit financing. To understand the problem the US faces, neither Ferguson or Krugman has the perspective to help you.The guy to focus on is Fernand Braudel.

Obama and Bernanke's "plans" won't work because they're not designed to work. Obama's trying to control Washington. People who think politicians care about them are morons. How in the hell are you going to get an economic recovery when the people who ultimately pay the bills are up to their eyeballs in debt? To close a $3.2 trillion deficit you need $15 trillion in new GDP. This from a country where 25% of the population is negative on their house, 75% of the population is negative on their cars and ATV's and has $8,000 in unsecured debt?

The only reason we're coming out of this recession is that the government is manipulating the dog shit out of the statistics. According to last months jobs report we created 43,000 jobs in construction and 67,000 in Leasure and Hospitality.

Ifyou believe that, you deserve Krugman, Ferguson and Bernanke.

Jun 09 10:30 AM

[coreopsis:]

My take is quite different from the above but believe that Krugman is steadily showing signs of disconnectedness with the real market.

As a former Wall Streeter, the rise in bond yields shows the 'return' of a normal bond market in the sense that a normal yield curve situation is being restored and hence trading profits can be made. In that way, the financial services industry appears to be headed back to an unregulated, speculative environment that is in fact the root cause of the depression which is increasingly likely.

Ferguson, though, generally interprets the rising yields unfavorably and in this respect (effect on mortgage markets, consumers, real estate prices) he is closer to the truth than Krugman who is, after all, an academic economist for which we can only say that he is far less comprehending of the current global situation than his fellow Nobelist Joe Stiglitz.

What's quite clear is that Obama/Summers/Geithner will not regulate the fin svces industry and that suggests a catastrophic bubble in US financial markets some point further out in time (end of O's term, but maybe sooner). Equally evident is that O is a one-term president (I voted for him but he's overwhelmed).

As this is a Seeking Alpha blog, let's also say that 'finding' alpha in the US markets is decreasingly likely in the future.

Jun 09 10:34 AM

[coreopsis:]

Roger: succinct, brilliantly written, and on the money. I particularly liked your take on the vast cottage industry that has grown up in consumer financial services dedicated to traducing people into believing they have a good (or any) chance of making money holding equities. A review of the post WWII markets substantially proves otherwise.

Jun 09 10:38 AM

[jaume ribe,...:]

I find "basics" and most credible Paul Krugman position.
Jaume, Spain

Jun 09 11:36 AM

[CLH:]

I never read Krugman and his totally left wing views. However, I do agree with him here. Interest rates will not continue to go up when no one wants to borrow. The govt. borrowing will not replace the huge debt elimination of the private market.

Interest rates up slowly, stocks up and down, gold and dollar steady.

Jun 09 08:57 PM

[E Nuff Sed:]

There deflation in demand and prices + massive de-leveraging by consumers and the financial system. There are only two ways out.

1) Liquidate, liquidate, liquidate.
2) Print money and inflate.

1) will lead to the 2nd great depression and a 3rd world war.
2) we might live to live to fight another day.

Jun 09 11:38 PM

[Gregman2:]

"As I read the Krugman/Ferguson debate they can each be correct on certain things but I am leaning toward the Fergusonian side of the debate because it is closer to what I have expected would happen (not to the same magnitude) and because I see very little need to "protect" against a happy outcome." Your instincts are correct--follow them.;-)

Jun 10 12:42 AM

[Bill Jencks:]

Ah yes, Krugman. Fairly evident that this man is neither this nor that in economics. On the one hand, although benign to Obama, he criticizes his stimulus policies -- not enough bailout. Regarding the Republican Right, who purport less bailouts, he is a well defined enemy. It is obvious to me that he is slyly maintaining his own unsoiled position within academia by giving such a fuzzy non-opinion. If America were to suddenly fall economically tomorrow, Krugman would be the first to scream "See, I told you so...!!!". And if the Stimulus does work, he would find some way to come in with some credit. Either way his esteemed reputation in neutral academia would be maintained.

What else can you say about an economist who insists loudly in the media that there is not enough stimulus -- and then refuses to reveal the exact, curative figure that defines Enough Debt? And what can you say about a man who, when prodded by the the question. "...And, Mr Krugman, how is America to pay back all this horrendous debt that you propose?", this sends him rushing and hiding in the media bushes.

The man is empty of useful economic ideas.

Jul 16 09:04 PM