A Socratic Dialogue: Fearing the Collapse of U.S. Treasury Bond Prices 63 comments
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Meno: I haven't seen you since spring classes ended.
Adeimantos: I have been away: Paris. London. Frankfurt.
Meno: Oh. Pleasant? Interesting?
Adeimantos: Not really interesting--too jet-lagged, so I sit in my hotel room in my underwear, read the Economist and Financial Times, and reflect on how if in my 20s I had been in a fancy hotel in central Paris with someone else paying I would have thought I was in heaven, but that now I am just tired. Thus not too pleasant either.
Meno: Middle age is a shipwreck?
Kephalos: It gets worse...
Adeimantos: However, it was somewhat lucrative: talking to European hedge funds.
Meno: And what do European hedge funds think?
Adeimantos: They look at things like this:
Then they demand that I tell them why U.S. Treasury bond prices have not already collapsed (and Treasury interest rates risen) in anticipation of this forthcoming tsunami of bond issues. Given that Treasury bonds have not yet collapsed they are very very bearish about U.S. Treasury bond prices and interest rates. Supply and demand. The supply of U.S. Treasury bonds is about to become huge, and when supply goes up price should go down.
Socrates: But if that argument is correct, then rational profit-seeking traders should already have sold U.S. Treasury bonds and already have pushed their prices down in anticipation of the sudden increase in supply...
Meno: Are you Socrates or Milton Friedman?
Kephalos: There are two supply-and-demand arguments that can be made here. The first is that the supply of U.S. Treasury bonds is about to jump enormously -- and so by supply-and-demand the price will be low once the extra bond issues hit the market, and should be low now in anticipation of this low-price Treasury bond market equilibrium. The second is that the inverse of the price of U.S. Treasury bonds--the Treasury nominal interest rate--is the price of liquidity: the amount of interest income you forego by keeping your wealth in cash rather than in securities. According to this second argument, the supply-and-demand is the supply and demand for cash: when the supply of cash is high, the price of liquidity is low, and since the price of liquidity is the short-term Treasury interest rate the short-term Treasury interest rate should be very low.
Adeimantos: Which it is...
Kephalos: And the long-term Treasury interest rate is the average of expected short-term future Treasury interest rates. Since the Federal Reserve has flooded the economy with cash and will keep flooding it with cash for the foreseeable, Treasury interest rates should be low which means Treasury bond prices should be very high--which they are--and stay high.
Adeimantos: Loanable funds vs. liquidity preference.
Socrates: So, Kephalos, with your impeccable logic and deep wisdom derived from a long career financing expeditions to the shores of the Black Sea, you have presented us with two different supply-and-demand arguments, one saying that Treasury bond prices should be low and hence are about to collapse, and the other saying that Treasury bond prices should be high and are likely to stay more-or-less where they are for some time to come.
Meno: Which argument is right? Is the price of bonds the price that balances the supply and demand for bonds in the bond market? Or is the price of bonds the inverse of the interest rate which balances the supply and demand for cash in the money market? Both cannot be true, can they?
Adeimantos: Ah. But both arguments are true...
Meno: Why do I get the feeling that I am being cast as the dumb straight man in this dialogue?
Socrates: Because you are a sophist and we are philosophers. We write the dialogues, and we write them to make ourselves look good so that everyone thinks that philosophers are the roxxor and sophists are lame...
Meno: What have I ever done to you?
Glaucon: Tried to take our students and their fees, perhaps?
Socrates: And we have won. There are now departments of philosophy everywhere. But when was the last time you saw a department of sophistry?
Meno: OK. I will take up my role: Kephalos,: Can you explain to me how two perfectly-coherent supply-and-demand arguments lead to opposite conclusions? And if both arguments are coherent, why do European hedge funds all believe the first?
Kephalos: I can answer the second question but not the first: European hedge funds live in the bond market and they see the supply and demand of bonds all day, so that is the market they believe is most important...
Adeimantos: That is true about European hedge funds. But, Meno, the way you have posed the issue is somewhat misleading. It is not which supply-and-demand argument is correct--for both are: the price/interest rate on Treasury bonds clears both the bond and the money market, both loanable funds and liquidity preference. It is how does the economy adjust in order to make the Treasury bond price/interest rate clear both these markets.
Meno: And I have the feeling that you are about to tell me...
Adeimantos: Let's start with an economy in equilibrium--where Treasury bond prices are such as to satisfy both loanable funds and liquidity preference, so that everyone is happy to hold the bonds given their current price and everyone is happy to hold the economy's cash supply given the current interest rate. Now suppose the Treasury issues a huge honking tranche of bonds (and Obama spends the money hiring the unemployed to give people cholesterol screenings on the street and hand out statins). Now the supply of bonds is greater than demand at current bond prices. So what happens?
Kephalos: The prices of Treasury bonds fall--interest rates rise...
Adeimantos: And what happens in the money market as interest rates rise?
Kephalos: People are no longer happy holding the economy's cash--it's too expensive; it's burning a hole in their pocket. So they start spending it faster...
Adeimantos: And as they start spending it faster?
Kephalos: This puts upward pressure on prices and employment, as businesses find that they can charge more and make higher profits and so hire more people...
Adeimantos: Incomes rise, and as incomes rise savings rise because people don't spend all of their increased incomes, do they?
Socrates: Very true, Adeimantos.
Adeimantos: And what happens as savings rise?
Kephalos: People want to park those savings somewhere. They want to park those savings in Treasury bonds. And so demand for Treasury bonds rises...
Adeimantos: And the economy settles back at its new equilibrium, with (a) somewhat higher interest rates and (b) higher spending and income so that (c) people are happy holding the economy's cash at the current interest rates and rate of spending, and (d) people are happy holding the bonds at the current bond prices and level of income.
Kephalos: So both supply-and-demand arguments are true...
Meno: And the way that they can both be true is that there isn't just one quantity--the bond price--that adjusts to match supply and demand in the bond and the money markets...
Socrates: But there are two quantities that adjust: the bond price and the level of spending...
Adeimantos: Yes. You have just derived things that were well-known 72 years ago. See John Hicks (1937), "Mr. Keynes and the 'Classics': A Suggested Interpretation."
Meno: So when European hedge funds predict the collapse of U.S. Treasury bond prices as the new issues hit the market and ask where is the extra demand to hold all these new bonds come from, the answer is...?
Adeimantos: That even as the government issues the bonds it is also spending the money, and as the money it spends is parked in the bank accounts of the businesses the government is buying things from, the banks in which the money is parked take it and use it to buy Treasury bonds.
Meno: That sounds like sophistry...
Socrates: You should talk...
Glaucon: Actually, it's just general equilibrium...
Meno: But is this doctrine--that the government's issuance of a fortune in bonds and spending of a fortune in money will show up primarily not as a collapse in bond prices and a spike in interest rates but as an expansion of spending--true?
Socrates: We will see. Keynesian--or maybe I should say Hicksian--economists would say that bond prices/interest rates and spending/income levels are the two quantities that together adjust to jointly clear the bond and the money markets, to satisfy both loanable funds and liquidity preference equilibrium; that sometimes the principal movement is in interest rates; that sometimes the principal movement is in spending levels; and that right now it is likely that spending will adjust by much more than interest rates.
Adeimantos: And there is a little bit of empirical evidence that the Hicksian economists are right. Tim Fernholz sends us to Nelson Schwartz, who writes:
Europe Lags as U.S. Economy Shows Signs of Recovery - NYTimes.com: There was more evidence Thursday that the United States economy might be stabilizing, if not rebounding, even as economic reports in Europe remained gloomy. The American news — showing slight growth in retail sales and a dip in first-time jobless claims, as well as rising stocks — was not enough to end the disagreement between bulls and bears over how soon the economy would improve. But the apparent divergence of fortunes between America and Europe highlighted the different approaches to solving the financial crisis, and why some economists say the more aggressive American strategy may be working better, at least for now. It is a debate that is likely to be one of the issues dominating discussions when finance ministers from the eight largest economies meet in Italy this weekend.
Some private economists are even predicting that the American economy will resume growth in the fourth quarter, while Europe’s economy is expected to remain in recession well into 2010, after contracting an estimated 4.2 percent this year compared with an expected 2.8 percent decline in the United States. “The shock originated in the U.S., but Europe is paying a higher price,” said Jean Pisani-Ferry, a former top financial adviser to the French government who is now director of Bruegel, a research center in Brussels. Almost from the beginning of the crisis, the United States and Europe chose largely different paths to aiding their economies. The most stark was Washington’s willingness to commit hundreds of billions of dollars to stimulus spending — in addition to moving aggressively to shore up banks and keep credit flowing — versus Europe’s worry that similar spending would increase inflation in the future. Just as the policies pursued during the Great Depression have been dissected ever since by economists, the fate of the United States and Europe as the two regions emerge from the global crisis will be analyzed for decades to come.....
One crucial concern about America’s increased deficit spending — that it would lead investors to demand higher interest rates on United States debt, making it far more expensive to borrow and slowing the economy — has been allayed, for now. An auction on Thursday of $11 billion in 30-year Treasury bonds found enthusiastic buyers, helping to push the Standard & Poor’s 500-stock index to a seven-month high...
Meno: And the Chicago School economists who say that government borrow-and-spend logically cannot increase overall spending? The Robert Lucases who say: "[W]ould a fiscal stimulus somehow get us out of this bind...? I just don't see this at all. If the government builds a bridge... by taking tax money away from somebody else, and using that to pay the bridge builder... then it's just a wash.... [T]here's nothing to apply a multiplier to. (Laughs.)... [And] taxing them later isn't going to help, we know that..."? And the John Cochranes who said: "[W]hile Tobin made contributions to investing theory, the idea that spending can spur the economy was discredited decades ago. 'It’s not part of what anybody has taught graduate students since the 1960s. They are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false.'" To borrow money to pay for the spending, the government will issue bonds, which means investors will be buying U.S. Treasuries instead of investing in equities or products, negating the stimulative effect, Cochrane said. It also will do nothing to unlock frozen credit..."?
Socrates: I, at least, find myself unable to understand them. They say they believe in the quantity theory of money -- that spending is equal to the economy's cash times its velocity. And they say that they believe that velocity is interest elastic -- that people respond to incentives and spend the cash in their pockets more rapidly when nominal interest rates are high. They say that they believe that bond prices/interest rates are such as to balance saving and investment and make people willing to hold the stock of bonds. That's all you need to be a Hicksian. Yet they also claim that Hicks is wrong, somehow -- without giving arguments. I can trip up and make foolish anybody who makes an argument, but if they don't make an argument I cannot make them look any more foolish...
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This article has 63 comments:
Kephalos: People are no longer happy holding the economy's cash--it's too expensive; it's burning a hole in their pocket. So they start spending it faster...
It seems to me that the opposite should occur. As interest rates rise people are more willing to forego current consumption in favor of future consumption, since they will be able to consume more by putting their cash into savings and earning interest.
The bottom line is that the recent tendency for most investment capital to hit the Silk Road is only going to accelerate. Stimulus in the US economy will not create conducive conditions for productive investment. All that is going down is that a largely ignorant electorate are being bribed by debt secured against the sweat of their grandchildren.
For a Roman perspective:
That cannot be true, even if Cato says it is.
On Jun 13 05:39 PM Tom Armistead wrote:
> Interest rates rise to compensate for inflation. During inflationary
> times the best strategy is to spend money before its purchasing power
> declines further.
Hmmm, I wonder if U.S. officials have thought of these methods.
On Jun 13 11:18 PM Skep Tick wrote:
> One can peddle Treasury bonds by falsifying U.S. inflation data,
> and also bribing foreign investment group leaders, including foreign
> government officials, to buy these bonds. These foreign leaders
> who have for years been deciding to buy Treasury bonds could also
> be reminded that if they don't keep buying, the value of their existing
> holdings would plummet and make these leaders look bad. If they
> still waver, the Feds can themselves buy Treasuries for a while to
> keep the price up until these other methods can be bolstered. <br/>
> Hmmm, I wonder if U.S. officials have thought of these methods.
As long term interest rates are compounded options on short-term (nominal) interest rates the only factor is volatility and short-term interest rates.
Inflation comes into play only if it causes the FED to hike the short term interest rates (cf Volcker the Fool). If not I wonder where the bond holders would put their money away. Under their mattress may be?
As far as inflation is concerned: as long as there is over supply of goods services and work I don't really see where the inflation would come from except from the mineral prices.
Inflation comes from supply and demand as long as the rich get richer, and investments grow (supply grows), and the poor get poorer (and Consumption relatively goes down) you can't have inflation!
People should be serious the real threat is still the Greenspan Conundrum.
This is just a techincal rebound.
Unless, of course, the poor get richer and the rich get poorer!
On Jun 13 07:52 PM Kinabalu wrote:
> "Treasury interest rates should be low which means Treasury bond
> prices should be very high--which they are--and stay high"
>
> For a Roman perspective:
>
> That cannot be true, even if Cato says it is.
By printing money and turning on inflation expectations, the Fed/U.S. Gov't avoids killer deflation. (Imagine how difficult it would be to pay back trillions of dollars after coming out of a multi-year bout of deflation!) With a real threat of inflation, consumers spend their money. This creates velocity and actual inflation. Begin feedback loop; hyperinflation becomes a threat. At some point, Fed has to pull back on monetary easing by selling all those Treasuries it bought (ever noticed how coy Bernanke is about when/how he will undo QE?). The author of the article gets it wrong at this point, contending that "as the money [the gov't]spends is parked in the bank accounts of the businesses the government is buying things from, the banks in which the money is parked take it and use it to buy Treasury bonds" (the "not a closed loop" comment hinted at the problem). What is missing is that at this point, foreign investors in dollar-denominated assets (Treasuries) simply will not buy more dollars when hyperinflation is on the horizon. They will sell their dollars and buy other stuff somewhere else. When there are not enough willing buyers for the Fed's inventory, Treasury prices collapse, interest rates go through the roof. (The alternative is the Fed holds on to its inventory and inflation spirals out of control.) Economic growth is stifled. Ironically, taxes then go up to shore up the gov't's debt outlook. Treasuries recover. New equilibrium is established with a dollar that is worth significantly less than before. With a weak dollar, U.S. workers get the chance to manufacture things again -- and discover it's not that much fun after all.
We all end up poorer (probably deservedly so), but there's still baseball being played.
On Jun 13 08:46 PM prudentinvestor wrote:
> If government borrowing and spending creates true value in the form
> of economy-enhancing infrastructure, then all you said makes sense.
> On the other hand, if government borrowing and spending is to "dig
> holes and fill them", then its effect is just inflation, pure and
> simple, leading to a collapse in treasuries. The latter, or an approximation
> thereof, appears to be the case in the US, and China, by contrast,
> appears to be implementing the former.
Second assumption, the yield curve is shifting parallely. The consumer behavior you specify (cash burning a hole in your pocket) makes sense if high _long-term_ rates are a reflection of inflationary expectations and we have a steep yield curve (we do). Higher short-term rates in absence of large inflationary expecations induce consumers to save rather than spend (we dont have this). There is also abundant evidence that the following statement is not completely accurate: "long-term Treasury interest rate is the average of expected short-term future Treasury interest rates". There are many other factors that come into play that make the statement a much too simplistic explanation of L/T rates.
As far as reality goes:
We have a promise to keep short-term rates low. (i believe will be held no matter how many people believe rate hikes will come this year)
We have high/rising long-term rates (inflation expecations).
We have a rising savings rate. (consumers are not spending cash, which they should be if they expect high inflation. They are repairing their household B/S)
We have govt borrowing crowding out private borrowing (credit is contracting)
The bottom line as I see it is that the consumers, long raised on easy credit, are deleveraging hard in the face of uncertain expectations of asset returns and rising risk premia. The government is spending (to replace private consumption) and borrowing (to finance its spending and in the process providing an alternative to private borrowing). While there is fungible supply of funds that can go either to govt borrowing or private borrowing, the demand for loanable funds from private side has fallen off a cliff. There is an expectation of inflation but if it does not materialize in the midst of a high unemployment, low growth environment, the carry trade will flatten the yield curve.
On Jun 13 11:33 PM Dave Wrixon wrote:
> Almost certainly, but unlike the snake oil salesmen that have BHO's
> ear, the Chinese and others have some real smart cookies onboard.
>
If interest rates go up, the stock market will likely fall, thus creating demand for treasuries, putting pressure on interest rates again. Another equilibrium to consider....
If Socrates had a freezer, he could say that reinflating the economy is like filling an ice cube tray (of course they didn't have automatic ice makers back then... duh). You pour water into one cube, but it should flow until all the cubes are full. Then when the water starts to spill out, you turn off the water (or tell the slave boy to do it).
All arguments about the likely direction of Treasury prices based around supply demand, even taken into account hedge funds, SWFs and foreign central banks will always founder on the unknowns surrounding the actions of the Federal Reserve, which is the greatest financial black box (or should that be black hole) in history.
I stopped reading this article when I came to this sentence:
" what happens in the money market as interest rates rise?
Kephalos: People are no longer happy holding the economy's cash--it's too expensive; it's burning a hole in their pocket?
Doesn't make sense. The premise of his argument falls apart.
On Jun 13 05:30 PM vagrantengineer wrote:
> Adeimantos: And what happens in the money market as interest rates
> rise?
>
> Kephalos: People are no longer happy holding the economy's cash--it's
> too expensive; it's burning a hole in their pocket. So they start
> spending it faster...
>
> It seems to me that the opposite should occur. As interest rates
> rise people are more willing to forego current consumption in favor
> of future consumption, since they will be able to consume more by
> putting their cash into savings and earning interest.
"All that is going down is that a largely ignorant electorate are being bribed by debt secured against the sweat of their grandchildren."
I doubt seriously if it will ever get to that. I expect the spending/money pumping to continue for years (as the alternative is a deflationary black hole) and then about 15 or 20 years from now, the U.S. will effectively repudiate all former debt through some sort of currency maneuver or reset, and then we will go on down the road with a new currency.
My plan is to stay long undervalued equities, short bonds whenever they spike, and have a hefty portion of my portfolio in commodities, especially when the signs are that global growth is about ready to go into another upswing, as we are seeing right now.
"We have govt borrowing crowding out private borrowing (credit is
contracting)".
What is happening is not that private borrowing is being crowded out; there are plenty who wish to borrow but cannot. The financial requirements established by banks (who have lots of cash on the balance sheets) that prospective borrowers have to meet has changed; the standards are much higher than the recent past (maybe all the way back to pre 1990's ?).
Or assume that they (prospective borrowers) are repairing household BS's and not seeking loans (still does not alter the fact that banks have lots of cash and willing to loan). What is the goal (assumption: rational consumer) of such behavior? To reduce payments to others; to have cash on hand in order to make purchases. Liquidity preference.
Why hold money in the face of clear evidence (or theoretical evidence as actual inflation has not been registered, only deflation) that inflation is going to occur in the future. Or to put in another way, why put money in the mattress when you know you are going to die and cannot use it anyway?
I do not see either scenario (Keynsian/Hicksian or Neo Classical/Chicago School/Austrian School) playing out. Unfortunately, I am like Meno. I do not have the answer as to what exactly is the answer. The Keynsian school has better grasp of the dynamics than does the Neo Classical version so I suspect the ultimate outcome will be more towards that end of the argument.
On Jun 14 01:42 AM odin wrote:
> Good argument, however, a key assumption is that the demand for treasuries
> comes out of a closed system. Supply is increasing so yields must
> rise. What if demand changes as well? Aging population, volatile
> markets, scarcity of risk-adjusted yield.
>
> Second assumption, the yield curve is shifting parallely. The consumer
> behavior you specify (cash burning a hole in your pocket) makes sense
> if high _long-term_ rates are a reflection of inflationary expectations
> and we have a steep yield curve (we do). Higher short-term rates
> in absence of large inflationary expecations induce consumers to
> save rather than spend (we dont have this). There is also abundant
> evidence that the following statement is not completely accurate:
> "long-term Treasury interest rate is the average of expected short-term
> future Treasury interest rates". There are many other factors that
> come into play that make the statement a much too simplistic explanation
> of L/T rates.
>
> As far as reality goes:
> We have a promise to keep short-term rates low. (i believe will be
> held no matter how many people believe rate hikes will come this
> year)
> We have high/rising long-term rates (inflation expecations).
> We have a rising savings rate. (consumers are not spending cash,
> which they should be if they expect high inflation. They are repairing
> their household B/S)
> We have govt borrowing crowding out private borrowing (credit is
> contracting)
>
> The bottom line as I see it is that the consumers, long raised on
> easy credit, are deleveraging hard in the face of uncertain expectations
> of asset returns and rising risk premia. The government is spending
> (to replace private consumption) and borrowing (to finance its spending
> and in the process providing an alternative to private borrowing).
> While there is fungible supply of funds that can go either to govt
> borrowing or private borrowing, the demand for loanable funds from
> private side has fallen off a cliff. There is an expectation of inflation
> but if it does not materialize in the midst of a high unemployment,
> low growth environment, the carry trade will flatten the yield curve.
"Nice, theoretical argument, but I am afraid that our Greek Philosophers have forgotten that we can no longer regard the US financial system as a closed loop. The importance of European Hedge Funds has already been hinted at and these pale into insignificance against the Sovereign Investment Funds that have been totally ignored.
The bottom line is that the recent tendency for most investment capital to hit the Silk Road is only going to accelerate. Stimulus in the US economy will not create conducive conditions for productive investment. All that is going down is that a largely ignorant electorate is being bribed by debt secured against the sweat of their grandchildren".
Dave, if a good part of the capital hitting the “Silk Road” is flowing into commodities and stocks, higher prices increase revenues and capital which in return increases tax revenues and sovereign demand for US Treasuries (benefits of the reserve). When commodity and stock prices decrease significantly the unwound carry-trade increases demand for US Treasuries (benefits of the reserve).
At what point is there not enough liquidity to support the US deficit when most of the world’s foreign currencies are inseparable from US consumption and US denominated commodities?
I'd hardly call it enthusiastic when you're forced to buy back your own paper or simply buying to cover your short position. Something smells very fishy in the bond/currency market.
spend more?
But the article put the horse before the carriage, i.e., interest rates go up leading to people spending more leading to inflation...
It is very important to differentiate between cause and effect.
On Jun 13 05:39 PM Tom Armistead wrote:
> Interest rates rise to compensate for inflation. During inflationary
> times the best strategy is to spend money before its purchasing power
> declines further.
On Jun 14 05:40 AM Cliff Wachtel wrote:
> The author was making important points, but I just ran out of patience.
> Now that we've established what a smart & well educated fellow
> he is, could someone please summarize all that verbiage into a few
> relatively easy reading paragraphs? A page? thanks, Cliff
On Jun 14 09:09 AM nobby73 wrote:
> Surely most extra dollars in people's pockets will simply be used
> to paid down existing personal debt? There must be some sort of deleveraging
> factor applied, so that for every dollar of stimulus only a few cents
> of that will be used to invest in Treasuries.
>
> All arguments about the likely direction of Treasury prices based
> around supply demand, even taken into account hedge funds, SWFs and
> foreign central banks will always founder on the unknowns surrounding
> the actions of the Federal Reserve, which is the greatest financial
> black box (or should that be black hole) in history.
On Jun 13 06:43 PM Dave Wrixon wrote:
> Nice, theoretical argument, but I am afraid that our Greek Philosophers
> have forgotten that we can no longer regard the US financial system
> as a closed loop. The importance of European Hedge Funds has already
> been hinted at and these pale into insignificance against the Sovereign
> Investment Funds that have been totally ignored.
>
> The bottom line is that the recent tendency for most investment capital
> to hit the Silk Road is only going to accelerate. Stimulus in the
> US economy will not create conducive conditions for productive investment.
> All that is going down is that a largely ignorant electorate are
> being bribed by debt secured against the sweat of their grandchildren.
> out; there are plenty who wish to borrow but cannot. The financial
> requirements established by banks (who have lots of cash on the balance
> sheets) that prospective borrowers have to meet has changed; the
> standards are much higher than the recent past (maybe all the way
> back to pre 1990's ?).
I'm not sure that qualifies as demand at market. I could wish to borrow billions of dollars at treasury rates. On a risk-adjusted basis, the rate for that loan will be much higher. My wish to borrow would only consitute real demand if I am willing to borrow at rates that are realistic on a risk-adjusted basis. I dont see evidence that credit-worthy borrowers are unable to borrow (there is evidence that loan servicing is taking much longer in the mortgage industry but its not clear thats its because of the lack of loanable funds). Agreed with you that risk is being repriced, but by definition, if banks are building reserves and not lending to consumers (putting money in S/T treasuries) leads me to state that govt borrowing is crowding out private investments. This is evident in the collapse of the money multiplier.
>
> Or assume that they (prospective borrowers) are repairing household
> BS's and not seeking loans (still does not alter the fact that banks
> have lots of cash and willing to loan). What is the goal (assumption:
> rational consumer) of such behavior? To reduce payments to others;
> to have cash on hand in order to make purchases. Liquidity preference.
>
I'm not saying that there is a conscious decision on the part of the consumer to do that. However, if your bank cuts credit lines, refuses to extend more credit to you at a rate you can afford, you foreclose, sell your house and pay off whatever part of the mortgage the money brings, you are essentially deleveraging. If you spent in the past to buy a SUV or a big screen TV on the expectation that you could withdraw from the real estate ATM, but those dreams now shattered leads you NOT to buy those items, you are saving. If Wal-mart starts getting more business at the expense of Nordstrom, we are saving. If Pepboys profit rises at the expense of GM & Chrysler, we are saving.
Agreed with you that in the face of inflationary expectations, consumers will not save. However, as I mentioned, a lot of this saving is being forced on the consumer. We are not "over-saving" by any means like the Asians. We are simply moving from the 0-neg savings rates of the past few years towards a more historic norm (though I am sure the savings rate will overshoot the avg).
On Jun 14 01:20 AM long roh wrote:
> I agree with prudentinvestor's comment except that I disagree about
> the relative worth of gov't spending. Even if you spend it wisely,
> you end up in the same place monetarily just with better social outcomes.
> I also think inflating our way out -- aka taxing every dollar no
> matter where it resides without having to spend anything on enforcement
> -- is the only way out. The U.S. risks much worse without it.
>
> By printing money and turning on inflation expectations, the Fed/U.S.
> Gov't avoids killer deflation. (Imagine how difficult it would be
> to pay back trillions of dollars after coming out of a multi-year
> bout of deflation!) With a real threat of inflation, consumers spend
> their money. This creates velocity and actual inflation. Begin feedback
> loop; hyperinflation becomes a threat. At some point, Fed has to
> pull back on monetary easing by selling all those Treasuries it bought
> (ever noticed how coy Bernanke is about when/how he will undo QE?).
> The author of the article gets it wrong at this point, contending
> that "as the money [the gov't]spends is parked in the bank accounts
> of the businesses the government is buying things from, the banks
> in which the money is parked take it and use it to buy Treasury bonds"
> (the "not a closed loop" comment hinted at the problem). What is
> missing is that at this point, foreign investors in dollar-denominated
> assets (Treasuries) simply will not buy more dollars when hyperinflation
> is on the horizon. They will sell their dollars and buy other stuff
> somewhere else. When there are not enough willing buyers for the
> Fed's inventory, Treasury prices collapse, interest rates go through
> the roof. (The alternative is the Fed holds on to its inventory and
> inflation spirals out of control.) Economic growth is stifled. Ironically,
> taxes then go up to shore up the gov't's debt outlook. Treasuries
> recover. New equilibrium is established with a dollar that is worth
> significantly less than before. With a weak dollar, U.S. workers
> get the chance to manufacture things again -- and discover it's not
> that much fun after all.
>
> We all end up poorer (probably deservedly so), but there's still
> baseball being played.
>
> On Jun 13 08:46 PM prudentinvestor wrote:
On Jun 14 12:20 AM Missing_Link wrote:
> You only need to post it once. 5 times is a bit much.
The thing that is different today is that the overall market size for everything is now much bigger (because of China, India, and other developing country populations wanting laptops, etc.). This growth benefits everyone, and will increase demand for Everything, which is good news for everybody, I believe.
On Jun 13 08:46 PM prudentinvestor wrote:
> If government borrowing and spending creates true value in the form
> of economy-enhancing infrastructure, then all you said makes sense.
> On the other hand, if government borrowing and spending is to "dig
> holes and fill them", then its effect is just inflation, pure and
> simple, leading to a collapse in treasuries. The latter, or an approximation
> thereof, appears to be the case in the US, and China, by contrast,
> appears to be implementing the former.
“But the article put the horse before the carriage, i.e., interest rates go up leading to people spending more leading to inflation...
It is very important to differentiate between cause and effect”
Yes, I agree because if interest rates go up where asset prices go down, people’s savings will lead to deflation.
What a great deal! Ha Ha!
It looks like to me these same banks would like to see higher yields on mortgage rates than they are paying for the shares people purchased or borrowed for. How many of these same institutions control these peoples equity?
if you dont like this type of article, go read the 50 other new ones on the topic with a more standard less thought intensive format
this guy is a political economy professor at berkley. it makes sense for him to write this article.
i found it entertaining and thought provoking
This will increase the carry cost of the U.S. debt, since it mostly short term at this point therefore subject to variable interest rates, which will result in even more debt being issued to cover the additional cost, putting even more downward pressure on the price of treasuries.
If the Fed increases its monetization of the debt to avoid falling prices for U.S. debt instruments, then inflationary expectations and/or actual inflation from an ever expanding U.S. money supply will drive the price down instead. Either way, treasuries are headed down and interest rates are going up. The attempt to suggest otherwise is the kind of elegant intellectual "sophistry" that gave us AAA rated subprime mortgage derivatives.
On Jun 13 11:48 PM Shalom Hamou wrote:
> As you pointed out Market price is the equilibrium between supply
> and demand.
>
> As long term interest rates are compounded options on short-term
> (nominal) interest rates the only factor is volatility and short-term
> interest rates.
>
> Inflation comes into play only if it causes the FED to hike the short
> term interest rates (cf Volcker the Fool). If not I wonder where
> the bond holders would put their money away. Under their mattress
> may be?
>
> As far as inflation is concerned: as long as there is over supply
> of goods services and work I don't really see where the inflation
> would come from except from the mineral prices.
>
> Inflation comes from supply and demand as long as the rich get richer,
> and investments grow (supply grows), and the poor get poorer (and
> Consumption relatively goes down) you can't have inflation!
>
> People should be serious the real threat is still the Greenspan Conundrum.
>
> This is just a techincal rebound.
>
> Unless, of course, the poor get richer and the rich get poorer!
On Jun 14 02:23 PM thepolarbear wrote:
> In the end the simplest explanation should prevail. When you flood
> the market with something without a corresponding flood of new demand
> for that something, eventually the price of that something will fall.
> In the case of T-bills and T-notes, the falling price will also cause
> interest rates to rise.
>
> This will increase the carry cost of the U.S. debt, since it mostly
> short term at this point therefore subject to variable interest rates,
> which will result in even more debt being issued to cover the additional
> cost, putting even more downward pressure on the price of treasuries.
>
>
> If the Fed increases its monetization of the debt to avoid falling
> prices for U.S. debt instruments, then inflationary expectations
> and/or actual inflation from an ever expanding U.S. money supply
> will drive the price down instead. Either way, treasuries are headed
> down and interest rates are going up. The attempt to suggest otherwise
> is the kind of elegant intellectual "sophistry" that gave us AAA
> rated subprime mortgage derivatives.
Some times all you have to do is roll down the limousine window to know whats happening.
On Jun 13 05:30 PM vagrantengineer wrote:
> Adeimantos: And what happens in the money market as interest rates
> rise?
>
> Kephalos: People are no longer happy holding the economy's cash--it's
> too expensive; it's burning a hole in their pocket. So they start
> spending it faster...
>
> It seems to me that the opposite should occur. As interest rates
> rise people are more willing to forego current consumption in favor
> of future consumption, since they will be able to consume more by
> putting their cash into savings and earning interest.
Of course uncle Ben with pump like crazy to stop that. We shall see.
arabianmoney.net/2009/.../
On Jun 14 05:30 PM The Virginian wrote:
> That's only in the "real world." In the theoretical world of the
> sophist economist (outside of the Austrians), high interest rates
> are a dis-incentive to save. In all seriousness, I don't know where
> the Keynsians come up with this stuff. The above argument is so
> far from the common-sense reality of most people, it's no wonder
> most economists make meteorologists look like Oracle of Delphi.<br/>
My principal concern, however, is that whether the loop is open or closed, the huge slack in our economy will see little effect from the price/rates on Tbills & bonds. With real unemployment (U6) in the upper teens and likely to continue growing, most people will save every extra dollar for a more rainy day. Manufacturing levels are near half of the potential and falling, so there is level incentive to borrow and invest in capital equipment. And, to top it all off, the consumer, the financial sector, and some corporations (see autos, construction, casinos, etc., for a starter) are so over-leveraged, every extra dollar they may earn that is not saved/invested goes to paying off huge--and often overdue--debts.
I think Socrates & company above should stick to the nature of the universe rather than the nature of the economy.
They may also rise due to a perceived deterioration of the future credit of the issuer, even in the case of the US government. Unless, of course, if you think they can issue infinite amounts of debt without consequence.
On Jun 13 05:39 PM Tom Armistead wrote:
> Interest rates rise to compensate for inflation. During inflationary
> times the best strategy is to spend money before its purchasing power
> declines further.
It is unclear whether higher interest rates lead to higher savings or higher current spending. There are two variables that determine this: the income and substitution effect. When people see savings as a superior alternative to spending they will allocate more of their money to savings (substitution effect); however, if they feel richer because of the increase in returns on their savings, they may be willing to spend more now because of this comfort (income effect). Therefore, it is hard to say whether higher interest rates (that being the only variable) will lead to higher current consumption or lower current consumption, and it may even stay the same.
On Jun 13 05:30 PM vagrantengineer wrote:
> Adeimantos: And what happens in the money market as interest rates
> rise?
>
> Kephalos: People are no longer happy holding the economy's cash--it's
> too expensive; it's burning a hole in their pocket. So they start
> spending it faster...
>
> It seems to me that the opposite should occur. As interest rates
> rise people are more willing to forego current consumption in favor
> of future consumption, since they will be able to consume more by
> putting their cash into savings and earning interest.
European Hedge funds see dollars and dollar bonds as a commodity, so if the supply increases they think it should be worth less relative to other commodoties: sound currencies, gold, silver oil. That will drive their investments and have some effect on the market but it won't crash the dollar.
Next year when the mortgage crisis peaks and sovereign debt defaults become more common will be a year of volatity for the bond markets, where flight to quality is offset by flight out of the dollar into commodities when inflation fears pick up.
Your version makes a lot more sense to me than Socrates' idea that all those formerly homeless people would be ramping up the economy almost instantaneously to the point that most of that cash that was spent has already been reinvested into long term Treasuries.
On Jun 13 11:18 PM Skep Tick wrote:
> One can peddle Treasury bonds by falsifying U.S. inflation data,
> and also bribing foreign investment group leaders, including foreign
> government officials, to buy these bonds. These foreign leaders
> who have for years been deciding to buy Treasury bonds could also
> be reminded that if they don't keep buying, the value of their existing
> holdings would plummet and make these leaders look bad. If they
> still waver, the Feds can themselves buy Treasuries for a while to
> keep the price up until these other methods can be bolstered. <br/>
> Hmmm, I wonder if U.S. officials have thought of these methods.
Liquidity creation = creating assets that folks willingly hold in place of cash.
When the rest of the world starts creating liquid instruments that folks want to hold in place of cash, then you might see effects from oversupply of US Treasuries.