In Which Jamie Dimon Misunderstands Fixed Income And Banking Markets

by: Cullen Roche

I've had a number of readers send me this link from Wednesday's interview with Jamie Dimon at the Council on Foreign Relations so it's obviously worth a brief comment. Although I've been debunking the USA's "bond vigilante" and "bond bubble" myths for years now, this is a good time to nail home some of the principles of Monetary Realism and use Mr. Dimon as an example of someone who doesn't fully understand (gasp) the fixed income markets or our banking system (I know, this is blasphemous, but please read on).

In case you missed it, Jamie Dimon said the following:

CFR: "How worried are you that one day you wake up and your your Blackberry or iPhone is red hot because the bond market is essentially moving against the United States?"

Jamie Dimon: "It's virtually assured. It's not a matter of when, but how….It's a matter of time. It will happen."

These are odd comments. First of all, Dimon runs the key Primary Dealer in the U.S.A. The Primary Dealers are required to do the Fed's bidding in government bonds. As the NY Fed says:

Primary dealers are also required to participate in all auctions of U.S. government debt and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account-holders.

If you've ever wondered why U.S. government bond auctions never fail it's because the banks are harnessed by the government to bid at auctions. They are "required" to do so. And they pick up fees and other benefits in return for doing the government's bidding. The banks know the U.S. government can't "run out of money" and that the Fed is there to backstop the whole operation in a worst case scenario (something Dimon is all too familiar with) so it's nonsensical for Dimon to worry about bond vigilantes attacking the U.S.A. due to some solvency crisis. He seems to be mistaking the U.S.A. for Greece or another nation whose central bank, Treasury and policy makers have no unity. He should know that the U.S.A. has already implemented the fix for Europe - an integrated central bank, Treasury and political system.

Dimon isn't the first one to make claims like this though. David Einhorn mentioned it many years ago, Alan Greenspan constantly discusses it and Bill Gross has famously said the U.S.A.'s bond markets are bound to run out of buyers. Many people said we might have a bond market crisis after the U.S.A. was downgraded from AAA status. Of course, yields FELL after that and continue to fall despite constant concerns over the U.S.A.'s debt levels. But when one understands Monetary Realism you understand that the U.S. government can't "run out of money" because the system is designed not to run out of money. And while MR shows us how the banks are in control of the monetary roost as the primary issuers of money, it's also important to understand the symbiotic relationship between the banks and the Fed. The banks are only in control of the monetary roost because our government chooses to have a market-based monetary system (controlled by private for profit banks) as opposed to a government controlled system (such as a nationalized banking system). In return for this incredible profit generating power, the banks do the government's bidding when it asks them to.

But the real moral of this story is that the U.S.A. isn't going to have a sovereign debt crisis like Greece because Mr. Dimon's bond traders aren't going to stop buying bonds because Mr. Dimon is in the business of doing the Fed's bidding. As I've stated on many occasions, bond traders in the U.S.A. (and in Japan for instance) know that the government can't run out of money and that the solvency of government debt is never an issue (i.e, getting paid at maturity is never a worry). So the thing that keeps bond traders up at night is inflation. And as we all know, inflation isn't exactly scaring bond traders out of their holdings.

* It's possible that the banks could revolt in the case of a hyperinflation during a total economic collapse (it would obviously be unprofitable to buy government bonds when the currency is cratering), but hyperinflation is a very different phenomenon than a sovereign debt crisis. Of course, the natural response to this article is "what might cause interest rates to rise?" The answer is here.