odin

A Socratic Dialogue: Fearing the Collapse of U.S. Treasury Bond Prices

> 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 ?).

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).

A Socratic Dialogue: Fearing the Collapse of U.S. Treasury Bond Prices

I left out tax expectations. My disinflation argument loses strength if people truly believe higher taxes are in the future with the higher government borrowing/spending. However, I am not sure that people believe that _their_ taxes will be high. I still think that the general expectation is that someone else will pay the tax bill (rich, future generations beyond the scale of their investment horizon etc).

A Socratic Dialogue: Fearing the Collapse of U.S. Treasury Bond Prices

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.

China's Statements About U.S. Debt Are Overblown

For the same reason domestically a rich man wants to trade with a poor man in the same country.

Life is mean-reverting in the very long run but we still struggle to maintain our relative advantages.

I dont buy that trade is a zero-sum game. While we export jobs to China, China exports goods to us to raise our std of living (supposedly... those $10 flying choppers ARE terribly entertaining... who would have thought even 10 years ago that you could buy a sophisticated flying toy with a microchip for $10!), Net-net, China has future claims against the US and hopefully will exercise them in the future when they run a deficit and provide employment to a new generation of Americans.


On Jun 01 03:46 PM infp wrote:

> On a very simple level, I never understood how globalization could
> be broadly beneficial for a wealthy country like the US. If an average
> US worker is making $20/hour and an average Chinese worker is making
> $1/hour, eventually I would expect them both to make $10.hour. I
> do not offer this extremely simple observation as an indictment of
> globalization, I simply offer it as my expectation that some sort
> of global salary equilibrium is inevitable in a global economy.

China's Statements About U.S. Debt Are Overblown

On Jun 01 01:08 PM Donald Ingram wrote:

> First;
> The Chinese don't mind "taking the hit" as you put it. However it
> will be at a time of their choosing. Get ready for the rug to get
> yanked!

Very true. The Chinese central banks (or the ruling regime) may be less concerned about the yield on their fx reserves. The main agenda is the value of the RMB (to keep its factories humming and provide continued employment). However, the Chinese are giving up current consumption by accumulating these reserves -- they should want to consume them at some point as the bulk of their population moves through its productive years into retirement (20+ years down the road) with a much smaller workforce to support them (1-child policy). Low US inflation and safety of principal is not totally irrelevant to them.

> Second;
> "Need these exports"? They would be nice to have, but they really
> don't "need" them to survive and prosper.

Sure they do. Tiannenmen Square happens when you have hundreds of millions of unhappy people. Rising standard of living is what keeps people happy. Pissed off Chinese workers agitating for a revolution is a key "black-swan" event in my play book. It is likely that risks of violent conflict between nations rise in that case to build up nationalist sentiment and deflect attention from domestic problems (Taiwan, Japan look to be the main sufferers in this case. It is not lost on me that many major economic crises have been followed by wars. It is also an important point that in the thousands of years of history -- China and Japan have never shared regional power and there is considerable latent hostility in china towards the former imperial power, which by all measures is collapsing under the weight of demographics.)

However, the export-policy is not sustainable. They need to increase _PRIVATE_ domestic consumption. Stockpiling commodities or growth in state-sponsored behemoths is not the answer. The commodities are only as valuable as the strength of the buyers that the Chinese will want to sell their exports to. And related to domestic civilian growth projects -- someone should _need_ and want to occupy the building complexes that are getting built. It is not clear to me that spending on infrastructure mega-projects in China is the need of the hour. They have a terrible history of inefficient use from a cost-benefit perspective (Three Gorges for e.g.). Growth in China has come entirely from its coast -- I want to go further and cautiously add that it can primarily come only from its coast (interior of china is parched, relatively sparsely population though I am unfamiliar with the availability of other natural resources...). China needs to spend on education, healthcare (with pollution levels having exploded in the past 20 years, its only a matter of time before the piper will need to be paid), social safety nets (domestic harmony -- despite the cultural norms, it is unlikely in the long run that 1-2 productive adults will not be stressed about supporting an additional 4 non-productive adults+kids).

> Third;
> They know EXACTLY what their course of action is and where it's going.
> To assume otherwise would be to underestimate them. Big mistake.

The Chinese government is indeed far-sighte--more so than a democratic one would be--but precisely for that fact, it is also constrained by the politics of their situation. But it would be folly to assume that the decision-makers are not narrowly self-interested.

>
> Fourth;
> They are moving into gold in a big way. The central bank of China
> has already put in a reserve bid for the upcoming IMF 403 tonne gold
> sale. All of it! Good way for them to unload some their US dollar
> holdings!

As pointed out in the article, the supply of gold is very limited and it is not possible for any central bank to accumulate meaningful amounts of gold without moving its price. (And higher gold price implies inflation...something the Chinese do not necessarily want, if they want to maintain Chinese competitiveness).

> Fifth;
> Real estate prices are a fore gone conclusion, they will be in the
> tank for years to come.

While very true that it will take years to recover and may not "bubble" again for decades, "they dont make land anymore". But a growing population will still need to be housed, construction still depreciates and in an inflated future, real estate does maintain its value. Speaking of which, do you think the Chinese central bank will want to buy Las Vegas from us?

> Sixth;
> The Chinese Yuan (Renminbi) will be the next worlds reserve currency.

The reserve currency status is mainly determined by military strength. China, undoubtedly growing in this regard, has a lot of distance to cover before it can lay claims to this. It needs to float its currency to become a reserve currency (causing it to rise and lower competitiveness of Chinese exports). Rationally, the time when China will want to do that is when it is cashing in its claims on world productivity (when its aging population causes a trade deficit and it is no longer accumulating $ and has much weaker _economic_ growth prospects). Remember, the TIC data shows that China even now is accumulating US $ reserves (at a pace not too far removed from the frantic one we saw in 2008)

> This is what the Chinese are working towards. Yes, it will take years,
> but what are years when you plan in generations?
> Seventh;
> This is the most asinine presumption of all - "Work off the debt?"
> Your children, your grandchildren and their children will thank you!
> The only way the debt will be paid is with dollars that are worth
> pennies!

The only two ways to pay off our debts (private or public) is to either inflate it away (very likely in the long run but unlikely in the short run) or to grow into it. I think the combination is the most likely scenario.

Waxing a little philosophical: growth due to technological shifts should not be underestimated -- take any snapshot in time (20 years, 50 years, 100 years) and its amazing to me the exponential explosion in knowledge. Average quality of life is still on a upward trajectory. And the US is on the forefront of such growth. We may not feel that way because expectations of what "average" std of living have been rising faster than the actual rise. I am very optimistic about the future of the US -- by far, it is the one nation that is most open to progress, the most innovative and the most welcoming and nurturing of raw talent. And a part of the "hostility" that Americans sometimes feel abroad is somewhat traced to this I think -- with 24x7 info flows (CNN and American pop culture exports), people in repressed regimes often ask: 'Why do we not have that?' The answer accepted (and sometimes given by their ruling regimes) is not often based on self-evaluation but by deflecting blame onto Americans.

Julian Robertson Bets the Farm on Inflation

China is not so much selling the long end, it is shifting its buying towards the shorter end. I recommend Brad Setsers blog for insight into TIC flows.

Until China develops domestic consumption (I am also skeptical of its stimulus), it needs to finance the US. Thats what keeps its factories humming and its population employed and copacetic (nearing the Tiannenmen Sq anniversary...that is especially relevant point).

Given the slowdown in the economies, its likely that China may accumulate less of a surplus (have to sterilize less) over the long run (in this scenario, people will have to give up the green shoots fantasy). However, that means that US is running less of a deficit (and that savings in this country are going up). I am skeptical that ALL those savings are getting channelled into stocks and real estate again. They will inevitably flow into treasuries to satisfy a risk-averse yield-hungry investor. (Where do you think MM funds, bank excess reserves are flowing to?)

Likely everyone is still risk-averse (from an inflation view) and wants to crowd the short-end of the curve...and granted the yield curve is steep at the moment. But given its steepness and a willingness on part of the Fed to keep rates low for an extended period (which they can, given the demand at the short end), the carry traders will get busy.

I would wait till the fat chairman sings before proclaiming the death of treasuries.


On Jun 04 04:08 PM Living4Dividends wrote

> Odin - I thought China had pretty much stopped its net buying of
> Treasuries. TIC data is confusing because China is selling the long
> end and buying the short end. As well, China is selling GSEs and
> buying Treasuries (Short end)

Julian Robertson Bets the Farm on Inflation

That is significant point. If Japan, arguably a much more riskier sovereign credit (in light of its slowing productivity, stagnant demand, already high savings rate, low consumption and high debt-to-GDP), couldnt reinflate and could continue to borrow at low levels in face of massive re-deleveraging, what makes the US an exception?

I'm not saying that we will follow the path of Japan (and the last thing we need is a bond bubble and another hit to bank earnings) but all I want to point out is that "4.5%" or thereabouts isnt a magic number in and of itself... That yield can only be too low or too high or just right in some context to which its trading.

Well, look, if you believe in the neon green shoots and think we are back to normal, the money-multiplier is back to normal, lending activity is back to normal, and that the US is continuing to run a easy monetary and easy fiscal policy in the face of those facts, then obviously inflation is the answer. However, the same crowd that points to inflation argues about an extended muddle-through economy and rise in risk. Shouldnt the equity/credit premiums rise in that context and depress yields on those assets?

If massive inflation is the worry, why not just re-leverage instead of trading stocks or shorting treasuries? Take out a massive mortgage, that auto loan, consume current productivity with bags, shoes, Wiis, flat-screen TVs (because you can discount future productivity heavily). I am skeptical of inflation in the near-term because I believe we are at the end of the line and risk premia have risen for good and the repairing of private balance sheets is inevitable.

On Jun 04 12:04 PM MinAkkar20 wrote:

> Japan's lost decade is used far too often as a comparison to the
> US. They aren't apples to apples. Japan: export driven, high-savings,
> aging population, no immigration. US: consumption driven, low savings
> (even now), high immigration / birth rate (relative to industrialized
> countries).
>
> Even Japan with its extremely high debt to GDP ratio doesn't come
> close to the size of debt that is being offered up by the US government.
> Eventually supply & demand must take hold. China can't stop
> purchasing treasuries altogether, but they surely could demand a
> higher return to offset the risk &amp; size of their holdings.<br/>
>
> And unless your equity portfolio outpaces what you could buy with
> it if you sold it, you aren't in the black. You are breaking even.
> There is no wealth creation with inflation - it just makes everyone
> feel good when they look at their 401k.

Julian Robertson Bets the Farm on Inflation

For those who think that "4.5%" is too small a number, the word is: Japan.

Other words that come to mind: output gap, unemployment, deleveraging, rising savings rate. The government borrowing is simply trying to replace private borrowing to keep the economy chugging along. China cannot stop buying treasuries (dont look at the rhetoric, look at the TIC data) if it doesnt want a recession on its hands. It may buy and store commodities, but there is a limit to it (and for what purpose if US consumption fails?). It may buy gold (and will), but gold cant substitute treasuries....the market just isnt that big.

The banks may be making hay while the yield curve is steep...but they also are knee-deep in real estate (where a steep YC is no fun).

Inflation may very well be in our future down the road. But it is no different than saying "this house will eventually be worth more than what i paid for it" or "my equity portfolio will eventually be in the black"..

Julian Robertson Bets the Farm on Inflation

For those who think that "4.5%" is too small a number, the word is: Japan.

Other words that come to mind: output gap, unemployment, deleveraging, rising savings rate. The government borrowing is simply trying to replace private borrowing to keep the economy chugging along. China cannot stop buying treasuries (dont look at the rhetoric, look at the TIC data) if it doesnt want a recession on its hands. It may buy and store commodities, but there is a limit to it (and for what purpose if US consumption fails?). It may buy gold (and will), but gold cant substitute treasuries....the market just isnt that big.

The banks may be making hay while the yield curve is steep...but they also are knee-deep in real estate (where a steep YC is no fun).

Inflation may very well be in our future down the road. But it is no different than saying "this house will eventually be worth more than what i paid for it" or "my equity portfolio will eventually be in the black"..


On Jun 04 11:08 AM Harry Tuttle wrote:

> I fully agree that it is a crowded trade, however, there is a lot
> of supply ahead of us which is usually not the case with most things
> one can short. By the way, Rosenberg likes treasuries. For what
> it's worth, I don't.

Julian Robertson Bets the Farm on Inflation

For those who think that "4.5%" is too small a number, the word is: Japan.

Other words that come to mind: output gap, unemployment, deleveraging, rising savings rate. The government borrowing is simply trying to replace private borrowing to keep the economy chugging along. China cannot stop buying treasuries (dont look at the rhetoric, look at the TIC data) if it doesnt want a recession on its hands. It may buy and store commodities, but there is a limit to it (and for what purpose if US consumption fails?). It may buy gold (and will), but gold cant substitute treasuries....the market just isnt that big.

The banks may be making hay while the yield curve is steep...but they also are knee-deep in real estate (where a steep YC is no fun).

Inflation may very well be in our future down the road. But it is no different than saying "this house will eventually be worth more than what i paid for it" or "my equity portfolio will eventually be in the black"..


On Jun 04 11:08 AM Harry Tuttle wrote:

> I fully agree that it is a crowded trade, however, there is a lot
> of supply ahead of us which is usually not the case with most things
> one can short. By the way, Rosenberg likes treasuries. For what
> it's worth, I don't.