First Britain, and now the US. As we see increasing evidence that governments have borrowed too much, bond markets are beginning to rebel against the prospects of even more debt. Here’s Bloomberg:
A Bloomberg index shows liquidity in the Treasury market is worse now than during the early days of the pandemic and the lockdowns, when no one knew what to expect. . . .
What should be most concerning to the Fed and the Treasury Department is deteriorating demand at US debt auctions. A key measure called the bid-to-cover ratio at the government’s offering Wednesday of $32 billion in benchmark 10-year notes was more than one standard deviation below the average for the last year, according to Bloomberg News. Demand from indirect bidders, generally seen as a proxy for foreign demand, was the lowest since March 2021, data compiled by Bloomberg show. Although the Treasury is in no jeopardy of suffering a “failed auction,” lower demand means the government is paying more to borrow.
All this is coming as Bloomberg News reports that the biggest, most powerful buyers of Treasuries – from Japanese pensions and life insurers to foreign governments and US commercial banks – are all pulling back at the same time. “We need to find a new marginal buyer of Treasuries as central banks and banks overall are exiting stage left,” Glen Capelo, who spent more than three decades on Wall Street bond-trading desks and is now a managing director at Mischler Financial, told Bloomberg News.
I opposed German fiscal stimulus at a time when most pundits were demanding that Germany do more. Even before Covid, I called America’s fiscal policy “reckless”. When Covid hit, our pundits were falling all over themselves demanding ever more fiscal stimulus.
Our public debt is now over 100% of GDP. If you raise interest costs on that debt from 1% to 4.5%, you’ve added an interest expense equivalent to the entire military budget. Yes, it doesn’t happen all at once (due to some long-term bonds), but this is the direction we are headed.
Here’s what I said in March 2020:
We are now seeing renewed calls for fiscal stimulus. This is a terrible idea. . . .
Instead of blindly throwing money at the problem, we need a smart response to the coronavirus epidemic. It would contain the following components:
1. An immediate shift by the Fed to level targeting, combined with a commitment by the Fed to buy whatever it takes (of any asset necessary) to quickly return to its price level (or NGDP) target path after the immediate crisis is over.
2. Fiscal programs strictly targeted to meet humanitarian needs, such as extending the unemployment compensation program beyond 26 weeks if the coronavirus epidemic lasts for more than 26 weeks. Perhaps the weekly payments could also be boosted during this crisis, as the “moral hazard problem” is secondary for the immediate future. Extra spending should be paid for with a higher payroll tax on upper income salaries.
Fiscal policy over the past few years has been perhaps the most reckless in all of American history, with an exploding budget deficit even as unemployment falls to 3.5%. The budget deficit is already over a trillion dollars; we certainly don’t need more deficit spending right now.
We are beginning to pay the price for the past 4 years of reckless borrowing under the Trump/Biden regime. Now do you see why I favor monetary stimulus over fiscal stimulus? And why NGDP level targeting is so important?
Debt may seem free when interest rates are near zero, but rates don’t stay near zero forever.
PS. It’s not all Covid. Here is the CBO projection from 2019. (The subsequent reality was far worse.) Notice how the deficit worsened during the peacetime boom of the late 2010s. That’s never supposed to happen. (Both political parties were largely silent. President Trump got away with a Liz Truss fiscal policy because our debt was much smaller at the time.)
READER COMMENTS
Brent Buckner
Oct 15 2022 at 12:44pm
I wonder how much of the decrease in liquidity evident in the auction of US Treasuries might be attributable to Quantitative Tightening.
Scott Sumner
Oct 15 2022 at 3:09pm
Yes, but if the market is that fragile then the government has borrowed far too much.
Majid Hosseini
Oct 16 2022 at 11:22pm
Right now, QT only involves the Fed just retiring the bonds they have and not buying anything. It doesn’t involve selling anything. If the bond market needs the Fed as a buyer, and doesn’t have liquidity otherwise, it means the supply is more than the demand and not enough buyers exist for US debt
artifex
Oct 15 2022 at 12:45pm
Why are they near zero? Why are there even sometimes negative real interest rates in some places? It’s intriguing. I’m so puzzled about it. If someone knows some good discussions of it, I’d appreciate links.
Knut P. Heen
Oct 16 2022 at 4:22pm
Supply and demand. The supply increases when you print a lot of money. A limited amount of money may be stored without risk of theft, hence some investors prefer bonds with negative rates and no risk of theft. Some funds may even have to invest at negative yields because regulation prevents them from holding cash.
artifex
Oct 17 2022 at 1:40am
That’s interesting. I’d read about banks having to hold risk-free assets to be allowed to hold more profitable things as an explanation for negative rates, but didn’t understand why cash wouldn’t also count as a risk-free asset and be preferred to bonds in that situation (other than needing time to adjust).
j r
Oct 18 2022 at 2:00am
There are two things to remember.
One, what we term “the market” is made up of discrete buyers, mostly institutional money managers who have a mandate to invest in one particular asset or another. If you run a T-bill fund, you can decide to buy more or less treasuries and of this or that tenor, but you can’t decide to buy corporate bonds or equities. Asset allocation changes over time, as investors decide to move their money from one type of fund to another or just let it sit in cash. This creates a lag.
Two, money managers get paid on the basis of their performance, but their performance is benchmarked against the other managers in that asset class. Yes, it’s better to make money rather than lose money, but what’s really important is that you do better than the competition. So, there is some incentive to stay in the game and try to make smart trades rather than just parking your money on the sideline.
vince
Oct 15 2022 at 3:58pm
On NGDP level targeting, you’ve mentioned NGDP futures. Isn’t a problem the lack of demand for such futures? What about this variation: The Fed sets an NGDP target and trading is on deviations from that target. For example, a firm concerned about a recession could hedge it with a put option on the target according to the level of downside deviation.
Scott Sumner
Oct 15 2022 at 3:59pm
“Isn’t a problem the lack of demand for such futures?”
No, that just means policy is on target. If it’s off target then I’ll trade the contract.
Thomas Lee Hutcheson
Oct 15 2022 at 5:47pm
I agree the government has borrowed too much both in the sense that it has failed to invest in activities with NPV>1 and invested in others with NPV<1 and in the sense that reductions in marginal tax rates on income under Reagan, GWB ad Trump, were not made up with higher tax rates on consumption.
Mark Z
Oct 15 2022 at 9:13pm
So would you agree with Tyler Cowen – and disagree with Matthew Yglesais – that German fiscal policy is being vindicated? Tyler seems kind of obviously correct to me on this.
Scott Sumner
Oct 15 2022 at 9:21pm
Yes, Tyler is correct.
Spencer
Oct 16 2022 at 10:25am
It would seem that somewhere, somehow, if total net debt (not just Federal Debt) keeps rising faster than production (Real-GDP), the burden of interest charges at some point now indefinite and unknown, but nevertheless real, will become too great to carry.
Kevin
Oct 16 2022 at 4:42pm
This seems fairly obvious to me, especially given our demographic difficulties with entitlements, but the “adults in charge” will just write us off as right-wing cranks.
The CBO keeps suggesting that the federal debt burden is unsustainable, but respected centrist economists insist that we can outgrow interest rates that (they feel) ought to settle back to around 1% for the government.
I guess time will tell who is correct, but if I’m not mistaken, the 75 year outlook for federal debt suggests we may well hit a 600% or 700% debt to GDP ratio…I’ve even seen models predict more than 800%. At some point, this must become a problem, yes?
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