Alfie, you are right in that Moody’s downgrade does not affect the plumbing, but it is a shot across the bow of the Treasury and Congress warning of further potential downgrades if the US does not get its fiscal house in order.
A seriously flawed analysis. Suggest a review of Cochrane's A Fiscal Theory of Inflation. Government spending competes with Private Investment. More spending takes resources from productive private sector. Deficits are not growth inducing but inflation inducing. Holders of debt evaluate ability of Debtors to repay, risk increases, interest rates go up, willingness to hold more declines then ceases. The only question is when. It behooves the United States to put its house in order
''.....for every $ the US pays for interest on debt, there is an investor making $ on risk-free interest rates she is collecting by owning Treasury bonds''
--> I understand this logic, but don't you think it matters if that $ of interest being earned takes place within the US system or outside of it?? Foreigners own 43% of long-term Treasury debt and 21% of short-term Treasury debt... doesn't that break your 'circular' equation because there isn't a feedback loop into US consumer spending or US bank deposits - the $ is truly paid away? The US has to rely on the kindness of strangers to fund their twin deficits and MMT surely works best in a closed onshore system with a current account surplus....(Japan / China)
All You But-Heads who worry about the deficit and the credit rating. Don't you see that the strength of the currency depends on the military and economic power of the country. As long as the US can invade and steal, the currency will remain strong!
So it’s all just made up money backed by nothing . A quadrillion nothings is still a nothing. The charade can only be sustained that long before reality exerts itself the rest of the world will only put up with this for so long
The issue that faces the US fiscal debt isn't the interest per se. It is what the US spends the principal of the bond/debt on. Weapons, an unsustainable social safety net are two of the expenses that eat the nation's seed corn. Taxes need to be raised and/or expenses reduced in this scenario, eventually. MMT is an extend and pretend system. As long as Yankee$ is the reserve currency of the world the extend and pretend system of MMT will work. Once the demand for Yankee$/Eurodollars diminishes so do Treasuries, particularly bonds.
If the debt, however, is for productive ROI investments then that investment debt will pay for itself and then some as both the private and public sectors earn more income in the household sector and thereby ceteris paribus the public sector receives more revenue through increased taxes and/or the public is better educated, healthier, etc.
There are many holes in your theory of how the debt growth is A-OK. Since the 80's we have not been collecting enough revenue to run the country. Over the same period as you pointed out companies and their shareholders (the wealthy) have made out through suppressed taxation and corporate/asset growth. But 90% of America has not taken part other than some real estate inflation or a check or two during COVID. With deficits growing now at 2X GDP we are in a death spiral. Great for people who own hard assets horrible for people getting by. Since the 90's the Fed and Treasury has always raced in to save asset holders when a recession starts, at the deficits expense. We really have one sided "free" markets that protect the wealthy. If your argument was true we should just double/triple our borrowing as it just washes out in the end...But we know that's not true. Thalia below points out just one of the many flaws in your neutral monetary model...
This explanation far underestimates the risk of high and eventually hyper inflation. Deficits running $2t before future stimulus requirements (kick the can) due to weakening economy, is causing a death spiral of debt and interest payments. It is unrealistic to speak of "structural deficits". Interest cost must be included in all analyses at this point. Deficits will soon increase with SS and Medicare requirements. Time to look at Venezuela and Weimar. House of Cards.
I don’t think we’re in any immediate danger of hyperinflation as long as someone like Powell is in charge of an independent federal reserve. People who advocate for ending the fed should be careful what they wish for. Having said that the author pointed out (with no source or attribution) that now the fed is targeting inflation of 3%. If true then investors are going to want at least 6-8% nominal interest rates depending on the maturity of the duration of the debt. That’s not unthinkable or even particularly unusual, given that they were at those levels in the nineties, albeit with much lower deficits and debt.
The 30-year Treasury yield is flirting dangerously with the 5% threshold. Interest rates are not just raw numbers: they are signals, messages, clear indicators. An episode of stress similar to what the UK experienced in October 2022 cannot be ruled out. In this case, however, it would affect the world’s reserve currency and the ultimate risk-free asset. The consequences could be nonlinear.
hello Alf, I appreciate your analysis which is always very helpful. I think the issue with the US is the leakage of the huge budget deficits through the trade deficit, resulting the necessity of huge UST holdings by the external sector. Clearly this situation imposes significant constraints to continuing the current polcies.
I found the last 20% of your message, about the higher equilibrium real rate driven by stimulus, much more interesting than the rest. It seems to me that that the financial plumbing is not changed by the downgrade is not really the point. The point is that the huge debt, and the downgrade is just a symptom whatever the holy plumbing, is becoming more of a straight jacket for the Treasury. Straight jacket 1. Donald wants to reshore manufacturing as fast as possible? He cannot, unless he crushes the bond market. He want to export much more? He cannot, unless he does not care about the recycling of US dollars in the bond market. Straight jacket 2. Donald wants to produce more oil to drive growth in the energy sector? He cannot without crushing the bond market. Straight jacket 3. Donald wants to hang tough with the Chinese? He cannot, as just the thought of empty shelves and higher prices from triple-digit tariffs made the bond market dysfunctional, Scott was rushed to the Swiss Alps to cave in, and all the rest is now history. Whatever Washington wants to do to change the status quo of total US dependency on ROW, the bond market stands in the way. And investors have got it. If the math says that the solution to the American illness ultimately is negative real rates, why bother to buy Treasuries when one can buy gold? So, put in context the downgrade is reason for concern. When the growth rate of debt becomes super exponential, it becomes unsustainable and the system has to reset. This is what nonlinear mathematics and Didier Sornette, who devised models to time bubbles, tell us. It is the other way around: the plumbing will be changed because the system itself will become untenable. The whispered solution for now seems to be less dollars, more gold globally as a neutral reserve asset …
Well explained! And you didn't even have to mention Modern Monetary Theory directly, though it's the best analysis framework for understanding deficit, debt, taxes, and dollar creation. Thank you!
"The Moody’s downgrade doesn’t affect the role of US Treasuries in the financial plumbing world: banks still face 0% risk-weights when buying Treasuries"
If Moody's downgrade results in higher Treasuries interest rates, then banks can face a lot more than 0% risk-rates. If you don't believe that, then just ask the folks at Silicon Valley Bank. Oh wait, that's no longer possible, is it.
"Bonds are fairly priced here. I would start accumulating more 30-year Treasuries >5.25%."
If you do that, Al, then you are a very brave man, who is not afraid to swim against the tide.
"In February, foreign central banks unloaded a net $19.6 billion in longer-term U.S. bonds and notes. They sold $24.1 billion in January and $42.3 billion in December. A little over a billion was sold in November. The data were released as part of the monthly Treasury International Capital report on Wednesday."
I can certainly understand why the Chinese are dumping U.S. Treasuries, but what I can't understand is why the Chinese are now dumping their gold.
People don’t like to admit it but Modern Monetary Theory is how the economy works.
Alfie, you are right in that Moody’s downgrade does not affect the plumbing, but it is a shot across the bow of the Treasury and Congress warning of further potential downgrades if the US does not get its fiscal house in order.
A seriously flawed analysis. Suggest a review of Cochrane's A Fiscal Theory of Inflation. Government spending competes with Private Investment. More spending takes resources from productive private sector. Deficits are not growth inducing but inflation inducing. Holders of debt evaluate ability of Debtors to repay, risk increases, interest rates go up, willingness to hold more declines then ceases. The only question is when. It behooves the United States to put its house in order
''.....for every $ the US pays for interest on debt, there is an investor making $ on risk-free interest rates she is collecting by owning Treasury bonds''
--> I understand this logic, but don't you think it matters if that $ of interest being earned takes place within the US system or outside of it?? Foreigners own 43% of long-term Treasury debt and 21% of short-term Treasury debt... doesn't that break your 'circular' equation because there isn't a feedback loop into US consumer spending or US bank deposits - the $ is truly paid away? The US has to rely on the kindness of strangers to fund their twin deficits and MMT surely works best in a closed onshore system with a current account surplus....(Japan / China)
All You But-Heads who worry about the deficit and the credit rating. Don't you see that the strength of the currency depends on the military and economic power of the country. As long as the US can invade and steal, the currency will remain strong!
So it’s all just made up money backed by nothing . A quadrillion nothings is still a nothing. The charade can only be sustained that long before reality exerts itself the rest of the world will only put up with this for so long
The issue that faces the US fiscal debt isn't the interest per se. It is what the US spends the principal of the bond/debt on. Weapons, an unsustainable social safety net are two of the expenses that eat the nation's seed corn. Taxes need to be raised and/or expenses reduced in this scenario, eventually. MMT is an extend and pretend system. As long as Yankee$ is the reserve currency of the world the extend and pretend system of MMT will work. Once the demand for Yankee$/Eurodollars diminishes so do Treasuries, particularly bonds.
If the debt, however, is for productive ROI investments then that investment debt will pay for itself and then some as both the private and public sectors earn more income in the household sector and thereby ceteris paribus the public sector receives more revenue through increased taxes and/or the public is better educated, healthier, etc.
There are many holes in your theory of how the debt growth is A-OK. Since the 80's we have not been collecting enough revenue to run the country. Over the same period as you pointed out companies and their shareholders (the wealthy) have made out through suppressed taxation and corporate/asset growth. But 90% of America has not taken part other than some real estate inflation or a check or two during COVID. With deficits growing now at 2X GDP we are in a death spiral. Great for people who own hard assets horrible for people getting by. Since the 90's the Fed and Treasury has always raced in to save asset holders when a recession starts, at the deficits expense. We really have one sided "free" markets that protect the wealthy. If your argument was true we should just double/triple our borrowing as it just washes out in the end...But we know that's not true. Thalia below points out just one of the many flaws in your neutral monetary model...
This explanation far underestimates the risk of high and eventually hyper inflation. Deficits running $2t before future stimulus requirements (kick the can) due to weakening economy, is causing a death spiral of debt and interest payments. It is unrealistic to speak of "structural deficits". Interest cost must be included in all analyses at this point. Deficits will soon increase with SS and Medicare requirements. Time to look at Venezuela and Weimar. House of Cards.
I don’t think we’re in any immediate danger of hyperinflation as long as someone like Powell is in charge of an independent federal reserve. People who advocate for ending the fed should be careful what they wish for. Having said that the author pointed out (with no source or attribution) that now the fed is targeting inflation of 3%. If true then investors are going to want at least 6-8% nominal interest rates depending on the maturity of the duration of the debt. That’s not unthinkable or even particularly unusual, given that they were at those levels in the nineties, albeit with much lower deficits and debt.
I thought Powell was targeting 2% inflation? When did it become 3% ?
The 30-year Treasury yield is flirting dangerously with the 5% threshold. Interest rates are not just raw numbers: they are signals, messages, clear indicators. An episode of stress similar to what the UK experienced in October 2022 cannot be ruled out. In this case, however, it would affect the world’s reserve currency and the ultimate risk-free asset. The consequences could be nonlinear.
hello Alf, I appreciate your analysis which is always very helpful. I think the issue with the US is the leakage of the huge budget deficits through the trade deficit, resulting the necessity of huge UST holdings by the external sector. Clearly this situation imposes significant constraints to continuing the current polcies.
Ciao Alfonso,
I found the last 20% of your message, about the higher equilibrium real rate driven by stimulus, much more interesting than the rest. It seems to me that that the financial plumbing is not changed by the downgrade is not really the point. The point is that the huge debt, and the downgrade is just a symptom whatever the holy plumbing, is becoming more of a straight jacket for the Treasury. Straight jacket 1. Donald wants to reshore manufacturing as fast as possible? He cannot, unless he crushes the bond market. He want to export much more? He cannot, unless he does not care about the recycling of US dollars in the bond market. Straight jacket 2. Donald wants to produce more oil to drive growth in the energy sector? He cannot without crushing the bond market. Straight jacket 3. Donald wants to hang tough with the Chinese? He cannot, as just the thought of empty shelves and higher prices from triple-digit tariffs made the bond market dysfunctional, Scott was rushed to the Swiss Alps to cave in, and all the rest is now history. Whatever Washington wants to do to change the status quo of total US dependency on ROW, the bond market stands in the way. And investors have got it. If the math says that the solution to the American illness ultimately is negative real rates, why bother to buy Treasuries when one can buy gold? So, put in context the downgrade is reason for concern. When the growth rate of debt becomes super exponential, it becomes unsustainable and the system has to reset. This is what nonlinear mathematics and Didier Sornette, who devised models to time bubbles, tell us. It is the other way around: the plumbing will be changed because the system itself will become untenable. The whispered solution for now seems to be less dollars, more gold globally as a neutral reserve asset …
Well explained! And you didn't even have to mention Modern Monetary Theory directly, though it's the best analysis framework for understanding deficit, debt, taxes, and dollar creation. Thank you!
"The Moody’s downgrade doesn’t affect the role of US Treasuries in the financial plumbing world: banks still face 0% risk-weights when buying Treasuries"
If Moody's downgrade results in higher Treasuries interest rates, then banks can face a lot more than 0% risk-rates. If you don't believe that, then just ask the folks at Silicon Valley Bank. Oh wait, that's no longer possible, is it.
"Bonds are fairly priced here. I would start accumulating more 30-year Treasuries >5.25%."
If you do that, Al, then you are a very brave man, who is not afraid to swim against the tide.
"In February, foreign central banks unloaded a net $19.6 billion in longer-term U.S. bonds and notes. They sold $24.1 billion in January and $42.3 billion in December. A little over a billion was sold in November. The data were released as part of the monthly Treasury International Capital report on Wednesday."
I can certainly understand why the Chinese are dumping U.S. Treasuries, but what I can't understand is why the Chinese are now dumping their gold.
https://oilprice.com/Metals/Gold/Gold-Prices-Sink-as-China-Dumps-Stockpiles.html
Yeah well rates on the long duration Treasuries did jump at the open , but the demand was huge! I think you're spot on.