The interest yield on 10-year US Treasuries – the benchmark price of long-term credit for the global system – jumped 33 basis points last week to 3.45pc week on contagion effects after Standard & Poor's issued a warning on Britain's "AAA" credit rating.(Via Instapundit.) OK, who's been warning you about this? March 23:
The yield has risen over 90 basis points since March when the US Federal Reserve first announced its controversial plan to buy Treasury bonds directly, a move designed to force down the borrowing costs and help stabilise the housing market.
The yield-spike may be nearing the point where it threatens to short-circuit economic recovery. . . . The Obama administration needs to raise $2 trillion this year to cover the fiscal stimulus plan and the bank bail-outs. It has to fund $900bn by September.
"The dynamic is just getting overwhelming," said RBC Capital Markets.
The US Treasury is selling $40bn of two-year notes on Tuesday, $35bn of five-year bonds on Wednesday, and $25bn of seven-year debt on Thursday. While the US has not yet suffered the indignity of a failed auction – unlike Britain and Germany – traders are watching closely to see what share is being purchased by US government itself in pure "monetisation" of the deficit.
My own point of view is that last week's Fed buy-up of Treasury notes represents the fateful step into the fiscal/monetary abyss of Weimar America. We are so f****d now that the only question is what kind of financial rubble we will find most useful in rebuilding the shattered wreck of an economy that will be left desolated by the remorselessly descending spiral of inflation/stagnation that now begins in earnest. . .I've tried to explain this in more detail at the American Spectator. I'm not an economist, of course, but you don't have to be an economist to understand (a) bonds are sold in a market, (b) the pace of deficit spending means a huge increase in the supply of debt, and (c) the loss of capital in the meltdown means weak demand for securities.
When that disaster finally hits -- when capital freaks the hell out and the bond market goes sideways -- the lone sanctuary of sanity and calm will be Galt's Gulch.
OK, so even if there were enough demand to buy up all these bonds (i.e., the Treasury notes issued to pay for the deficit spending), if the Treasury sucks up that much capital, what will be the impact on the stock market? And what will this mean for the amount of capital available to private borrowers including businesses?
Bill Clinton was elected in 1992 after promising all kinds of new stuff during his campaign. But then he sat down to talk to his economic brain trust (Larry Summers, Lloyd Bentsen and a lot of Goldman Sachs people) and they said, "Uh-uh. You pile on all kinds of fresh deficit spending, and the bond market will tank."
Like Obama, Clinton was an Ivy League law grad who didn't know jack about macroeconomics, but his background in Arkansas gave him that kind of Chamber of Commerce pro-business attitude that most Southern governors had. So when his financial advisors explained the basic reality of capital markets and why new deficits would hinder recovery, Clinton took it seriously and canceled a lot of his promises.
This infuriated a lot of people, including Labor Secretary Robert Reich, and James Carville famously said, "Man, I wish I was the bond market. Then people would respect me."
That basic story has been told by Robert Reich, William Greider and others, and I had it in the back of my mind in December when I first wrote "It Won't Work" in December and followed up with "It Still Won't Work" in February. Clinton wisely heeded the warnings about the bond market, whereas Obama pushed recklessly ahead, and so we march down The Road to Weimar America.
UPDATE: Welcome, Instapundit readers! In the comments, Jimbo begins a dissertation by telling me that I "don't understand how reserve accounting works in a floating exchange rate fiat money system." And I don't for a minute claim to do so.
However, I do understand that supply and demand function in every market, including bond markets, stock markets and currency markets. Furthermore, I understand that "currency" and "capital" are not the same thing. When the government prints currency, the mere act of printing does not create capital.
What we are dealing with, in this recession, is a capital shortage. The collapse of the housing bubble wiped out a massive amount of value. People had borrowed money against that value, and the creditors whose capital was invested in those loans are now trying to figure out exactly how many cents on the dollar they might be able to collect, and how soon.
Ergo, there is a severe liquidity crunch, which the federal government is attempting to remedy through deficit spending. But deficit spending is borrowing, and so money that might otherwise be invested in the (job-creating, growth-inducing) private sector is instead being siphoned off into government bonds.
Something is wrong here. Whatever the result of such a policy, it will not be economic growth. Exactly what "reserve accounting" has to do with this, I don't know. What I'm seeing is the monetary cat is chasing its fiscal tail, and taking an educated guess that the result will be stagflation.
UPDATE II: Linked at RCP Best of the Blogs.