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Treasury today released April data on federal government revenues and outlays. The deficit in the past 12 months now totals $1.25 trillion, and as the second chart shows, revenues are collapsing while spending is soaring. Let's be optimistic and assume the economy is already beginning to grow again, but it's hard to see a recovery in revenues that is much stronger than what we saw coming out of the 2001 recession. What was then the "jobless recovery" is going to be replaced by a recovery that has to climb a wall of higher taxes. That means that revenues probably won't turn up meaningfully for another couple of years. Meanwhile, we know that spending is on track to reach $4 trillion next year. The amount of debt that will need to be sold over the next few years is thus absolutely staggering. It hasn't upset the bond market much, however, because there is still a lot of fear of the future out there, and bond investors are willing to accept meager yields on Treasuries because they are concerned that the alternatives—corporate bonds—will suffer from very high default rates because the economy will remain weak.In the sometimes-circular logic of the bond market, then, the prospect of massive Treasury supply is being ignored as a threat because that same supply will bring with it a massive increase in taxes, which will in turn keep the economy weak for the foreseeable future, which will in turn keep inflation low.
9 comments:
I wonder if the bond market might take a hit later on this year, perhaps if investors decide that Asia, Europe and Australia are better investments than the US.
I can see how there could be pressure on the Fed to monatize a significant share of this debt and this could result in inflation. But it's been so long since inflation has been a major concern. Still, some economists are predicting a period of high unemployment and high inflation.
I can't figure out how Obama's health care plan fits into this. Can they really propose spending even more than they have already?
Ricardian equivalence.
Scott,
You just described a self defeating economy. If it grows too fast we have a Fed tightening, high interest rates and inflation and a declining dollar. If it grows moderately, the Fed will have to tighten or else rising inflation will cause the bond vigilantes to do it for them once the safe haven effect is gone. If no growth or negative, revenues will decline, increasing debt and deficits. All of these scenarios will require the U.S. to devalue the dollar. Then no one will buy our bonds without collateral.
I see but one way to avoid this. Elect 218+ responsible adults to the House & 15+ in the Senate in 2010, freeze spending, eliminate all income and investment taxes and enact a 23% Fair Tax with a prebate to exempt necessities. Plus, repatriate $1/2 trillion foreign earnings @ 5%. Investment capital will flood the U.S. Then go to work on cutting ineffective spending and reforming entitlements and paying down our debt. I have a grandchild on the way and I want him/her to be debt free when they enter the workforce.
I remember reading one of Woodward's books where he observed President Clinton team's chagrin about bond market discipline killing off their liberal impulses to spend like crazy. Obama and his band of tax cheat flunkies appear to have no such concerns.
Spiral: I fully expect the bond market to take a big hit, probably within the next 6-12 months. All it would take is evidence that a) the economy is growing, and/or b) inflation is rising.
The pressure is already on the Fed and they are monetizing the debt, plus buying other assets in a big way. This could be very inflationary if they don't reverse course as demand for liquidity declines (which would occur as the economy picks up).
The health care plan is way outside the range of the budget. Let's hope they realize that the budget can't be tapped any more than it already is.
Donald: I do see a way out. Fed tightening is not necessarily bad for the economy. We saw very strong growth in the late 1990s as the Fed tightened. Tight money lifts animal spririts, because it enhances the value of money. Higher interest rates are a net positive for the household sector since it holds more floating rate assets than floating rate debt.
Rising inflation is the thing to worry about. So far it hasn't really happened, and there is no reason to be sure that the Fed will abandon its low-inflation objective. Bernanke made that point in a speech last night, talking about how the dollar is likely to remain strong because the Fed wants it to be strong in order to fight inflation.
But your election call is spot on. That's exactly what we need to do.
Paul: The stock market cratered in February precisely because the market realized that Obama & Co. don't care at all for the capital markets. They think they can just command and control everything, and their ends justify the means. It is indeed scary.
Donald,
Your post accurately describes the fallacy of trying to control the entire economy by changing the rate the Fed charges on overnight funds.
The problem the Fed faces is that an increase in the funds rate which is supposed to reduce the supply of dollars and thereby control inflation can also reduce the demand for dollars . If the demand for dollars shrinks more than the supply of dollars demanded you get higher interest rates and inflation. When the Fed signals a rate hike it is telling the economy that it expects economic activity to be slowed.
Bernanke has abandoned the rate target for his latest experiment with quantitative easing but has no solid target or at least not one that he has announced. His target might be the equivalent of $500 per ounce of gold or it might be $2000 per ounce of gold that is what scares me.
Am I missing something or wouldn't a stable dollar go a long way towards removing risk from the market ie lower prices on everything
This quote from James Carville illustrates my point about the differences between the Clinton and the Obama regimes:
"I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 basball hitter. But now I would like to come back as the bond market. You can intimidate everybody."
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