Page 3 of 3 It all comes down to Keynes
By Julian Delasantellis
It's too late for all but armchair economists to go back and again fight the
battles of 2008, seeing if the effect of letting a Bear Stearns or Citibank
fail would have been all that bad. It certainly was pretty bad when Lehman
Brothers was allowed to fail. It's not too late for public policymakers to
learn the lesson of 2008 for the future, that letting a financial system be so
unregulated as to be free to follow its worst, moral hazard generating
instincts creates huge, almost incalculable costs, such as this year's $1.8
trillion budget deficit.
In the final analysis, the debate centers around one final core datapoint - the
dramatic current gyrations in the market for US government 10-year debt
securities. Amazingly enough, both Ferguson and Krugman see and acknowledge the
exact same
data and then draw radically different conclusions from it.
At today's interest rates of just under 4%, 10-year US Treasuries are yielding
about what they were last summer, right up until the market-smashing effects of
mid-September's Lehman bankruptcy.
Note yields topped out recently in the spring of 2007 at just under 5.25%,
right before the news of the bankruptcy of the Bear Stearns subprime hedge
funds that set the dominoes tumbling on the entire world financial crisis. In
the roughly 15 months from then until the chaos of September 2008, note yields
lost about 125 basis points, as more and more scared investors weighed the
nebulous possibility of capital appreciation of corporate stocks and bonds
against the highly real and growing possibility of corporate insolvency, and
then decided to go for the guaranteed, "get your money back 100% of the time"
appeal of US Treasuries.
After Lehman, the move into US Treasuries became a panic. Yields basically
halved from September of last year to New Year's Day, bottoming out just over
2%. With 2009 came a little bit more confidence that the private-sector
corporate counterparties a money-market trader was dealing with today would
still be there tomorrow morning, and money started to come out of Treasuries.
The yields on 10-year notes rose from 2% with the new year to just under 3%
before the Fed Treasury buying initiative, fell back immediately afterward to
around 2.5%, and have been rising ever since.
Why?
After spending most of the last 30 years in the muck and mire of the financial
markets, I've learned one thing about the "why" question as regards to
determining causation in the financial markets - don't ask it. It's like
volunteering to spend an afternoon in an amusement park's maze of mirrors.
Especially with cash and near-cash settled futures markets such as the
financials (as opposed to the markets in "real" commodities such as foods and
livestock), you'll probably never really know, for certain, why prices move
over the short term. Newspapers such as the Financial Times and Wall Street
Journal, as well as wire services such as Bloomberg and Reuters, have their
reporters call around a list of the usual suspects seeking the answer as to
what happened, which, over time, becomes the first draft of history.
Occasionally, Fox News will try to spin the market news for its own demented
ends; an example of this would have been its reports that blamed one of the
financial crisis-related stock market selloffs in early spring 2007 on
"traitors" who leaked the details of the US National Security Agency's domestic
wiretapping program on Americans. Everybody knew that this explanation was just
blithering balderdash, but no one could really say just why.
With that warning as prologue, here are Niall Ferguson and Paul Krugman's
explanations for the recent rise in US Treasury note yields.
Ferguson says this is supply and demand at its finest. With the supply of
loanable investment capital essentially fixed (it is?) and the US government
taking so much more of it with the need to finance the $1.8 trillion deficit,
interest rates rise - that is, the price of money rises, as would the price of
any scarce commodity under such increased demand. In this, Ferguson claims,
Obama's expansionary, stimulative budget policy is essentially pointless, as
that any job gains to be had through the increased government spending will be
more than matched through the job losses engendered through higher corporate
borrowing rates.
Krugman, as anyone looking at a chart always should, looks back beyond the
immediate present to put some of today's events in historical perspective.
Here, the important datapoint is not today's near 4% rates, but last winter's
2% rates. That was in the midst of the worst of the financial system's panic,
when the prospect of investing in anything other than guaranteed US Treasury
securities was looked at as being about as sensible as jumping in the shark
tank at feeding time.
The fact that these fears are subsiding, that money is slowly coming out
government guaranteed markets to test the water in the private corporate bond
and money markets, is a symbol of the success, not the failure, of the
initiatives put together by former Treasury secretary Henry Paulson, his
successor Timothy Geithner, and Obama in backstopping and providing confidence
to the markets.
It is in looking at the interest rate rises in recent historical perspective
where I believe Krugman provides more substance to the debate. Last December, I
remember wondering what idiot would be so stupid as to accept only a 2%
interest rate for a commitment to a 10-year security, but even back then there
were even greater fools - those taking 2.55% per year on the US Treasury
30-year security. The fact that interest rates are heading back in the
direction of their normal averages, which they're still underneath, is more a
sign of underlying normalcy than impending Gotterdammerung.
That may be the situation for today, but what about tomorrow? What if the
economy starts to recover, but government policies remain stuck on full open
throttle cruise control stimulus.?
On numerous occasions, before Congress and at other venues, Federal Reserve
chairman Bernanke has affirmed that he fully intends to stop quantitative
easing and raise short-term interest rates above 0% upon witnessing significant
evidence of an economic rebound. Already, with each successive "green shoots"
better-than-expected economic report, whispers are heard in the markets as to
when he will start to prove true to his word.
But for President Obama, pulling in on the deficit may be infinitely more
complex. It is likely that economic growth will re-start long before the
unemployment picture improves; that will preclude much of the
revenue-generating effects of workers returning to work and resuming paying
payroll taxes.
What will the 10-year interest rate be doing then, with an improving economy
and still huge budget deficits? Will yields rise back up towards their levels
of the 1980s, in the double digits? At that point, the Keynesian solution would
be clear - a tax hike, along with steep cuts in government spending, to rein in
both the C and G functions of C+I+G.
That's a lot easier than it sounds; president Lyndon Johnson essentially
sacrificed his dream of a second term elected from out of the shadow of the
assassinated president Kennedy with the 10% Vietnam War surtax meant to contain
his "guns and butter" budget deficit and subsequent inflation.
In this case, Ferguson would be right - the budget deficits were driving up
interest rates. But his victory would be most pyrrhic, since, in the final
analysis, the victory would not be his but of his nemesis, Keynes, whose policy
prescriptions on what to do with excess aggregate demand leading to inflation
were most clear. Is it his fault that ever-feckless politicians lack the
cojones to implement them?
I see that, after knocking around America for the past few years like an
academic version of English Bob (Richard Harris) in 1992's Unforgiven,
Ferguson is scheduled to return to the sceptered island in 2010, accepting the
Philippe Roman Chair in History and International Affairs at the London School
of Economics. Will he be welcomed back as prodigal son or pariah?
Probably the former. After all, the UK, that other Eden, that demi-paradise,
still needs the foreign currency fill-up it can get from a man who can sell
never-to-be-read books to Middle Americans who think that the presence of a
Niall Ferguson book, like those of Stephen Hawking or Alistair Cooke before
him, on the coffee table puts a bit of the class back in the house that the oil
well in the backyard takes away.
Note:
The online "Urban dictionary" gives the following definition for nebbish:
Originally a Hebrew word, popularized in English by the cartoonist Herb
Gardner. A "sad sack", a loser, a person who can't make any thing or any
situation work right for him or her; unassertive, shy, timid. Reference: The
Joys of Yiddish, by Leo Rosten. His definition is "An innocuous,
ineffectual, weak, helpless or hapless unfortunate."
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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