* This post was written in 2011 before Mr. Roche founded Monetary Realism, a post-MMT school that was formed due to several disagreements with the school of thought. For more info on the difference in views please see here. For more on MR’s views please see here.
Does the USA need to fear those dreaded bond market vigilantes?
“Remember the bond market vigilantes, that frightening band of financial marauders who once roamed the earth like a fearsome herd of Tyrannosaurus rex? They were so scary that in February 1993, as President Bill Clinton struggled to reduce the federal budget deficit, James Carville quipped that he wanted to be reincarnated as the bond market so he could intimidate everybody.
Well, they’re baaack! Not in the United States, though. Here, the Treasury Department continues to borrow brobdingnagian sums of money at extremely low interest rates—about 3.5% for 10-year Treasurys and under 1% for two-years lately—even though everybody knows that the federal budget deficit is on an unsustainable path toward the stratosphere. (Could it be that not everybody knows?)”
Can you hear it? That drum beat? I can. It’s growing louder. It’s those evil bond vigilantes and they are on the attack. They’ve attacked Greece, they’re attacking Portugal, they’re attacking Spain and the USA is next on their radar. As Paris Hilton might say – “we are, like, so totally screwed”. Or are we?
There is an earth shattering shriek coming from a certain group of market participants. The hyperinflationists are at it again. They’ve been undeniably, horrendously, atrociously wrong for 25 years, but this is their day in the sun. It’s finally coming. Hyperinflation is on the horizon. And that means the bond vigilantes are going to attack the USA and bring the great American empire to its knees once and for all. We will be crushed for our reckless behavior! All of this “money printing” and reckless deficit spending is the end of us. It’s time to call up the funeral parlor and make an appointment. Uncle Sam has one foot in the grave and the other is being tugged on by a bond vigilante.
The only problem is, there is no inflation. In fact, we’re on the verge of a deflationary relapse. Also, there are no bond vigilantes in the USA. Interest rates keep dropping like a stone in water. So what is so wrong here? Why are the hyperinflationists wrong again? Peter Schiff says the dollar is done for. Nouriel Roubini has been saying for almost two years that bond yields could spike as “unsustainable” deficits get attacked by the bond market. Alan Blinder, (a former vice chairman of the Federal Reserve and Chief Economic Advisor to Bill Clinton) says we are on the verge of becoming the next Greece as our debts pile up and drive us towards eventual extinction. All three men have been and continue to be fantastically wrong. Why are Peter Schiff, Nouriel Roubini and Alan Blinder and the other “bond vigilante” fear mongerers so wrong? In large part, because they don’t understand how the monetary system works. Roubini was recently quoted saying:
“if [the US government] maintains large budget deficits, bond market vigilantes will punish policymakers. Then, inflationary expectations will increase, long-term government bond yields would rise and borrowing rates will go up sharply, leading to stagflation.”
Those damned “borrowing” rates. Unfortunately for Mr. Roubini, the United States government doesn’t fund its spending via the bond market. NOT ONE PENNY. China is not our banker. Neither is Japan. And neither is the private sector. The government bond market is a monetary tool. A remnant of the failed gold standard. Nothing more. It funds nothing. I’ve shown this ad infinitum in recent months (regularly readers probably hate me by now – I apologize profusely for putting you through this), but I can’t stress how important this fact is.
Commentators like Mr. Roubini and Mr. Blinder are obviously very influential people. Unfortunately, their understanding of the monetary system is antiquated neo-liberal hogwash and it is helping to drive this country and the global economy into ruin. We are not Greece. Not even close. If anything, we are Japan, who coincidentally, has met with NOT ONE bond market vigilante in 20 years despite persistently high deficits.
I’ve repeatedly shown how there is no solvency risk in a country who is the issuer of the currency in a non-convertible exchange rate system where the debt is denominated entirely in that currency. But most importantly, the only real risk of large deficits is inflation. But I’ve also shown that there is no risk of inflation in the current environment. Consumers are still deleveraging, there is ZERO wage growth, very low borrowing demand, low capacity utilization, high output gap, climbing unemployment, low aggregate demand, low cost push inflation – not exactly a recipe for inflation. In fact, not even close (Japan should be coming to mind once again). So, is the high deficit a concern? You bet. Is it going to be the demise of our country? Only if we misunderstand it (which is the path we are currently on).
It’s time for someone to stand up and silence these men who are nothing better than ignorant fear mongerers. Half of them are broken clocks and the other half have made a life out of scaring people. In the meantime, they’re on an endless campaign to convince the population of the United States that we are all bankrupt and the country is about to get flushed down a New York City urinal. The facts say they are undeniably wrong. They keep saying inflation is right around the corner and it keeps on not showing up. If your portfolio has been positioned for inflation in recent weeks you’ve been crushed just like you were in 2008 – despite this (supposedly) “different” return of the credit crisis.
If we want to become Greece I recommend that the Obama administration continue taking advice from men who have failed to revive this economy and have done nothing to increase aggregate demand or reduce unemployment despite nearly TWO FULL years at the helm. If we want to become Greece we should impose harsh austerity measures and raise taxes. Sounds great doesn’t it? The Greek citizens obviously love it.
Please pardon my unusually unreserved temperament here, but we are talking ourselves into a second Great Depression. We are confronted with an enormous task ahead of us. I still believe most investors are underestimating the gravity of the situation here. As I’ve hammered on for two years now, the credit crisis never actually ended. The private sector never fully recovered. The government was never ready to hand off the baton. The recent turmoil in Greece will only exacerbate our problems.
Even worse, I now highly doubt that President Obama will survive the Great Recession. This is a great tragedy in my opinion as it has the potential to crush the hopes of millions (and this is coming from a registered Republican!). Hope is fading as we are talking ourselves onto the ledge because we don’t understand the fundamental differences between the highly flawed EMU and our own monetary system. We cannot talk ourselves into a second Great Depression just because of the ignorance of influential economists and politicians. It’s time for someone with some confidence to stand up and show the American people that they understand our monetary system. And it’s time for the fear mongering hyperinflationists to sit down, close their mouths and stop attempting to scare everyone into believing that the United States is the next Greece. Nothing could be farther from the truth.
The Tyrannosaurus Rex is extinct. It’s time to put this neo-liberal economic thinking into extinction as well. If not, it will be the extinction of the once mighty USA that young Chinese boys and girls read about in the history books.