Tuesday, October 30, 2018

The Coming Bond Market Implosion

James Grant says it’s time to worry. About what, pray tell? About the national debt, of course. Since Grant counts among those precious few who understand the workings of credit markets, we pay close attention to his views. After all, he was sounding the alarm about mortgage backed securities in 2006 and 2007. Some consider Grant to be something of an outlier, but he is a brilliant and highly respected outlier.

Thus, I pass along some of his commentary, from an essay in The Weekly Standard. I pass it along without any commentary. Call it a public service. Truth be told, I have no right to offer wise opinions on these matters, so, silence seems the best strategy.

Grant begins:

America’s deteriorating public credit is the cold-button issue of the 2018 midterms. With rare bipartisanship, Democrats and Republicans compete to pretend that the country isn’t going broke.

What produced this crisis?

The remote political cause of this predicament is the ideology of statism. In Washington, this takes the form of tax and tax, spend and spend, elect and elect; on Wall Street, it’s found in too-big-to-fail, a virtually socialized mortgage market, and an overreaching, manipulative central bank.

In time, Grant will argue that Richard Nixon, seriously erred when he ended the promise that you could exchange your dollars for gold or silver. It was the only way to have both guns and butter during the Vietnam War:

From Alexander Hamilton to Richard Nixon, the dollar was an IOU, a promise to pay gold or silver at a fixed rate. It subsequently became a thing unto itself, an IOU nothing. In consequence, for the past several decades, federal liabilities have grown faster than the national income with which to service them. Ultra-low interest rates have cheapened the cost of this profligacy and hidden the looming dangers.

The gold standard, Grant argues, imposes fiscal discipline. You can only spend dollars up to the amount of gold you have on hand. Without it, governments simply borrow and spend. When the government is obliged to pay back its creditors it simply borrows more money. Try doing that with your own debt.

From 1789 till 1971, with time out for the Civil War, America’s bank notes were convertible under law into precious metal at a fixed and statutory rate. By the time the sand ran out on the gold standard, only foreign governments enjoyed the right to exchange their promises to pay (a dollar being a note, or debt obligation, a promise to pay as opposed to money itself) for gold at the then-fixed rate of $35 an ounce. And when the foreigners sought to exercise their rights more vigorously than the depleted American gold store could bear, Nixon ordered the Treasury to suspend payment. Henceforth, the dollar would be just as good as paper or, subsequently, a digital representation of paper; the date was August 15, 1971.

But the 21st-century Treasury is under no pressure to take such actions. Its creditors, for now, seem perfectly happy. Though the supply of government securities on offer this fiscal year, from all sources, including the Federal Reserve, is projected to be the greatest, as a percentage of national output, since World War II, interest rates have risen only by enough to rattle President Trump and (at this writing) the stock market; the government is still easily financing its $3.9 billion or so of daily new borrowing needs. The dollar-exchange rate likewise signals complacency. In the worldwide laundromat of fiat money, the dollar is the cleanest dirty shirt….

The truth is that in the absence of monetary or market constraints, federal borrowing begets more federal borrowing.

Until it doesn’t. Until the world’s creditors decide that the risk is too great. And they move, as China seems to be doing, into gold.

... the dollar has become America’s greatest export. It costs us nothing to produce, and only we may lawfully print it. The Google or Coca-Cola of monetary brands, it passes for value the world over. Spending it, we may—and we do—consume much more than we produce, putting the balance on the tab.

Under the true-blue gold standard, nations settled up accounts in commercial bills exchangeable into gold or, less frequently, in the metal itself. To get money, you dug it out of the earth or attracted it with high interest rates or fetching investment opportunities. Some gold-standard-bound nations, of course, were more powerful than others (Britain ruled the roost until 1914), but the system inherently advantaged no one participant over the others.

The government could, Grant opines, decide not to pay off its debt, not to pay bondholders what it owes. The markets would be highly displeased, but it could still do so.

Credit, ultimately, is an opinion, and America’s creditors may wake up one morning and change their minds about either the ability or willingness of this country to meet its obligations.

Therefore, taking one thing with another, I would advise worrying now.

The real crisis is not Russian hackers violating our pristine democracy. It’s the debt bomb that threatens to blow up and to blow away our prosperity.

Better to begin with the humble hope that someone, maybe a Republican or a Grover Cleveland Democrat, says something about the scandal of the national balance sheet. It is no opinion, but an arithmetic truism, that our debts are growing faster than our means to discharge them. It strains credulity to think that our creditors are unaware of the fact. Some of us fret about foreign hackers tilting American elections with lies. We should all spare a worry about hackers causing a bond-market crisis by spreading the truth.

No one ever called James Grant an optimist. But, in time of optimism, someone needs to show us that things might not always be quite so rosy.

23 comments:

Anonymous said...

pristine democracy? does not compute.

Stuart Schneiderman said...

does compute... ironically

Anonymous said...

WHAT happened to our Massive Republic with 'Democratic-like'-crispy-bacon-bits feature?

Dan Patterson said...

Any argument for a return to some fiscal sense is roundly booed. What part of the budget can be cut, they ask? We MUST confiscate more money, they shriek. Does NOT make sense. None of the accounting principles in the federal gummit are widely accepted, are they? I cannot use the same ones in my life. And the argument to return to pm-backed money is also widely trounced; I understand the problems but how can the present model continue?

Stuart Schneiderman said...

At some point, we are not going to have a choice. And, fixing it will not be pretty.

Ares Olympus said...

A good article for Halloween. Everyone can agree debt is a problem, although its hard to see how a modern world can run on gold, although the gold bugs would love it if their precious 10lb retirement stash goes from $200k to $20 million, although at some point shaving off a few layers atoms from your bars each week to pay for groceries or smokes gets a little absurd.

And as scary as the federal debt looks, the benefit of sovereign debt is you can clear it with a printing press or a button on the Federal Reserve's keyboard. And we can be afraid people, and corporations and governments will stop buying our bond if they think inflation will exceed their returns, but actually in the current climate of the filthy rich, when things are good, they'll may a killing, and when the markets go bad, they'll gladly throw their money even into effective negative interest rates, as long as it is safe. And so sovereign debt means we'll never "default" and inflation takes money away from all savers, not just those invested in bonds.

And so we have to imagine on the next economic crisis, the race to the bottom will just go deeper, and we'll add another $20 trillion to the federal debt, to protect the markets, so baby boomers can continue extracting the last resources of our dying empire. And the next generations will have to find its own way in the ruins when the global economy goes down. But until then at all levels of society, the more you borrow, the more you can have you cake and eat it too.

Anonymous said...
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Anonymous said...

[Ares,]
Trump could have always set up some an external counterpart mouthpiece (so not to incur blame the messenger wrath) and have a continuous dialogue concerning such concerns, thereby increase the level of 'official' communication beyond the white noise banter of daily Tv News pundits, just be sure to choose a primary single 'most-important concern' whatever that might be to our elite, and go with it almost exclusively until it has been repeated enough times so everyone at a 4th grade level of understanding can comprehend it in intricate honest step by step details, however, I don't him doing that sort of communication campaign. Trump wouldn't even have to take an unpopular side so long as whatever the desired message of those in power want is delivered convincingly with repetition.

Ares, I'll try to FEELS it as well with you, I know you worry about the safety of the Best of Americans too (the Leaders us the majority look up to) I too worry for the safety of all our wonderful American economic leaders, who have been leading America to MAGA. You should have full faith and trust that they will dominate the Hill'derbeast's flying monkey demons and everything will be alright. Even if our wise Philosopher Kings must sacrifice all of us who are economically too unworthy to be considered human let alone one of the Great Americans worthy of the Trump, should the might of Trump by no fault of his own fall to the next inevitable Crisis.

You don't have to worry so much about Trump and his supersweet-Fam will hopefully be kept safe and A-ok no matter what disaster befalls any of us worthless people who are economically unworthy to be American anyway and must have voted for Succubus Hillary too, so if they accidentally die from starvation or exposure while homeless they can ask Hillary for help as their last futile act.


*I have long suspected that psychologists know less than even psychiatrists (who seem to know little) do about the experiential workings of the mind, that is why they fear and pathologize-with-pseudoscientific label(s) anything that does not conform to that which they do not understand.

Anonymous said...
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Anonymous said...

In Trump's broad circle, there's Elon Musk talking about the creation of artificial intelligence gadgets capable of playing both Chess and Go better than any world champion, in the form of AlphaGo, DeepMind and pretty much any of the currently maintained chess engines. This is fascinating, as well as terrifying. Synagogue shooters are only terrifying, never interesting or positive, nevertheless are less serious threat than cybernetics.

Anonymous said...
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Anonymous said...

I take that as you are not a fan of that film. Everyone has films they don't like, violent movies are pretty bad too. Happy movies are better than violent.

Hal Gore said...

The debt doubled under W (5-10T), doubled again under Zero (10-20T) and we must assume it will double again under Trump. I don't get how things keep working. FWIW it was about 40 years from FDR's gold theft to Nixon's gold theft and it's been just over 40 years since Nixon. Trump does seem different perhaps he really can drain the swamp. Next Tuesday will be the day to watch.

David Foster said...

It's worth noting that the question of Deficits is interlinked with the question of Trade/Tariffs, via the accounting identity which is basically:

Trade Deficit = Private Sector Deficit + Government Deficit

Some thoughts on this, some of which are contrary to most-common economic thinking, here:

http://carnegieendowment.org/chinafinancialmarkets/77009

Ignatius Acton Chesterton OCD said...
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Ignatius Acton Chesterton OCD said...

Hal Gore: Eventually, it will all stop working.

Yes, that’s the point.

First, the rational argument: “There is no such thing as a free lunch”

Then, the irrational argument: “It’s all FREEEEEEEE!!!”

These two operating premises are incompatible.

Who’s correct? We shall see.

One thing I can guarantee you: When things get really hairy, no one will be listening to the rational people.

Anonymous said...

Ignatius, Hal, else
I'm doing my best to appreciate the style of communication here. After catching up on reading some comments it has proven more productive than adding any more useless comments of my own. The comments present are more topical than any thing I can must. I don't want to add any more useless junk to what is already confusion. Thanks for being patient and hearing out my nonsense.

Illuninati said...

When I clicked on this post and began to read it the subject matter was so unusual I momentarily forgot who I was reading. When it comes to human relationships, Schneiderman is a very gifted person and a pleasant read so a trip into the dismal science is quite a shock. I'm not sure why people are complaining about our present monetary system since right now it seems to be working well - but to each his own. Anyone who wants to put himself/herself on the gold standard is free to purchase all the gold he/she wants. But really, why bother?

Stuart Schneiderman said...

I was passing along the views of a very wise and well-informed student of credit markets.

Dean Gil Barry said...

Years ago a financial news publisher discovered that gloom and doom articles were more popular than optimistic articles, thus the emphasis was put on gloom and doom to sell more newsletters and magazines.

Wye Pei Mor said...

I had never worried about a gargantuan national debt and “putting our grandchildren into bondage,” etc. We can simply default on the debt. Yes, the bond holders would be super pissed, and reluctant to buy our bonds for awhile, but with a clean slate, we would be much less likely to default for years to come. It is like the person who overspends and declares bankruptcy. Soon after, he gets credit card applications in the mail because he is free of debt and can afford monthly payments once again.

David Foster said...

"Bond holders" are not some exotic class of people in other countries. They include American pension funds and many American individuals.

Default is theft, and if it is intended in advance, it is premeditated theft.

Anonymous said...

iLluninati said... "The Dismal Science" Nice! The frown is good.