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.