Without Excusing Geithner, This Is Bush's Inflation
The recent spike in U.S. Treasury yields has generated renewed commentary about the specter of inflation. It's even being asked if we're repeating the inflationary mistakes of the late ‘70s that occurred on Jimmy Carter's watch.
In some ways Treasury Secretary Geithner added gasoline to the fire with his much laughed at recent suggestion that Chinese investments in Treasuries are safe, but the inflation we're doubtless experiencing should in no way be solely blamed on our current Treasury head. Just as the Carter administration inherited massive inflation whose origins could be traced to the Nixon administration, the admittedly hapless Obama Treasury team is presently dealing with major monetary mistakes that originated under George W. Bush.
While existing Treasury yields aren't abnormally high by any modern standard, their rise brings to mind similar Treasury weakness from 1979 to 1981 when yields doubled. Jimmy Carter was understandably criticized for the dollar's decline in concert with rising Treasury rates, but to some degree this criticism was overdone.
Indeed, the dollar's decline began in 1971 when President Nixon chose to close the gold window so that the dollar could float. Lacking the credibility formerly offered by its relationship with gold, the dollar's value understandably collapsed, while commodity spikes soon followed. Contrary to the establishment view suggesting that inflation results from too much growth, the real truth is that inflation is always and everywhere the result of a decline in the value of the unit of account.
The dollar's collapse in the early ‘70s was inflation, and the subsequent rise of commodity and consumer prices mere symptoms of the original devaluationist mistake. Much like this decade, it took many years for Treasury rates to register the inflation that began with the dollar's decline. As Alan Greenspan pointed out in The Age of Turbulence, the yield on the 10-Year Treasury in 1979, despite the dollar's impressive fall throughout the Carter years, was only modestly higher than it had been in 1975.
The reason for this was pretty basic: no one, even as late as 1979, guessed that our flirtation with a floating dollar (floating currencies have always been the exception to the commodity-defined currency rule) would serve as policy for the long-term. But if U.S. policy was to continue to lean in favor of a weak dollar, Treasury rates would eventually rise, albeit not exactly in concert with the dollar's fall.
The above is important because despite the arrest of the dollar's decline in the 1980s and ‘90s, Treasury rates were still high. This too was easily explainable given investor awareness of the 1970s. So long as the inflationary ‘70s loomed large in investor memory, Treasury rates would to some degree have to reflect the past despite the dollar's renewed strength. Sure enough, interest rates on Treasuries were still adjusting to two decades of dollar health right into this decade.
In analyzing Treasuries since 2001, it's important to keep what happened in the '70s in mind. That's the case because in many ways the first decade of the new millennium was merely a repeat of the 1970s. And just as Treasury yields took a long time to rise in response to the weak 1970s dollar, so have they remained low this decade despite policies from the Bush administration which favored a weaker greenback. Treasury prices have benefited this decade from the '80s and '90s when dollar policy was mostly good.
Many inflation deniers and Bush partisans pointed to quiescent CPI readings to argue that inflation was nowhere in sight during the Bush years, but the rise of the euro (+54%), pound (+33%) and gold (+228%) against the dollar said otherwise. All that, plus they could never explain why government measures of inflation in Euroland and England hit two-decade highs despite the relative strength of their currencies. When we bring other countries with dollar pegs into the picture, we find that as recently as 2007 inflation measures in Qatar and Vietnam came in respectively at 13 and 25 percent, while inflation hit a 10-year high in China even though the yuan had risen 20 percent rise against the dollar since July of 2005.
In short, inflation has very much been with us most of this decade, but our frequently unrealistic CPI measure failed to pick up on it. There are many reasons for this, but the basic answer is that consumer prices change and decline for reasons that have nothing to do with the value of the currency. As for Treasury yields, just as they took years to register the dollar's collapse in the ‘70s, so did they this decade.
Returning to Tim Geithner and the Obama administration, their acceptance of the dollar's continued weakness means the inflationary mistakes that began under Bush will similarly be theirs. Assuming a two-term Obama presidency, markets must now price in four presidential terms in which dollar weakness will be ignored. Treasury yields are presently adjusting to this reality, and just as they spiked toward the end of Carter's presidency, there's the potential for a similar scenario under Obama.
Still, this is not something GOP partisans should crow about. Indeed, the long-term dollar weakness that is creeping into the cost of our debt was fathered by the Bush administration, discredited Bush's presidency as inflation always does, and was merely inherited by the Obama regime.
What remains unknown is whether there's enough institutional knowledge within the present Administration such that it won't allow what felled Bush to destroy its own economic credibility. Tim Geithner's comments in China suggest Obama et al are similarly oblivious to the destructive nature of inflation, and that being the case, long-term Treasury rates will have to adjust upward until responsible monetary authorities irrespective of party wake up to the essential importance of a strong and stable dollar.