Everything Is About Obscuring the True State of the Economy
(AP Photo/Patrick Semansky, File)
Everything Is About Obscuring the True State of the Economy
(AP Photo/Patrick Semansky, File)
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Humans love round numbers, attaching cultural or other kinds of significance and meaning to them for as long as we’ve used numbers. Most of the time, reaching an even level is just mere coincidence; is there anything really special about turning 50, for example (I hope so)? How about Dow 35,000?

The US federal government’s gross national debt topped $30 trillion for the first time. You probably have already heard about it, this balance was widely reported practically everywhere because it was a nice round number, an especially enormous one on top.

Was it really any more or less significant than the $29.687 trillion from only a few weeks ago? Not really. The even-thirty trillion by itself isn’t particularly significant; it’s special for how much coverage and attention it created, and that’s a good thing.

The American people need to be reminded more often about just how destitute our country has become. This is no partisan issue, either, rather politics is employed by both sides to obscure these basic facts: between 1993 and 2008, US public debt was remarkably stable when measured against real GDP.

At around 65% following the 1991 recovery, the level dipped as the “new” economy of the dot-com age began to take shape while at the same time the Clinton government exercised a modicum of fiscal discipline not witnessed since Eisenhower. Famously, by the end of the 20th century our biggest worry was running out of on-the-run Treasury securities for the starved collateralized eurodollar marketplace (not that anyone heeded the significance).

For those fifteen years of so-called Great “Moderation”, public debt as a proportion of total economic output would drop to around 54% at its lowest point entering the dot-com bust (Q2 2001) and would complete the round trip during the modest recovery from it rising back up to around 63% by the onset of the Great “Recession.”

Ever since that point, well, this explains so much official silence broken only occasionally by reasonable voices raising alarms; along with these few impossible-to-ignore milestones.

These critics have wisely, rationally, sometimes coolly pointed out the innumerable historical examples of governments gone wild. It almostnever ends well, another uncomfortable fact that formed the basis for what used to be called bond vigilantism.

Those, however, have gone extinct.

But why?

The major problem faced by those disgusted by the US fiscal situation is that in reaching back into history there’s an obvious correlation: go too far with debt, the system risks way too high a likelihood of imploding. Many times, these worried few have even flagged a threshold beyond which there is, they say, little hope for escape.

We’ve overstepped these and then some. Perhaps the most famous of them is the 100% rule of thumb; fiscal debt above even with GDP, and the dangers rise precipitously.

According to the US Office of Management and Budget (OMB), the government it reports to reached that level nearly a decade ago and did so only including the amount of public (rather than gross) debt outstanding created by all the government “stimulus” expended in the aftermath of the aforementioned “great” contraction.

But already we can see the outlines of the real and, for America, unprecedented problem. That “stimulus” in the form of the ARRA, along with the Fed’s QE program(s), these were supposed to “pay off” in legitimate economic recovery thereby creating the fertile macro conditions by which the feds would then use to escape this debt trap.

Grow your way out.

It was the same way Truman then Eisenhower had taken in the aftermath of WWII (and the New Deal) debt explosion. Contrary to what many if not most nowadays claim, inflating the currency is not the only way from under crushing loads. If done right, expeditiously, through a combination of government discipline and actual economic expansion there is indeed a happy ending.

Yes, easier said than done.

But it wasn’t done, not anywhere close, in the years following 2009. Therefore, by the start of 2012 – with yet another “unexpected” slowdown creating a second devastating setback to the recovery – public debt would top 100% of real GDP and stick around. By the fourth quarter of 2019, on the cusp of yet another setback, we were already at 106% and climbing before COVID.

The country hadn’t fallen apart, the US dollar defied all the plenty predictions of imminent and total collapse. Thus, sadly, it had grown all-too-easy to dismiss and ignore debt levels since there hasn’t been the usual chaos history has associated with them.  

As of the OMB’s last estimates for Q3 2021, US public debt-to-GDP sits at a grotesque 122.5%, nearly double the ratio from once-upon-a-time pre-crisis; 2008 crisis. The economic response to 2020’s pandemic response put that past “rescue” to shame.

While CPIs have exploded curiously interest rates have not while at the same time the US dollar has been able yet again to avoid its long-predicted calamitous fate. Long-term Treasury yields, in particular, have managed to remain closer to historical lows (set in August 2020) than the last cyclical peak set in October 2018 – when those levels were themselves utterly low by comparison to any other period.

Any other period save the Great Depression and its prolonged, painful aftermath.

We’re beginning to zero in on why rates are stuck closer to that lower nominal bound than anywhere resembling normalcy. Like the thirties and forties when last the government ran up such shocking deficits, deflationary circumstances prevailed upon those very instruments issued to maintain the government’s borrowing through nothing more than liquidity and safety preferences.

What this has meant is utterly perverse, and it may have led to an underappreciated feedback mechanism which only serves to make the whole situation worse still.

Again, the correlation between lack of growth and governments trying to do something about the lack of growth via borrowing (Keynes) is uncontroversial. Where it becomes a “debate” is whether any such attempts have been successful. Going by nothing more than the debt-to-GDP figures cited above, you have to at least seriously consider the most obvious explanation for them.

In other words, when debt wasn’t a problem – especially that one 13-year period – actual economic expansion was easily established by every economic account. By those same accounts, “something” big changed in 2008 so that afterward economic growth has been impaired (Economists blame you and me for this, calling us lazy and drug-addicted therefore ruining their “stimulus” attempts) which has meant an almost constant government profligacy.

This hasn’t led to the historical collapse in its bonds or “its” currency because no matter how much the government borrows (or the Fed issues bank reserves) the currency’s exchange value only seems to go higher (in general) along with the price of government debt.

No, no, no, the critics say. On the contrary, the government debt is priced where it is by the government’s nominally independent (allegedly linked) central bank. The Fed and its QE, these are responsible for keeping the shell game afloat; the old dirty trick of monetizing.

This is actually something scholars and researchers at the Federal Reserve, along with top policymakers, have been desperate to establish if for their own purposes (obviously not couched in that way). Ever since the first US QE an inconceivably long thirteen years ago, authorities have tried repeatedly to make this same connection – that without the Fed’s bond buying the Treasury market, in particular, would be in a much different shape.

Their reasoning and motivation stem from the clear desire to prove success along the mythical interest rate channel (the other two theoretical QE channels, portfolio effects and sentiment, haven’t produced, either). And it is the one you’d think, knowing little or nothing about QE, would be the least controversial and most easily demonstrated.  

After all, the central bank buys whatever bonds, their price should go up. The more which gets bought, the higher the market price is nudged if not shoved therefore reducing the interest rate. And since current Economic theory equates low interest rates with stimulus – despite an equally long and unbroken historical track record showing otherwise – anyone near or around the Federal Reserve (like ECB or Bank of Japan) has been urgently seeking this validation ever since that long-ago first attempt.

It has proved only elusive.

Not for lack of trying. One such robust shot was made last March, a paper published in the prestigious Journal of Monetary Economics by the University of California’s Eric Swanson (a special thanks to Mr. Tateo for first reading through it). It was straightforwardly titled: Measuring the effects of federal reserve forward guidance and asset purchases on financial markets.

Using quantitative econometrics (what else?), Professor Swanson tries to quantify the effects of both large-scale asset purchases (LSAP) as well as forward guidance on asset markets, including others besides the one for the assets being purchased. We’ll stick to his findings on Treasuries here given our focus.

According to Swanson:

“Finally, for LSAPs, we would like the units to be in billions of dollars of purchases, which is a more difficult transformation. Nevertheless, a number of estimates in the literature suggest that a $600 billion LSAP operation in the U.S., distributed across medium- and longer-term Treasury securities, leads to a roughly 15bp decline in the 10-year Treasury yield.”

That’s…underwhelming, to put it mildly. For the sake of comparison, recall Ben Bernanke’s second QE (why did he feel it necessary to repeat?) was that very number: $600 billion. Does a fifteen-basis point effect on yields count as anything more than a rounding error, or indistinguishable from any nondescript normal market fluctuation? There have been individual days when the 10-year rate moves nearly as much.

We should all be asking Ben Bernanke for our money back. But that’s the thing, there was never any money in any of these QE’s.

This is why Swanson was searching for success in addition to the raw bond buying itself (LSAP), fishing for some extra contribution derived by forward guidance, too. To that end, he claims to have found…some mostly in other markets. When it comes to bond yields, though, there wasn’t really much (forward guidance was found to be more “effective” in markets for stocks or in short-term Treasuries).

“The effect of forward guidance on the 5-year Treasury yield is a bit less than 5bp on the first day, and is statistically significant. The effect is a bit smaller, 3–4bp, over the next 15 days and generally remains significant. After about 20 days, the estimated effect varies between 0 and 7bp and is no longer significantly different from zero.”

For most Treasury maturities, the Federal Reserve (or any central bank) is really left with the act of purchasing bonds and it isn’t anywhere close to satisfying (and even what small amounts are quantified in this paper are betrayed by their questionably wide confidence intervals which fall on both sides of zero).

This did not stop Esther George, the Fed’s Kansas City branch President, just days ago from improperly (and risibly) extrapolating the alleged 15 bps effect from any $600 billion LSAP into claiming the Fed’s QE6 and its “$6.9 trillion holdings of federal agency and longer-term Treasury debt is depressing the 10-year Treasury yield by roughly 150 basis points.”

First of all, since March 2020 the central bank has only purchased an additional $3.2 trillion of all kinds of Treasuries; it already held roughly $2.5 trillion at the start and reports a little over $5.7 trillion as of Wednesday.

And then Ms. George “for some reason” throws in agency debt on top. Under QE6, the Fed has increased its holdings of agency-issued MBS by a little less than $1.3 trillion; from $1.38 trillion mid-March 2020 to this week’s $2.66 trillion.

Treasuries alone are $3.2, but even if you include the other it’s $4.5, not $6.9 trillion (which is the total amount held, not how much has been bought).

In other words, poor desperate Esther is claiming that cobbling together the activity for all six QE’s she might then presume a cumulative impact spaced out over more than a decade altogether has subtracted 150 bps from the 10-year Treasury yield.

That’s not how this works; that’s not how any of this works.

For one thing, are we really supposed to believe a more than 11-year-old QE (#2) of $600 billion still has its alleged -15 bps over the 10-year Treasury rates of today? She obviously wants us to.

Furthermore, that $600 billion of QE back in 2010 and 2011 represented a much higher proportion of public debt than it would today when public debt is approaching $30 trillion; gross debt beyond that much. Dilution, in other words; maybe you could have “bought” 15 bps with $600 billion way back when, not today.

They are trying too hard, blatantly attempting to conjure up some favorable numbers no matter how dubious, expecting (for good reason) how no one will ever check their math or equations with confidence intervals.  

But here’s the thing; all these calculations and studies are mere angels dancing on the pinhead, the splitting of the most minute hairs. Let’s give Ms. George every benefit of every one of these serious doubts and just concede her assertion of this 150-bps cumulative effect on Treasury’s 10s.

Add them to today’s yield of 1.83% and you get 3.33%. Does that even change anything, really? From ultra-low to still historically low. And this from the very people who have every incentive to manipulate the effect.

Three and a third is only a tiny bit more than the top yield reached during October and November 2018. That’s the same vicinity as November 2008, a crisis rate before any QE’s of any type were begun (in the US). And the last time we saw 3.33% on the benchmark 10-year it was May 2011 – right toward the end of QE2 just as yields were about to tumble after the bond buying ended.

It is so indelibly and thoroughly underwhelming, even when giving LSAP’s and “monetary” policies every ridiculous benefit to every appropriate doubt. In any sort of rational sense, QE hasn’t left any mark on Treasury prices.

Which means the market wants them at almost any cost even as our broke government goes broker by the minute, by the second. As this continues to be the case (see: yields in 2022 despite QE being tapered and rate hikes looming in a matter of weeks), even though public debt itself moves toward $30 trillion, what of this discrepancy?

It’s not really a mystery, rather a misunderstanding and, paging Esther George, an often deliberate one designed to obscure all these things starting with the true state of economic growth, the Fed’s and feds utter inability to do anything about this, to Japanese-style debt along with why the safe and liquid remain the most favored instrument on offer anywhere despite “our” total debts having now surpassed that unthinkably huge round number.

Bond vigilantism has taken a back seat, a way back seat, to the more immediate concerns which are and can only be greater than the cosmically large $30 trillion in federal debt. No other calculations or comparisons are truly necessary.

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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