Page 2 of 2 In the shadow of unwanted bunds
By Julian Delasantellis
well and good - as long as the governments can borrow the money. If not, things
get a lot more complicated.
All the stimulus advocacies and proposals assume a huge supply of virtually
limitless pots of cash available for these governments to borrow, and, more
importantly, that the current owners of these riches actually want to lend it
to the governments. What, as the failed bund auction seems to imply, if the
funds needed to borrow to inflate the stimulus balloons just aren't there?
What if the current estimates for what the world's governments will be
borrowing this year, currently running at US$3 trillion even before the US
Congress gets its hungry paws on the process, are
so scary to people with lendable cash that they pull back from carrying out
their Keynesian duty?
At the very least, this will mean that the governments will have to pay higher
rates on the debt than they previously planned or desired. This, in and of
itself, would act as an economic drag, as the higher rates paid by governments
lead to even higher rates that would have to be paid by corporate and mortgage
borrowers.
Some say that this problem could be dealt with very simply, by having the
world's governments and/or central banks step in and buy the debt, in essence,
to print money and use it to buy the bonds.
But on the first day of their first economics course students learn that
there's no such thing as a free lunch, so it's only logical to assume that this
10-course pigout of government spending would have a hefty price tag as well.
Already, governments such as the US have essentially nationalized the short end
of the yield curve with their massive expansions of central banks' asset
holdings, such as the US Federal Reserve's balance sheet exploding to over $2
trillion from $800 billion in just a few months. (See
Ben's big ZIRP! moment, Asia Times Online, December 18, 2008.) Buying
out the long end of the yield curve, like the 10-year notes that Germany could
not sell, would further expand government balance sheets, probably to a far
greater extent than what was expended to buy out the short end of the curve.
There is no way that these developments will enhance confidence in the
financial system, a key factor in stopping the slide into calamity. In and of
itself, a steepening yield curve, what happens when the difference between
short and long rates expands, is usually taken as a sign of an economy in which
investors are losing confidence that the government is able to, or even cares
about, controlling inflation.
If it is seen that the yield curve, already unusually steep with short rates so
low, is being held in place only through the sleight of hand of artificial
government manipulation, confidence would soon depart in one, or in most of the
world's economies. If the loss of confidence begins, or seems to be contained
in just one nation, that country's currency would collapse - the euro is
already falling against the US dollar and has fallen off a cliff versus the
yen. If confidence in the entire world economy is put into question, then gold
and other commodities would skyrocket, further diminishing the prospects for a
recovery from our current misfortunes.
In the early 1980s, economist Dr Edward Yardeni, then working for Prudential
Securities, coined the term "bond market vigilantes" to refer to investors in
long-term government securities who, fearing that governments were not
sufficiently looking after the future purchasing power of their principal
against the threat of inflation, pulled their bids from government debt
auctions, causing rates to rise. (Ed Hart of Financial News Network later
popularized the term.)
This seems to be what happened in Germany last week, as, much like Paul Kersey
did with the street punks, the bund auction was blown away. Now, the fear
stalking the world's finance ministries is that the vigilantes have only begun
their reign of vengeance, and the ministry officials wonder who's next.
By the end of last week, auctions for securities similar to those that did not
sell in Germany went off smoothly in France and Spain, soothing frayed nerves a
bit. As Al Labita noted on this site on Monday (see
Manila sets bond pace, January 13, 2009) the Philippines has also just
conducted a very successful bond auction. Was all the bund sturm und drang
just resultant from peculiarities in the bund auction process?
But then, on Friday, there were seen only very tepid rallies in world
government bond markets in response to the shockingly bad US employment news.
Some market commentary claimed that the failed bund auction was still leaving a
bitter taste in the decision processes of prospective government debt
investors.
A gilt auction in Britain last week went better than the one in Germany, in
that it actually sold, but demand for the offering was significantly under what
it was the last time a similar security was offered in 2005. Some say this is a
poor augur for the 51 billion pounds (US$76 billion) of debt the government of
Prime Minister Gordon Brown plans to borrow this quarter to counter the UK's
own deepening economic collapse.
It is interesting that, in the market for credit default swaps, that strange
hybrid of financial derivative and fully loaded Russian roulette pistol, whose
profligate overuse some say contributed to the current financial meltdown, it
is now more expensive to insure against the default on the debt of many
governments, including the US and UK, than it is to insure the corporate debt
of McDonald's - then again, the Big Mac maker is not trillions of dollars in
the hole, and going down deeper every day.
Of course, for most of this decade, any story about purchases of government
debt, especially American government debt, has essentially been a story about
China. Thus, a story from the front page of the New York Times on January 7,
"China Losing Taste for Debt From US", attracted lots of interest across the
blogosphere and punditocracy, much of it from people who wouldn't know the
difference between foreign exchange reserves and strawberry preserves.
As most everyone has known for quite awhile, China is diverting a lot of its
previous multi-hundred billion dollar purchases of government securities,
especially US Treasuries, more towards the financing of crucial infrastructure
and social service spending; also, with the decline in exports from China to
the capitalist world, the government in Beijing simply has a lot less to
invest.
Still, the article's real import is probably the fact that, as reporter Keith
Bradsher noted, "a series of hints from Chinese policy makers over the last two
weeks" were so obviously intended to get the message to the new Obama economic
team that the once seemingly endless money spigot is being slowly shut down.
For years, economic conservatives who glorified in American over-consumption as
a symbol of the nation's greatness pooh-poohed the idea of a cutoff of Treasury
purchases from China, claiming that it would be China itself that would be more
hurt than America from such an action. Critics answered that, eventually, China
would stop being America's money pusher, but, to minimize market turmoil,
they'd do it very, very slowly and carefully - exactly as they're doing now.
All during the private sector's glorious run this decade, governments were
starved of what they needed to meet the basic consumption needs of their
citizens in favor of the idolization of private consumption. Here, the
operating philosophy was simple and consistent, to go big - big houses, big
SUVs, big plasma TV, big glory and big glamour, proudly displayed to all in big
glossy magazines devoted to the splendid over-excess that signified the era.
Now, government is in the catbird seat, and it seems, much like the Bourbon
Restoration was described after the fall of Napoleon in 1814, to have learned
nothing and remembered everything. It is governments the world over that are
now going big, with big stimulus programs.
Doing this will require a triumph over the vigilantes. For the sake of the
millions of people now falling into misery and unemployment with each
successive government report, one would hope that today's economic constabulary
are more competent than were the forever feckless flatfoots who always seemed
to be letting Bronson's Paul Kersey slip from their grasp.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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