Understanding The Modern Monetary System...
This isn’t a post. It’s an open question.
Why are bond yields in a 30 year bear market?
The forces propelling bond yields lower over 30 years must be extremely powerful.
Too easy! Globalization. That has put tremendous downward pressure on wages…
Yep – this should be a factor. But it’s not what I was looking for!
Would suggest saving preference over investment preference, likely due to falling profit rate, declining innovation, and lack of attractive investment opportunities. It’s about risk-weighted return. Many savvy people are preferring bonds in this calculation.
This is a big reason for the strong push toward greater liberalization. The argument is that regulation is constricting investment opportunity.
I also think these are factors. There is something else I was thinking to be more important.
“Many savvy people are preferring bonds in this calculation.”
Wouldn’t that make for a bull market in bonds, not a bear market?
OIC. A **bear** market in bond **yields**. Thanks for the obfuscation.
It’s because of the way fiscal, monetary and trade policy have been conducted during the last 30 years. The economy operates below potential almost all of the time because 1) Trade deficits create demand leakages and 2) Deficit-hysteria never allow fiscal deficits large enough to keep AD high enough. The Fed has to lower rates each recession to boost the economy, but since we never operate at full potential, the Fed never raises rates during recoveries to get back to the levels of the previous expansion.
So through each recesssion/expansion cycle we get a lower trough and and lower peak in rates. Now we’ve hit the zero bound and the game is over, either policy makers wake up and start using fiscal policy in sufficient amounts or we’ll be stuck in a Japan style BSR for years to come.
I think it all started with the Volcker Disinflation. The thing to remember is that they were in a 30 year bull market prior to that.
I think there’s a feeling among monetary and fiscal authorities of “never again.”
Remember during Clinton’s term where after meeting with Greenspan he was talked into not doing anything that would upset the phantom bond vigilantes?
Overall, there may have been other factors but I don’t think it was an accident.
Though I’m a skeptic of him, Sumner did recently make an interesting point that while we see a 7% yield in a euro coutries bond as a nightmare scenario, historically a 7% yield is not so high.
A few years ago most countries had yileds that level and it wasn’t considered an emergency. Indeed in the 70s that would have been a thing of envy.
Sumner’s explanation is predictable-the reason a 7% yield is unsustainable in the ero countries today is because of flagging or negative NGDP
Combo with DetroitD: chinese deflation and robotic deflation
BTW I don’t really mean just robots but all technology related mechanization/automation (internet, s/w, etc.) (Was trying to make a joking parallel between the chinese = robots [or at least the robots of the chinese government ;->])
Demand leakage from trade deficit and skepticism that deficits will fill the gap?
Global warming? Gay marriage? I’m sure we could connect it to both if we tried.
The end of World War II, or more precisely, the paying down of our war debt. Bill Vickrey figured the US had 2 x GDP in available private investments but 3 x GDP in available private savings. Public debt is needed to fill in the gap. If it doesn’t the excess savings will drive down interest rates and build up asset bubbles (quoting here from an email I wrote last week).
Ragu Rajah (who coined the term “Let them eat credit”) wrote something interesting the other day:
“starting in the early 1970s, advanced economies found it increasingly difficult to grow. Countries like the US and the United Kingdom eventually responded by deregulating their economies. Greater competition and the adoption of new technologies increased the demand for, and incomes of, highly skilled, talented, and educated workers doing non-routine jobs like consulting. More routine, once well-paying, jobs done by the unskilled or the moderately educated were automated or outsourced.
The short-sighted political response to the anxieties of those falling behind was to ease their access to credit. Faced with little regulatory restraint, banks overdosed on risky loans”.
Bill Vickrey would suggest the real problem was that the public debt (run up during WWII) had become too small a percentage of GDP.
“The “deficit” is not an economic sin but an economic necessity. Its most important function is to be the means whereby purchasing power not spent on consumption, nor recycled into income by the private creation of net capital, is recycled into purchasing power by government borrowing and spending…
Over much of this century trends in the ratio of profitable private capital to national product have been downward, as a result of capital saving innovation such as fiber optics, the trend to light industry away from steel mills and other heavy industry, and the increasing importance of services. Prospects are that for the foreseeable future the capacity of private industry to find profitable use for private capital will be not much greater than two years of gross domestic product. On the other hand aspirations of individuals to acquire assets to provide for retirement and other purposes have been growing, due to longer life expectancy, higher retirement aspiration levels, the loosening of family ties, the development of expensive medical technologies, and other factors. Current aspirations appear to be moving towards three years or more of gross domestic product. This leaves a gap to be filled by government debt of about one year of gross domestic product…
If governments fail to fill the gap and meet the demand for assets by issuing an adequate volume of securities, the attempt by individuals to acquire assets by non-spending will cause a reduction in sales, temporary investment in excess inventories, cutbacks in orders, unemployment, and reduced national income and product. This may be partially offset by the bidding up of asset values, leading to a certain amount of additional spending out of capital gains, but the “saving” imbedded in these capital gains does not involve the creation of new capital or the employment of individuals in construction.”
Looking at it in this way, the post-war economy was so strong because the investment demand gap was met by the 120% or so of GDP in T-bonds issued during World War II, but as the debt was paid down (and perhaps because the public investments it bought wore out), the economy became sluggish. Check out this chart, the debt didn’t reach pre-war levels until the 1970s. Like Rajah said, “starting in the early 1970s, advanced economies found it increasingly difficult to grow.”
Good one, beowulf. Also starting in the Reagan years depreciating public investment in infrastructure was not matched by new spending on repair, replacement or innovation. US infrastructure is not in good shape as a consequence.
Right, its piss poor that while China spends 9% on GDP (and Europe spends 5%), we only spend 2.5%. We should take capital spending off-budget (there’s your deficit savings right there!) and double it.
We can start by building out a string rail network. )
You might like this post from Michael Roberts – The Great Depression and the war http://thenextrecession.wordpress.com/2012/08/06/the-great-depression-and-the-war/
Also one question – you also at one time quoted someone saying that the President had the power to issue tax credits to be able to buy tanks and planes — who said that and when?
Not exactly, the tax code can only be amended by Congress passing a law. I was referring to the late David Bradford’s hypothetical “weapons supply tax credit” example of how tax expenditures are economically the samevas appropriated spending.
From Michael’s comments above, this feels like one of those tests you take in elementary school, so here’s the answer from a 10 year old: because bond prices have been in a 30 year bull market! ;->
lol. Partial Credit for cleverness.
Over the years, power has shifted in favour or capitalists. In the early 70s and before, workers had higher negotiating power and the rising power led to fast rise in wages which led to accelerating/spiralling inflation.
Near that time, there was near full employment and the Monetarists started hypothesizing the NAIRU nonsense and according to it, the accelerating inflation was due to near full employment rather than due to rising costs. As usual neoclassical economists went wrong.
Instead of recognizing the problem, the Monetarists completely missed the point and also started saying inflation was due to central bankers’ incompetence: not being able to control the money stock. The Monetarist experiments of the late 70s/early 80s completely killed trade union militancy by deflating demand to the point that the resulting high unemployment significantly reduced the bargaining power of workers. Governments liked it because it gave them a smoke screen to take powers from union leaders.
So after that wages have not risen as fast and capitalists got to have a higher share of the national income. So a slower rise in wages has resulted in slower price rise and meanwhile frequent periods of deflation (due to tighter fiscal policy) have resulted in low short term rates which the long term rates follow because long term rates are partly explained by the expectations hypothesis.
Even in periods of no deflation, inflation is low due to all this.
Opening of trade also leads to a bit of cost reduction because firms try hard to compete with foreign firms. So there’s “Death by Renminbi” in the United States.
Also, long term rates are also explained by the “market segmentation theory” or the “preferred habitat theory”. The United States enjoys have its currency as the reserve currency of the world and foreigners have a high portfolio preference for US Treasuries and this also is responsible for low long term yields.
Mike: “The forces propelling bond yields lower over 30 years must be extremely powerful.”
JMK: “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
because the fed funds target rate has been in a 30 year bear market
Ah, yes, of course, since the yield curve is extrapolated from FFR based on market expectation of future Fed action. Inflation was considered “tamed” after Volcker.
My assumption was that Mike meant bond yields for 30 yr tsys currently. You are saying FFRs have been bear over the past 30 years. Why would markets extrapolate that going forward?
I can see how I could have read that wrong though. Otherwise I would agree, but then the question is why have the Fed continued to set them so low.
Did you guy’s see SRW’s post- http://www.interfluidity.com/v2/3451.html
The same reasons the Fed always keeps rates low. Because unemployment has been persistently hight and inflation has been persistently low.
Why has inflation and UE been so high? Probably because the entity designated to maintain low inflation and full employment does not have the tools at its disposal to create such things. So monetary policy has ruled the roost and here we are finally finding out 30 years later that monetary policy isn’t as awesome as everyone once thought.
Along those lines, this was kind of interesting. It’s a link to an early 80s Minneapolis Fed paper questioning whether monetary policy has any effect at all. Via twitter, for a proper h/t and funny comment. Even 30 years ago at least some people were doubting it.
I wouldn’t go so far as to say that monetary policy has NO effect….monetary policy works through credit channels. Given that most of the money in our economy is “inside money” I think it’s silly to say that changing the cost of inside money has no impact on the economy. I think a lot of people are taking the current environment (in which demand for credit is low) to prove a point that confirms a bias (based on their hatred of monetary policy). It’s an extreme take on things in my opinion….
I’ve read that paper at least 10 times. It’s a classic paper. Scott S doesn’t have much of a response to it, I might add.
This exactly the reason and question I answered with my post at the top.
All of your other answers are caused by globalization. And globalization is caused in part by technological progress, so I’ll agree to share the prize money (T-bonds I assume) with jt26….
Isn’t that answer a bit general, Dan? Covers a lot of ground.
As the Austrians would say, it’s all a result of “human action.”
Hmmm. I suppose one would have to include the political forces that combined with the technological forces to break down the trade barriers. But there is no doubt that the Fed reacts to inflation, and inflation has been driven down by global labor arbitrage. Everything else is a result of these fundamentals…
I wouldn’t say only global labor arbitrage but also wage suppression by curtailing domestic labor bargaining power through union busting, for which there is still a strong push from business and on the right politically.
Fair enough. Ending the Cold War was undoubtedly a big factor too. Not only did it give a big lift to “free trade” and to the U.S. as the world’s only remaining superpower, it was also a huge psychological victory for capitalism at the expense of socialism.
Dan: ” it was also a huge psychological victory for capitalism at the expense of socialism.”
That and more. It eliminated the only major competitor. Until then the West had to take socialism into account as a possible alternative so capitalists had to co-opt workers. I remember thinking as the Berlin Wall came down that this would be the result that would develop. The gears had already shifted, e.g., with the breaking of union power and it was only a matter of time before a more aggressive approach would be taken. Right now, the thinking of TPTB is TINA — workers really have no where else to go but to accept the great leveling as Western wages and benefits fall to meet rising wages and benefits in the emerging world, and there is still a whole underdeveloped world waiting in the wings, while technological innovation threatens to reduce the need for human labor, too. Where this trend is leading is yet unclear.
What is pushing the yields on US, UK, Swiss, Danish and Swedish bonds down? The same factor as is pushing the yields up on Greek, Spanish and Italian ones: uncertainty.
If investors don’t have a clue what’s coming they will run for safety for what they THINK might be coming. In this case, they don’t have a clue so they go for the asset classes that are definitely going to at least maintain the nominal values of their capital. That includes the bonds of US, UK, Switzerland, Denmark and Sweden and certainly not the bonds of Greece, Italy, Spain etc.
Keynes nailed the theory of interest 76 years ago: it’s uncertainty and liquidity that decide the rate of interest.
We buried Henry Ford’s wisdom.
Going on over 30 years now, we have shifted production income share from wages to corporate savings; drivers being market saturations (supply coming to exceed demand), off-shoring and outsourcing, automation, and social-political change favoring the capitalist class over the labor class. The shift has caused a growing imbalance in relative supply (increasing) and demand (decreasing). Mitigating factors were the return of women to the workforce and household debt accumulation – with occasional and temporary exceptions, those moderating measures have now been spent. Mitigation of the trend has come also from central govt spending, but is increasingly being limited or forgone as a result of the social-political environment devaluing govt expenditures.
With occasional periods of exceptions, the longer-term of aggregate demand decreasing relative to supply is limiting pressure for corporations to invest in expanding production. Exceptions tend to be measures to gain market share by cannibalizing share of other producers, however the usual increased productivity further weakens wage growth, and in turn, aggregated demand relative to supply.
Combining the lack of investment opportunity (again, derived from stagnant wages and in turn growing imbalance in supply and demand) with related growing economic uncertainties, private savings has been increasingly seeking safe return in govt issued bonds driving rates down in a long-term trend without any change on the horizon.
Select EZ exceptions to higher rates are only temporary reactionary parts of the process of the longer term trend. The trend cannot be reversed until broadly recognized and widely accepted conventional wisdom driving the 30+ year social/political trend is thoroughly rejected. I don’t see that on the horizon.
The rate of interest at any time, being the reward for parting with liquidity, is a measure of the unwillingness of those who possess money to part with their liquid control over it. (Keynes)
Cash has a role as a store of value as well as a medium of exchange. If it is not currently being used for the latter then it will be stored; should it be stored, a certain rate of interest will be necessary to make the buyer part with their liquidity and buy a bond.
It just does not take much currently to entice someone with cash to part with their liquidity.
Agree with Bob Salsa and Ramanan. Supply-side is in the driving seat from early 1980s. Decrease in Real wages forced workers to take on more debt to maintain purchasing power. Both Fiscal (lower taxes) and Monetary policies (easy credit) boosting this to the extreme level resulting in yields falling at an increasing rate.
With the present conditions only this can only be reversed by increasing real wages. Another way is innovations that require specific workers skills that cannot be outsourced and demand higher wages. This puts pressure on corporations to invest in workers (higher wages) to increase production. This is ironic but unless profit margins don’t drop wages will not go higher.
With current policies in place corporations have no desire in investing because thier profits are already higher. FED is helping corporations by letting them speculate and inflate their financial assets. As a result corporations have lot of “cash” on their balance sheets.
Fiscal policy should be to help create new innovations and focus less on saving banks or create new welfare programs. Govt must discourage speculation in Wall Street and Real Estate. Govt should just enforce strict laws and let private sector build more infrastructure (energy, health care, telecommunications) by increasing spending and lowering taxes. This will give innovators a framework to take more risk and invent new industries.
Mike I thought you were planing to write more about Sumner’s NGDP futures? Has he effectively stumped you?
Nope, just been hugely busy. I had to cut back on nearly everything I do in the last 6 weeks and it has not been fun.
Scott is massively evading the questions I’ve raised, and I am not sure he even understands them. It’s sad.
Here is a post where he outlines the major components of his NGDP futures.
I did not respond to these specific constructions because I think they are so badly designed they would not work. He does not realize this, but I gave him the best possible contract design and then pointed out the flaws.
His design has significant flaws. For example, his ideas about margin and then using margins to get people to trade are not very well thought out.
If you notice, what I did was cut off the idea of using the fed as a market maker. Scott is extremely slippery about arguing multiple solutions at the same time, so it becomes like squeezing a balloon – you can’t really change the total volume in the balloon unless you compress the entire balloon at the same time.
My solution to this was to put up a wall in one specific area. It’s no longer possible to consider using the fed as a market maker at least in my scenario, because it’s obvious someone would make hundreds of billions of dollars when the fed makes a mistake – which would happen at some point.
He thinks his little trick with margins will save NGDP futures. Unfortunately, he never bothered to calculate the level of incentive necessary to compensate people for the risk of trading NGDP futures. You’ll notice he says nobody can make hundreds of billions because the margins will be set so high, but then uses lowering the margins to get people to trade these markets.
Its a fun trick – he gets to claim the safety of 10% margins and the incentive of very low margins at the same time. Paying someone above market interest is the same as lowering the margin, right?
Imagine a bond which pays 50% risk free, today, right now. What is the value of this bond? Scott is saying the Fed will sell you a bond like this at a fixed cost. If this bond is worth 150 (example only not real calculation), and you’re only paying 100, you are getting free money.
Apply the logic to putting up margin over a few weeks, and you’ll see paying a high rate of interest on deposited margins is exactly the same as lowering the margin, or perhaps having a negative margin. A negative margin is where you get paid to hold futures contracts.
So the question becomes, what level of incentive is enough? Ha – do the math there and its clear we’re talking bonds with huuuuuuggggee yields.
He just didn’t do his homework on the operational details of financial trading instruments like bonds, margin, and futures.
© Copyright 2011 My Domain · All Rights Reserved ·