Yield Myths

Paul Krugman has a post up about interest rates which I think requires a bit of elaboration.  He says:

“Low interest rates on the bonds of just about every country that still has its own currency have created a small industry of would-be explainers. It’s a bubble; no, it’s the global shortage of safe assets; no, it’s “disaster economics“.

Maybe there’s some truth to some of these stories. But surely the dominant story is very simple: it reflects market perceptions that the economy is going to be depressed for a long time. As I’ve argued before, you really want to look at Japan, which exhibited this syndrome at a time when there was clearly no shortage of safe assets and few were talking about disaster”

I think that’s largely correct.  But there’s an important element that I think Dr. Krugman is missing here.  If one understands the Contingent Institutional Approach laid out by MR then you understand the complex relationship between the Fed, Treasury and the Primary Dealers.  You understand how the Treasury, a currency user, can always fund its account by using the Primary Dealers as funding agents.  You also understand how the Fed works in a symbiotic relationship there to essentially guarantee the funding backstop.  In other words, the US Treasury can never “run out of money” because the Dealers are required to bid at auctions and the Fed can always theoretically step in to buy the bonds if necessary.

But this is a hugely important point when understanding why controlling your own currency is so important.  Why?  Because there are no bond vigilantes in the USA to send yields shooting higher.  That’s because the risk of a solvency crisis has been eliminated by institutional design.  Bondholders in the USA understand this and continue to feed at the trough of US bond auctions because the Fed and Treasury are constantly in their ear saying “here, take these free profits, we guarantee we’ll always be good at maturity!”.  And so they buy and buy.  And in a period of low growth, low inflation and uncertainty the buyers are fighting tooth and nail to get a good position at the trough.

About

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering asset management, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

View all posts by

Leave a Reply

7 Comments on "Yield Myths"

Notify of

Guest
JP Koning
5 years 12 days ago

“That’s because the risk of a solvency crisis has been eliminated by institutional design.”

What do you think about the many currency-issuers in Latin American, Africa, and Asia who have defaulted on their sovereign debt? Evidently they ran out of money somehow.

Guest
5 years 12 days ago

Inflation. See quantity value in the MR primer. Countries don’t run out of money. They run out of productive actors or implement incompetent policy….

Guest
Dunce Cap Aficionado
5 years 23 days ago

Also, this is a question I’ve always had but I doubt there’s an answer we’ll ever know-

When Nixon closed the gold window, did he (or is staff/advisors, or whomever) know exactly what they were setting up? Or did they just kind of have an idea that for reasons x,y,z it was ‘better’ than the gold standard and we end up where we are told with the relationship between Treasury, CB & PDs.

Guest
beowulf
5 years 21 days ago

No.
He had a first rate Tsy Secretary in John Connally (who Nixon wanted to see become the next President) urging him to pull the trigger, but I doubt either had thought through all of the ramifications like they were Michael Hudson or something.
http://pragcap.com/greece-the-first-of-the-dominoes/comment-page-1#comment-75467

Guest
Dunce Cap Aficionado
5 years 19 days ago

Thought I’d put this here for anyone who might be interested; link to super imperialism-
http://www.soilandhealth.org/03sov/0303critic/030317hudson/superimperialism.pdf

Guest
Dunce Cap Aficionado
5 years 20 days ago

Danka

Guest
Dunce Cap Aficionado
5 years 23 days ago

What was the bid to cover the other day? 4?

wpDiscuz