I'm serious. In a world where mortgage debt is backed/underwritten/guaranteed by the federal government, and mortgage interest rates are suppressed to an acceptable level by the federal reserve, mortgage debt loses most of the characteristics that once distinguished it from a government bond. Sure, it has refinancing risk and odd maturity calculations and all that, but when push comes to shove, the risk and payoff has effectively converged with government debt. That was part and parcel of the fed's plan to blow home prices back up to their previous bubble level. Remember, asset prices rising faster than the cost of funding those assets; it's a keystone to modern fed policy. Unfortunately, a brief consideration will soon convince any sentient lender that they're be better off holding the asset than the debt, so it's not a sustainable state.

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I can not agree with the default portion, not because I don't think its a possibility, but because I think eventually some action would have to be taken

Once again, we diverge from the point being discussed. I say default would have happened without QE, you say eventually some action would have to be taken. I'm not disputing that something would have been done eventually, I'm saying that other than monetizing debt, there was no alternative but default. Cumulative government deficits (not just ours) over the next few years would have approached the size of the entire money supply. The funding for an adequate level of fiscal stimulus did not exist, not in a world where economies were left to the vagaries of a banking collapse.

Two choices, print or default and those will be our choices next time too. So what should have been done? I don't know, but I do know that the aftermath of this round of stimulus will be worse, because more unproductive debt has been created, and the debt is still growing faster than the economy. But now the central banks are the ones holding risk assets, and the eventual demise of their balance sheets and subsequent currency collapse will be an unprecedented human catastrophe.

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Carry trades happen and correct over time

These carry trades will correct in a snowball of bond market failures. The JGB market is moribund, owned and controlled by the BOJ and some lackey pension funds. Almost half of Japan's annual budget is deficit spending and they no longer have a trade surplus to finance it. To top it off, they're extremely dependent on external energy. When will it fail; I have no idea but the result will be a carry trade tsunami that sloshes around world.

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How did foreign debt have any part of the asset bubble?

The BOJ was trying to weaken the yen vs the dollar, in order to maintain exports. Rather than let export based dollars flood back out into the FX market, the BOJ absorbed the dollars and used them to buy US Treasuries. In the process, they inflated the domestic money supply and kept interest rates too low. The result, as expected, was a destructive inflationary asset bubble.

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How is the US "hollowed out"? Refer to my points on the US above. Also the US has the ability to be a net importer due to our overall economic strength which in turn benefits all of these other countries that are able to increase their wealth and advance their domestic economies.

Of course it's hollowed out. We consume more than we produce, and have for decades. We spend more than we earn, and have for decades. We ship jobs overseas and treat the resulting unemployment with social programs financed by debt. We burn foreign oil and pay with freshly minted greenbacks. This is "Decline and Fall of the Roman Empire: Beyond Thunderdome". Do you really think foreign governments see this as increasing their wealth, lending us money to buy their stuff and then we pay them back with by increasing our money supply? I think they're just waiting for whatever moment best suits their interests to blow the whole thing up.

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Keyens said you had to tighten policy as things get better and loosen when things get worse. How is that not what we're doing this and next year?

We've run a budget deficit every year since 1970 or thereabouts. Continuous fiscal stimulus. Despite that rising debt, public/private debt compounding 3% faster than the nominal GDP since the early 80's by my calculations, the federal reserve has lowered interest rates steadily since Volcker started cutting in about 1982. Minor fluctuations around a very steady decline. Continuous monetary stimulus. This fiscal year we'll run a half trillion dollar budget deficit, 5 years into a "recovery", and interest rates are still below the rate of inflation. Every cycle is more extreme. Next time we'll run $5 T dollar deficits and celebrate when it dips back to $2 T.

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And why do you keep saying interest rates will stay at zero/depressed forever? The Fed has already hinted many times next year they will likely start raising rates.

I say that because I've looked at the debt numbers. Almost $18 T federal, another $4 or $5 T state and local. Another approximately $40 T of debt in various other sectors. Housing prices that are too extreme for the average buyer, except at subsidized below market interest rates. At every cycle peak since the mid 80's, our economy has tanked at a lower peak interest rate. At every trough it takes lower rates to get it started again. Too much debt. We can't tolerate higher real interest rates, it blows up the economy. It will this time too, or they'll just never allow rates to rise and inflation will eventually spiral out of control.

Don't get me wrong, I don't think the US is headed for 2nd tier status. I think all the tiers are headed for rubble status.

This post was edited on 9/11/14 at 11:59 pm

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Posted by wdhalgren

Member since May 2013

3059 posts

Posted on 9/11/14 at 11:44 pm to wdhalgren

I'll give you my final thoughts and let it rest. Over the long term, debt for consumption is not sustainable, because it does not produce a positive ROI. Instead, it has to be paid for with lower future consumption. Debt for production can, if used wisely, pay for itself, but artificially suppressed interest rates and moral hazard (bailouts) lead to unwise debt even in the productive sector.

We have ventured far from a sustainable debt model, over many decades. All the excess debt fueled consumption will be followed by a long period of reduced consumption and that will wreak havoc on a consumption based economy. Attempts to thwart that correction will cause currency destruction on a widespread scale.

This post was edited on 9/11/14 at 11:56 pm

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Posted by BennyAndTheInkJets

Middle of a layover

Member since Nov 2010

5611 posts

Posted on 9/12/14 at 3:51 pm to wdhalgren

I'm just going to focus on the market points here since we're going to disagree ideologically, and I don't want to play too much in extrapolated hypotheticals because it's the equivalent of debating religion and morals. Much of what you're saying is either prediction oriented or ideological.

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I'm serious. In a world where mortgage debt is backed/underwritten/guaranteed by the federal government, and mortgage interest rates are suppressed to an acceptable level by the federal reserve, mortgage debt loses most of the characteristics that once distinguished it from a government bond. Sure, it has refinancing risk and odd maturity calculations and all that, but when push comes to shove, the risk and payoff has effectively converged with government debt

If you're making the argument that the credit profile is the same for Agency MBS as it is for Treasuries, then yes I can agree with you there as long as Fannie/Freddie are under conservatorship. However, the similarities in your risk profile stop right there. You don't have prepayment/extension risk in Treasuries which greatly changes your payout, nor do you have optionality and negative convexity which greatly changes your interest rate risk given yield curve movements. From a very, very, very basic credit risk standpoint you can make the argument of similarity, but that's it.

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Once again, we diverge from the point being discussed. I say default would have happened without QE, you say eventually some action would have to be taken. I'm not disputing that something would have been done eventually, I'm saying that other than monetizing debt, there was no alternative but default.

Yes there was, austerity. If you want to make the argument that would lead to default that would have credence, but then again were making an assumption in the land of hypotheticals and flying to the land of extrapolated hypotheticals. If not a single country added stimulus, or began austerity programs, I think there would be political/economic negotiations that would lead to some "technical" defaults but not a collapsing default. It's very, very difficult for a country to just completely collapse.

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The BOJ was trying to weaken the yen vs the dollar, in order to maintain exports. Rather than let export based dollars flood back out into the FX market, the BOJ absorbed the dollars and used them to buy US Treasuries. In the process, they inflated the domestic money supply and kept interest rates too low. The result, as expected, was a destructive inflationary asset bubble.

The BOJ has ALWAYS tried to weaken the yen with various maneuvers including the ones you mention, and a gigantic asset has only happened once because of the factors I laid out previously. Those factors spawned from the high yen recession following the Plaza Accord, but again I don't want to stray off point here.

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Of course it's hollowed out. We consume more than we produce, and have for decades. We spend more than we earn, and have for decades.

That in no way means we're "hallowed out". Again, refer back to the characteristics of the US I laid out earlier that far surpasses any other country.

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We've run a budget deficit every year since 1970 or thereabouts. Continuous fiscal stimulus. Despite that rising debt, public/private debt compounding 3% faster than the nominal GDP since the early 80's by my calculations, the federal reserve has lowered interest rates steadily since Volcker started cutting in about 1982. Minor fluctuations around a very steady decline. Continuous monetary stimulus.

Budget deficits in itself are not a bad thing as long as they are at a manageable ratio to GDP. Is it sustainable to run it around 10% of GDP like 2009 or 30% of GDP like 1943? Absolutely not, but around the long run average of 2-3% of GDP combined with 2% inflation is a very manageable situation. If you're using 1982 as your relative starting point then yes, I guess you can say we have been easing for a long time, but to ignore intermediate trends and only focus on the primary trend when these intermediate trends are 3-5 time spans dilutes what was actually happening.

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This fiscal year we'll run a half trillion dollar budget deficit, 5 years into a "recovery", and interest rates are still below the rate of inflation. Every cycle is more extreme. Next time we'll run $5 T dollar deficits and celebrate when it dips back to $2 T.

And this half trillion deficit will be in the manageable 2-3% of GDP range.

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Every cycle is more extreme. Next time we'll run $5 T dollar deficits and celebrate when it dips back to $2 T.

Again, absolute levels tell you nothing. Have to look in proportion.

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I say that because I've looked at the debt numbers. Almost $18 T federal, another $4 or $5 T state and local. Another approximately $40 T of debt in various other sectors. Housing prices that are too extreme for the average buyer, except at subsidized below market interest rates. At every cycle peak since the mid 80's, our economy has tanked at a lower peak interest rate. At every trough it takes lower rates to get it started again. Too much debt. We can't tolerate higher real interest rates, it blows up the economy. It will this time too, or they'll just never allow rates to rise and inflation will eventually spiral out of control.

Your numbers are a little off but that's besides the point. Very high supply of debt would cause interest rates to rise from a supply/demand perspective. If your argument is that central banks will be forced to keep rates low because of debt loads, I completely disagree.

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