Posted by WARREN MOSLER on May 25th, 2009
by Mark Gilbert
May 21 (Bloomberg) —
The odds on the dollar, Treasury
bonds and the U.S. governmentâ€™s AAA grade all heading for the
dumpster are shortening.
True, but for the wrong reason. There is no solvency issue, but markets are pricing it in anyway.
While currency forecasting is a mugâ€™s game and bond yields
canâ€™t quite decide whether to dive toward deflation or surge in
anticipation of inflation, every time I think about that credit
rating, I hear what Agent Smith in the â€œMatrixâ€ movies called
â€œthe sound of inevitability.â€
Several policy missteps suggest that investors should stop
trusting — and lending to — the U.S. government. These include
the stateâ€™s pressure on Bank of America Corp. to buy Merrill
Lynch & Co.; the priority given to Chrysler LLCâ€™s unions over
the automakerâ€™s secured creditors; and the freedom that some
banks will regain to supersize executive bonuses by giving back
part of the government money bolstering their balance sheets.
When you buy treasury securities the government debits your transaction account and credits your securities account at the Fed.
When those securities mature the government debits your securities account and credits your transaction account. That is all there is too it.
There is no solvency issue at the operational level
Currency markets have been in a weird state of what looks
almost like equilibrium for the past couple of months. Whatâ€™s
really going on is something akin to an evenly matched tug of
war that fails to move the ribbon tied around the center of the
rope, giving the impression of harmony while powerful forces do
silent battle until someone slips.
â€œAll currencies are being debased dramatically by their
central banks at extraordinary speeds and so in relative terms
it appears there is no currency problem,â€ Lee Quaintance and
Paul Brodsky of QB Asset Management said in a research note
earlier this month. â€œIn reality, however, paper money is highly
vulnerable to a public catalyst that serves to acknowledge it is
all merely vapor money.â€
The ‘value’ is the purchasing power of real goods and services.
The largest and deepest thing for sale is labor.
Seems like currency still buys labor at pretty much the same price as the recent past,
And maybe even a bit more.
In fact, it may buy a bit more of just about everything vs a year ago. Particularly houses and land.
But yes, next year can always bring a different story.
Why pick on the dollar, though? Well, not necessarily
because the U.S. economy is in worse shape than those of the
euro area, the U.K. or Japan. The biggest problem is that
external investors — particularly China — have more skin in
the dollar game than in euros, yen or pounds, which makes the
U.S. currency the most likely candidate to meet the cleaver in a
crisis of confidence about post-crunch government finances.
China owns about $744 billion of U.S. Treasury bonds in its
$2 trillion of foreign-exchange reserves.
Chinese exports, though, are dropping as the global economy
weakens, with overseas shipments declining 23 percent in
April from a year earlier, leaving a nation that has already
expressed concern about its U.S. investments with less to spend
China doesn’t ‘spend’ it’s dollars on real goods and services which is why they
Have a trade surplus in the first place.
They sold things in exchange for ‘dollar balances’ which are financial assets and
then exchanged some of those balances for alternative USD financial assets as they
accumulated $744 billion of financial assets.
â€˜Heavy Hand of Governmentâ€™
Those kinds of concerns are starting to surface in a
steepening of the U.S. yield curve, driven by an increase in 10-
and 30-year U.S. Treasury yields.
True, though there is no economic imperative for the treasury to issue a 30 year security in the first place.
In fact, the treasury issuing securities and the Fed later buying them is functionally identical to the treasury never issuing them in the first place.
(note that Charles Goodhart of the Bank of England has recently been proposing the UK do exactly that- cease issuing long securities rather than issuing them and having the BOE buy them.)
The 10-year note currently
yields 3.23 percent, about 235 basis points more than the two-
year security, which marks a near doubling of the spread since
the end of last year.
Yes, though from very low flight to quality yields at the height of the fear of oblivion.
â€œWhen the government parks its tanks on capitalismâ€™s
lawns, that spells trouble for those who invest, add value and
create jobs,â€ says Tim Price, director of investments at PFP
Wealth Management in London. â€œTrillion-dollar bailouts do not
only leave massive public-sector deficits in their wake, they
also leave the presence of the heavy hand of government all over
industry and markets, so the outlook for government bonds is
less promising than the economic textbooks on deflation would
have us believe.â€
A totally confused chain of logic, though government does often reduce shareholder value when it intervenes. But that’s a different point.
Earlier this month, the U.S. reported the first budget
deficit for April in 26 years, with spending exceeding revenue
by $20.9 billion, even though thatâ€™s the month when taxpayers
have to stump up to the Internal Revenue Service and the
governmentâ€™s coffers should be overflowing. So far this fiscal
year, the U.S. shortfall is $802.3 billion, more than five times
the $153.5 billion gap in the year-earlier period.
Those are the ‘automatic stabilizers’ at work, which, fortunately, are out of the hands of
Congress. While they work the ugly way- falling employment and rising transfer payments- they do work to restore net financial assets to the private, non government sectors and thereby reverse the contraction.
Budget deficits = non govt ‘savings’ of financial assets
To the penny
It’s even an accounting identity. Not theory. Ask anyone at the CBO.
For the fiscal year ending Sept. 30, the Congressional
Budget Office forecasts a record deficit of $1.75 trillion,
That includes the purchase of financial assets which doesn’t add to aggregate demand.
Up until now the fed has always bought the financial assets when government wanted to do that and that hasn’t ‘counted’ as deficit spending for exactly that reason.
This time around the treasury bought financial assets and confused things, much like 1936 when social security first started and was accounted for off budget rather than consolidated as we quickly figured out was the right way to do it and it’s fortunately been done that way ever since.
almost four times the previous yearâ€™s $454.8 billion shortfall
and about 13 percent of gross domestic product. Bear in mind
that the target demanded of European nations wanting to join the
euro was a deficit no greater than 3 percent of GDP.
Yes, which is responsible for their poor economic performance as well.
David Walker, a former U.S. comptroller general,
And foremost US deficit terrorist
the Financial Times on May 12 that the U.S.â€™s top credit rating
looks incompatible with â€œan accumulated negative net worthâ€ of
more than $11 trillion and â€œadditional off-balance-sheet
obligationsâ€ of $45 trillion. â€œOne could even argue that our
government does not deserve a triple A credit rating based on
our current financial condition, structural fiscal imbalances
and political stalemate,â€ he wrote.
As if government payments are operationally constrained by revenues.
They are not, as chairman Bernanke made clear a few weeks ago
when he explained how he makes payments by changing numbers in bank accounts.
That is the only way there is for government to spend in its own currency, which
is nothing more than the process of making spread sheet entries on its own books.
Any constraints on the US ability to make payments in dollars is necessarily self imposed (and
can just as readily be removed by those wanting to spend the money.)
Said another way, government checks don’t bounce unless government decides to bounce its own checks.
If you want to claim govt won’t pay because it will vote not to pay, fine.
But not because ‘deficits can’t be financed’ or any other nonsense like that.
It is undeniable that the U.S. governmentâ€™s ability to
finance its borrowing commitments has deteriorated as its
deficit has ballooned.
The ability to deficit spend is the ability to make entries on its own spreadsheets.
The idea that that can ‘deteriorate’ indicates a fundamental lack of understanding of monetary operations.
Dropping the U.S. from the top rating
grade, though, wouldnâ€™t mean the nation is about to default on
its debt obligations; thereâ€™s a subtle distinction between
ability to pay and propensity to fail to pay.
And a less subtle distinction between knowing how it works and not knowing how it works.
Thereâ€™s also a
compelling argument that no government should be enjoying the
benefits of a top credit grade in the current financial climate.
There’s nothing to ‘enjoy’ or even care about.
Note Japan was heavily downgraded with a debt to GDP ratio triple the US,
With no ill effects as three month rates remained near 0 for the last
15 years and 10 year Japanese govt bonds fluctuated between .5 and 1.5%
Using the definitions outlined by Standard & Poorâ€™s, a one-
step cut into the AA rated category would nudge the U.S.â€™s
creditworthiness into a â€œvery strongâ€ capacity to fulfill its
commitments, just weaker than the â€œextremely strongâ€
capabilities demanded of AAA rated borrowers.
S&P cannot change the actual creditworthiness of the US, or any other
issuer of its own currency. There can be no solvency issue no matter what they do.
That seems an
appropriately nuanced sanction — albeit one that the rating
companies might turn out to be too cowardly to impose.
(Mark Gilbert is a Bloomberg News columnist. The opinions
expressed are his own.)