Doug Noland: Short-Term Unsustainable

Michael Bond Comments:

New Treasury Secretary Yellen said, “…even though the amount of debt relative to the economy has gone up, the interest burden hasn’t.”

This is one of the most dangerous and dishonest false narratives of our times. The interest rate burdened was relieved for debtors and speculators… and transferred to savers and pensions which are being drained of wealth to keep the financial bubbles growing.

We had policy failure that led to the first financial crisis that expanded in response to the financial damage and has led us to the current papered-over financial crisis. The stock market is broken – there should be no debate. Either the financial system needs to be allowed to collapse while protecting the economy, or it is all going to go at some point.

I don’t see that policy coming.

My last statement requires understanding that the financial system is not the economy. They have not been directing “stimulus” to the economy for most of the last 12 years, but to repairing a corrupt financial system then blowing even larger bubbles.

If only they had designed 11 fiscal-monetary programs to bypass wall street to assist the economy instead of 11 money-printing programs to pre-bailout the financial system during this stock market mania.

We are in the end-game. The damage is now bleeding over into our money system. Policy will decide the winners and losers. It will be decided soon. I vote economy over financial. It has to be one or the other at this point.

Austerity is lose-lose.


Short-term Unsustainable

by Doug Noland

Outstanding Treasury Securities began 2008 at $6.051 TN, or 41% of GDP. Treasuries ended 2019 at $19.019 TN, or 87% of GDP. And then, in only three quarters, Treasuries surged another $3.882 TN to $22.900 TN, or 108% of GDP. We must wait a few weeks for the Fed’s Q4 Z.1 report, but the federal government posted a fiscal deficit of $573 billion during this period, likely pushing outstanding Treasuries to near $23.5 TN, or about 110% of GDP. Since the end of 2007, Treasuries have inflated around $17.5 TN – approaching a three-fold increase.

For years now, I’ve listened as Washington politicians and central bankers admit to the obvious – that the trajectory of our federal debt is unsustainable – while invariably arguing it was not the time to be concerned or address it. With Treasuries blowing right through the 100% of GDP milepost – and likely poised to reach 125% within the next year or two – there’s no time like the present to recognize our nation is in serious fiscal trouble.

Senator John Thune (from Yellen’s confirmation hearing): “I’m going to try and roll a lot of thoughts and questions into sort of one big package here. But the one thing that concerns me that nobody seems to be talking about anymore is the massive amount of debt that we continue to rack up as a nation. And, in fact, the President elect has proposed a couple trillion dollar fiscal plan on top of that which we’ve already done – which would add somewhere on the order of about $5.3 trillion to deficits and that’s according to the committee for responsible budget of which you have been a board member.

That’s 25% of GDP, and it would move the additional debt above 100% debt to GDP – which is a category that we haven’t been in literally since the 1940s. And, so, what I’m concerned about is we seem to have no concern now about borrowing money in the short-term, and the argument is that interest rates are low. It’s like free money. It’s not. It has to be paid back.

And at some point, the risk/return ratio, that people who are lending us money are going to say, is not sufficient for the risk, and they’re going to demand a higher interest rate. That will happen at some point. Interest rates will start to normalize, and we have to refinance at a higher interest rate. And pretty soon the interest on the debt exceeds what we spend on even national security for our country.

Republicans traditionally have believed that we ought to reduce spending, we need to reform entitlement programs, that we need to have policies in place that create greater growth in the economy. All of which make the debt look smaller by comparison. Democrats have argued we need more revenue, more taxes…

But I just want to know what you think. Because I know in the past you’ve expressed concerns about the debt and the deficit. The two previous administrations have not been very interested in entitlement reform. We have not only the debt that we’re adding in the short-term because of the pandemic, but we have structural problems that are long-term that are going to continue to drive that debt higher in the future.

What are your thoughts with respect to reforming entitlements? With respect to the amount of the debt situation that we find ourselves in right now? And when is it enough? When is it too much? When do we hit that point where the thing starts to collapse? That’s what really concerns me. And nobody is talking about it really in either party anymore. It was something that used to occupy a lot of our discussions in the past, but nobody seems to care much about it.

And, for me, that is a huge warning sign on the horizon. The fact that we have an ever-growing deficit, an ever-growing debt and no apparent interest in taking the steps that are necessary to address it.”

Janet Yellen: “Senator, I agree with you that it’s essential that we put the federal budget on a path that’s sustainable. And that we’re responsible and make sure that what we do with respect to deficits and debt leave future generations better off. But the most important thing, in my view, that we can do today to put us on a path of fiscal sustainability is to defeat the pandemic, to provide relief to American people. And then to make long-term investments that will help the economy grow and benefit future generations.

To avoid doing what we need to do now to address the pandemic and the economic damage that it’s causing would likely leave us in a worse place fiscally and with respect to our debt situation than taking the steps that are necessary and doing that through deficit finance. We really have to worry about scarring due to this pandemic, of workers and the loss of small businesses that can really harm the long-run potential productivity of our economy and leave us with long run problems that would make it difficult to get back on the growth path that we were on.

And it’s really critically important to provide this relief now. And I believe it would be a false economy to stint. But over the longer term, I would agree with you that the long-term fiscal trajectory is a cause for concern. It’s something we will eventually need to attend to, but it’s also important for America to invest and invest in our infrastructure, invest in our workers, invest in R&D. The things that make our economy grow faster and make it more competitive and it’s important to remember that we’re in a very low interest rate environment. And that’s something that existed before the pandemic hit: interest rates were low even before the financial crisis of 2008. This has been a trend in developed economies, you can see it across the developed world, and it represents structural shifts that are likely to be with us a long time.

So, although the debt to GDP ratio has increased, it’s important to note that the interest burden of the debt – interest as a share of GDP – is no higher now than it was before the financial crisis in 2008 in spite of the fact that our debt has escalated. And, of course, interest rates can increase. Eventually we have to make sure that primary deficits in the budget are sufficiently small – that we’re on a sustainable path. But right now, our challenge is to get America back to work and to defeat the pandemic.”

The new administration’s view that Washington needs to be “on war footing” to win the battle over a once-in-a-century pandemic is understandable. The unemployment rate is currently 6.7%, businesses are failing, and there is even serious food insecurity in the U.S. For some perspective, the unemployment rate averaged 6.5% during the 20-year period 1980 to 1999.

This has been a terrible human tragedy, though there is light at the end of the tunnel. Millions of individuals and businesses are suffering mightily for no fault of their own. It’s terribly unfair, it sickens us, and as a nation we want to do what we can to rectify this injustice. Meanwhile, we are on trajectories that ensure a future crisis with an even greater percentage of our population suffering mightily for no fault of their own. Dismissive talk of an unsustainable long-term debt trajectory disregards myriad frightening short-term trajectories – Fed assets, federal debt, system Credit, “money” supply, stock prices, option trading volume, etc.

The pandemic is not close to my greatest worry. These days I have greater fear for the runaway Credit Bubble. I worry about the mania that has enveloped the stock market. I fear consequences of a historic debt crisis in already contentious social and geopolitical backdrops.

February 2, 2012 – Politico (Josh Boak): “Federal Reserve Chairman Ben Bernanke told a congressional panel Thursday that shrinking the deficit ‘should be a top priority,’ saying that spending projections over the next decade are ‘clearly unsustainable.’ Stressing that the budgetary threat did not emerge from the past three years alone of $1 trillion-plus budget deficits — with a fourth expected for 2012 — meant to ease the recession and aid the recovery, Bernanke warned the debt could explode over the next 20 to 30 years to levels that could paralyze the economy. The government faces an aging population, fast-rising health care costs, and a failure to close the gap between taxes and spending.”

Between Bernanke’s 2012 “clearly unsustainable” comment and the end of his chairmanship in early 2014, the Fed expanded its balance sheet by over $1 TN. The Yellen Fed added another $1 TN in 2014 – to $4.47 TN – fateful monetization in a non-crisis environment. Importantly, the Fed and global central bankers fundamentally altered market function. Treasury yields, for example, became divorced from expanding federal deficits. The Federal Reserve essentially granted Congress a blank checkbook, and the world will never be the same.

A critical issue gets zero attention these days: The pandemic struck as our nation – much of the world – was at a dangerous late-stage in a historic Bubble. We could not have been more poorly positioned. Washington will add in the neighborhood of $6 TN of debt over a couple years – part pandemic but much in response to Bubble Economy structural fragility. The Fed will expand its balance sheet upwards of $5 TN in a two-year period – part pandemic but more to sustain an increasingly erratic financial bubble. Egregious Monetary Inflation ensures Financial Bubble and Bubble Economy fragilities grow only more acute.

We’re in the throes of the greatest monetary inflation in U.S. history. Things have come home to roost – we just haven’t realized it yet. Fed liquidity is masking deep structural impairment, while Trillions necessary to stabilize a fragile Bubble Economy only push the runaway financial Bubble to more precarious extremes.

Traditionally, it was Federal Reserve doctrine to “lean against the wind” to at least ensure monetary policy was not exacerbating excess. The Fed some years back proclaimed it would not use rate policy to contain asset inflation and bubbles, choosing instead so-called macro-prudential measures. So how is our central bank reacting these days to such conspicuous excess: Well, it’s radio silence as they continue to pump $120bn of new liquidity monthly.

For too many years the Fed was content to disregard asset inflation and bubble dynamics. The fixation on tepid consumer price inflation has lacked credibility. The reemergence of “global savings glut” nonsense has been pathetic “analysis,” especially as unparalleled speculative leverage ballooned around the globe. The Fed was determined to sit back and keep financial conditions ultra-loose year after year, as if this would not promote historic debt growth, speculative excess and structural impairment.

Comments from Yellen and others suggest that low rates conveniently push potential debt instability far out into the future. Yet the problem is here and now; it’s acute – and the coronavirus is not the most pressing problem. The stock market mania is raging out of control. Debt growth is spiraling out of control. The Fed and global central banks are trapped in desperate inflationism. The Fed is poised to expand its balance sheet – add liquidity – to the tune of $1.5 TN this year with no regard for rampant asset price inflation and Bubbles. The trajectory of too many key metrics has gone parabolic, ensuring tremendous systemic damage is inflicted in a short period of time. And now the new administration has control of the blank checkbook and is determined to us it.

A day trader’s mentality has taken over our nation. There’s no long-term thinking or planning; everything is short-term focused. Ultra-loose financial conditions are supporting economic recovery. And while there are superficial short-term benefits, the costs to longer-term system stability are momentous. Washington is gambling with our nation’s future.

We’re witnessing today the consequence of the Fed and Washington’s disregard for asset inflation and Bubbles. At this point, aggressive stimulus is self-defeating. Zero rates stoke speculative excess in equities and corporate Credit. QE feeds liquidity into market Bubbles. Massive fiscal deficits inflate corporate earnings (and traders’ on-line accounts), while becoming instrumental to the bullish narrative and mania.

I wish the Biden administration nothing but success. I hope Yellen is right, because the next four years are critical for our nation. Our government today confronts major crises – the pandemic, unemployment, inequality, divisiveness and social instability, global competitiveness, climate change, mounting geopolitical risk and more. They have an aggressive agenda, and I would expect nothing less. And I don’t fault the administration for believing they will operate free of fiscal constraints.

I just can’t get over my fear that Washington is exacerbating the greatest risk to our nation’s future. M2 “money” supply has inflated a shocking $4.0 TN in 46 weeks – or 32% annualized. We’re witnessing the greatest monetary inflation the country has ever suffered – with nary a protest. The Credit Bubble is inflating the fastest ever. Arguably, stock market speculation is the most precarious since 1929. We’re witnessing the greatest redistribution of wealth in our nation’s history.

And when this Bubble eventually bursts, we’ll confront the terrible reality that the greatest expansion of non-productive debt ever fueled history’s greatest destruction of wealth.

Yellen: “The smartest thing we can do is act big. In the long run, I believe the benefits will far outweigh the costs.”

I hate being this pessimistic. But in no way do the long-term benefits of massive deficit spending today outweigh the cost. Current market and economic structures ensure resources are poorly utilized. The securities markets are today a powerful mechanism for resource misallocation and wealth-destruction. And I see Trillions of deficit spending generating limited sustainable economic benefit. Meanwhile, “acting big” will further fuel “Terminal Phase” excess, with terrible long-term consequences.

Yellen: “Well before COVID-19 infected a single American, we were living in a K-shaped economy, one where wealth built upon wealth while working families fell farther and farther behind.”

This “K-shape” is fundamental to Bubble Economy structure and a key manifestation of inflationism and resulting Monetary Disorder. As we’ve witnessed now for going on 10 months, throwing massive stimulus at the current structure exacerbates both Bubble excess and inequality.”

Yellen: “The world has changed. In a very low interest-rate environment like we’re in, what we’re seeing is that even though the amount of debt relative to the economy has gone up, the interest burden hasn’t.”

History will not be kind. A $3 TN plus annual deficit in the past would have been recognized as foolhardy if not negligent. It’s playing with fire. Washington has pushed things much too far – the most extreme debt growth and the most extreme Federal Reserve debt monetization. We’re witnessing an unprecedented late-cycle runaway expansion of risky non-productive debt – too much of it held by leveraged speculators. Market backlash is inevitable and overdue. I just don’t see market forces remaining inoperative indefinitely – supply and demand will matter again. The quantity and quality of system credit will prove momentously important.

Bloomberg: “‘The most important thing we can do is to defeat the pandemic, to provide relief to American people and to make long-term investments that make the economy grow and benefit future generations,’ said Yellen… Failure to address the crisis now ‘would likely leave us in a worse place fiscally,’ she said.”

The most important thing for our nation is to see a return to some semblance of fiscal and monetary sanity. I’m all for sound long-term investment, something our nation desperately needs. I’m not sure what we have to show for the $17 TN of Treasury debt accumulated since the last crisis. And it’s inexcusable that we came into the pandemic in such a fragile position – fiscally and in terms of the financial Bubble.

My biggest fear is materializing. When this historic Bubble bursts, a major crisis will unfold with our nation’s finances in complete shambles. The Fed’s “money printing” operation has gone parabolic as it desperately attempts to sustain an unsustainable Bubble. Treasury debt growth has gone parabolic as Washington tries to sustain an unsustainable economic structure. The system is on a trajectory that ensures a crisis of confidence – and I don’t see this as some long-term concern. This is an issue of short-term sustainability.

Washington has employed massive fiscal and monetary stimulus despite ultra-loose financial conditions and booming markets. The big crisis commences – the unsustainable is no longer sustained – when financial conditions tighten and the financial Bubble bursts. The time for “acting big” is in a post-Bubble backdrop and definitely not while the Bubble is inflating madly.

Original Post 23 January 2021


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