Matt Yglesias’s Very Bad, No Good Idea for Perpetual Government Bonds

Matt Yglesias in SlateDon’t Repay the National Debt – It’s time to revive a British financial innovation from the 18th century: perpetual bonds.

In 1752, Prime Minister Henry Pelham converted the entire outstanding stock of British debt into consolidated annuities that would become known as consols. The consols paid interest on an annual basis just like regular bonds, but with no requirement that the government ever redeem them by repaying the face value. Pelham created the bonds in order to reduce the government’s annual debt service costs. That isn’t our problem today. Instead, a modern-day consol would target another problem: political reluctance to take advantage of record-low interest rates.

As of Friday, the inflation-adjusted yield on 10-year Treasury bonds was negative 0.56 percent. Savers, in other words, want to pay the American government for the privilege of safeguarding their money. For the longest-dated bonds we sell, the 30-year Treasury bond, rates were 0.51 percent. That’s higher than zero, but far below the long-term average economic growth level. A sensible country would be taking advantage of that fact to finance some valuable public undertakings. Alternatively, if we think there’s nothing worth spending money on we could enact a big temporary tax cut aimed at reducing the unemployment rate and boosting the population’s skill level. Prolonged long-term unemployment, after all, has lasting effects that reduce the efficiency of the labor market and make it much harder to grow in the long term.

The first reason problem with Yglesias’s idea is that he thinks we should borrow money. We’ve been borrowing over a trillion dollars a year and the economy is still in the basement. We just had a quarter with negative GDP. If borrowing and spending worked it would have worked by now. As it is, we’re getting a negative return on government spending and the ratings agencies have already downgraded our credit rating once.

Then there’s the finance issue. There’s a yield curve on Treasuries. You can buy Treasuries in durations ranging from short term (1 month, 2 month, etc.) to long term (10 and 30 years). Treasuries with longer durations pay higher interest rates.

Yglesias glosses over that by expressing 10 and 30 year Treasury prices in terms of real interest rates – interest rates minus inflation. While real interest rates are a meaningful number, they also obscure the difference in interest rates. Currently the 10 year pays 2.03% and the 30 year pays 3.18%, or about 50 percent higher. If the yield curve went to infinity, investors would expect returns much, much higher than on the 30 year.

Third, does Yglesias think he’s the first person to notice that yields are at historic lows? Investors are still buying short- and medium duration Treasuries at low interest rates because they’re a safe haven. They’re not enthusiastic about long-dated Treasuries with pitiful returns. In fact, it’s the Federal Reserve buying those long-dated Treasuries as part of Operation Twist to mop up the excess in long-dated Treasuries and drive down interest rates.

Finally, there’s a huge, huge difference that Yglesias overlooks. If investors aren’t getting their original principal back, they will have to charge much, much higher interest rates.

Here’s why. Imagine I borrow $1,000 from you. If I promise to pay back the money in a year you might charge me 5% interest. Within one year you’ll get the original $1,000 principal back plus the $50 in interest. Now imagine I say I’ll never pay back the principal, but will just pay interest perpetually. Under the first plan you’ll get $1,050 from me in 1 year. Under the second plan with interest only it will be 21 years before I repay the same $1,050.

It’s pretty darned obvious that under the second plan you’ll have to charge a lot more vig. Besides the time value of money, you have to factor in the erosion of the real value of payments due to inflation over 21 years. Too, the longer I keep your money the greater the risk I’ll duck out on the payments. The fact that banks don’t offer interest-only loans for the life of the loan (as opposed to a brief introductory period) is a clue that interest-only loans are a bad idea for investors.

A consul-like debt instrument would also incentivize the government to foster inflation, which would make the government’s debt payments easier while diminishing the investor’s real returns.

US Debt to GDP Passes 101%

Zero HedgeAs US Debt To GDP Passes 101%, The Global Debt Ponzi Enters Its Final Stages

Most people still think of China as buying our debt, but China is unloading U.S. debt.

The biggest buyer of U.S. debt is … the U.S. And not retirement funds and investment firms. The biggest buyer of U.S. debt is the U.S. Federal Reserve, AKA the people who print the little green pieces of paper in your wallet with dead presidents on them. They buy U.S. debt and pay for it with money they print out of thin air. What could possiblie go wrong?

Zimbabwe saying you have a printing problem …

is like Charlie Sheen saying you have a drinking problem:

Topping off a weekend of surreal news is the announcement from the Central Bank of Zimbabwe that the country is now evaluating introducing a gold-backed Zimbabwean dollar, and, in keeping with the Salvador Dali feel to the past 48 hours, that the “days of the US dollar as the world’s reserve currency are numbered.” Yes. Zimbabwe, the same place that two years ago sported a brand new crisp Z$100 trillion bill. What is just as odd is that this news comes less than a week after Iran’s President Mahmoud Ahmadinejad criticized US economic policies, saying that the paper currency created by the American government is taking a heavy toll on the global economy. While Zimbabwe, which now transacts almost exclusively in foreign currencies such as the USD and the South African Rand, is actively considering ways to return its own currency into circulation, the man who has up to now served as an inspiration and a role model to Ben Bernanke, Gideon Gono, said the country should consider adopting a gold-backed currency.

The other part of the weekend’s surreal news was the head of the IMF getting arrested for sexual assault in New York.


Fill in the Blank

Newsweek Notices Inflation,

NewsweekThe Great Inflation of the 2010s:

And the reason the CPI is losing credibility is that, as economist John Williams [of] tirelessly points out, it’s a bogus index. The way inflation is calculated by the Bureau of Labor Statistics has been “improved” 24 times since 1978. If the old methods were still used, the CPI would actually be 10 percent. Yes, folks, double-digit inflation is back.

PreviouslyMainstream Media Taking Notice of Inflation,

Is the Fed Buying Puts on US Treasuries?

Seeking AlphaIs This What Hyperinflation Looks Like From the Inside?:

Some have speculated that the Federal Reserve is writing (selling) puts on Treasuries to keep rates low. As Frederick Sheehan notes, “the Fed-sponsored put option is the logical next step to dampen the yield curve.”

A put is an option contract that gives its owner the right to sell the put writer an underlying asset for a set price within a certain time. If one owns the underlying asset, buying puts on that asset is like buying insurance. One can also buy puts to make a downside bet on an asset. The put writer, on the other hand, is selling insurance or betting that the underlying asset will not fall below the set price within the time frame specified in the contract.

If the Federal Reserve is selling puts on Treasuries, and there’s reason to believe that it is because it did just that during the Y2K non-crisis, it is selling insurance on US debt. This is pretty much the same thing that AIG did. The only difference is that the Federal Reserve has a printing press and AIG did not. The Fed can’t default, but if rates go above its target strike prices, the Fed will have to print so much money that the currency will collapse.

Gold at $1,563; Silver Breaks $48, $49, $50; Dollar Down to $73

Silver climbed as high as $50 before closing the week at $47.94. A couple things happened to drive down the silver price. Tuesday was options expiration, so the price was beaten down by shorts. Second, the CME raised margin requirements for silver not once but twice this week.

Jesse expects silver to hit $55 by the end of May and that’s probably conservative.

Last week was the first time gold rose above $1,500. This week gold posted new records, closing at $1,563. We could see $1,600 in the next week or two. Gold was in the doldrums over the winter, but it’s on the move again.

Meanwhile, the US dollar hit its lowest point since 2008. With foreign reserves of the dollar shrinking, inflation is expected to rise.


FOFOA on Hyperinflation, Deflation, Gold, Real Estate

I’ve read FOFOA (Friend of Friend of Another) the past few years. I’ve occasionally liked things he’s written, but I’ve often come away confused by his writings. I’m not sure if that’s because he’s unclear in his writing, or if I’m just too dense to follow him. He has a stemwinder up that’s given me some things to think about and it’s convinced at least one deflationist that we’re heading for hyperinflation.

FOFOA – Deflation or Hyperinflation?

While deflation and inflation are practically polar opposites, deflation and hyperinflation look almost identical on the surface, with the main difference being the wheelbarrows of worthless cash. As I wrote in 2009 in The Waterfall Effect:

There is a quote I like that comes from Le Metropole Cafe. It goes, “we will have deflation in everything we own, and inflation in everything we use”. This is partly true. It is true during the run up to the rubber band snapping. It is true until we hit the waterfall. At that point I have my own version of the quote. “We will have hyperDEflation in everything measured against real money, GOLD, and we will have hyperINflation in everything measured against paper dollars.”

“Human nature has followed this path for thousands of years. You know the old joke about outrunning the bear? Well, these lenders will influence our financial policy as such. They will try to get their debt securities liquefied first, spend the fiat and in this process outrun you and I. Leaving anyone they can beat to the mercy of the hyperinflation bear eating their remaining fiat assets…”

“…hyperinflation is the process of saving debt at all costs, even buying it outright for cash… because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn!”

Remember, hyperinflation is a race, not against the bear (you can’t outrun the bear) but against your neighbor.

As I said, Marx got one thing right. History does bear out the dramatic story of centuries of class struggle. But if we eliminate his one small flawed premise, we can see it all much more clearly.

The two classes are not the Labour and the Capital, the rich and the poor, the proletariat and the bourgeoisie, or the workers and the elite. The two classes are the Debtors and the Savers. “The easy money camp” and “the hard money camp”. History reveals the story of these two groups, over and over and over again. Always one is in power, and always the other one desires the power.

1. Debtors – “The easy money camp” likes to spend (and redistribute) money it did not earn, either by borrowing it, taxing the savers for it, or printing it. They like easy money because it is always and everywhere constantly inflating, easing the repayment of their debts.

2. Savers – “The hard money camp” likes to live within their means and save any excess for the future. They prefer hard money (or in some cases “harder” money) because it protects their savings and forces the debtors to work off their debts.

Even if you accept that hyperinflation is 100% certain, real estate is still a poor investment choice to carry your wealth through. Gold is so much better that real estate shouldn’t even be considered an investment choice (choice, as in a new investment) beyond your primary residence. Even with 10x or even 20x presumed leverage in a near-term debt wipeout, unleveraged gold is still a much better choice. And in addition to it being the lesser choice, leveraged real estate also carries a non-zero political risk in hyperinflation. I’m giving this an extremely low probability in today’s world, but under any kind of conservative and personal “one percent doctrine” it must be factored heavily into the equation that includes expected leverage and the carrying costs on an unknowable timetable. This is an excerpt from an email I received a while ago:

Today I read a short little book titled Fiat Money Inflation in France by Andrew White (published 1912). My general impression is that there is no law so insane that it can’t be enacted during a hyperinflation. As you may know, they even passed a law such that debts increased along with the issuance of further currency, so that for every so many additional assignats printed, one’s debts increased by 25%. Thus they took away the one silver lining of currency debasement for the middle class. What a nightmare.

This is very important: Once hyperinflation commences it is characterized by a running shortage of cash, even though it appears like the opposite to the outside observer. The currency collapses in value against economic goods because the debt and the credit collapsed. There is no credit, only cash, and there is a shortage of cash for everyone, including the Elite and the government. So they, the Elite/government, print and print for their own survival while saying it is for yours.

Money Supply Inflated. Telemarketers Hardest Hit.

Random Nuclear StrikesSpooky Inflation:

I don’t watch much TV. I happened to have CNBC on just now to check the commodities and stock tickers, and found myself watching an ad for SunSetter Retractable Awnings. (You know, the one carefully targeted to retiring baby-boomers’ images of themselves, with the cute-hot middle-age-ish wife and the just-a-bit-too-hunky-for-her-husband. Of course a hot couple like that’s gonna need a retractable awning to shade all their swingers’ parties, don’tcha know.)

Anyway, so they get into the pitch and the guy’s mouth very clearly says the words “as little as three hundred ninety-nine dollars” but what the voice-over says is “FOUR hundred ninety-nine dollars.”

Apparently this edit may have been done as far back as two years ago. Still, for some reason the spooky, intentional unobtrusiveness of the price-jump made me feel like Roddy Piper in They Live for just a moment. Are there lots more commercials that have been modified this way?

Mainstream Media Taking Notice of Inflation,

Fast Money via CNBCInflation Actually Near 10% Using Older Measure:

After former Federal Reserve Chairman Paul Volcker was appointed in 1979, the consumer price index surged into the double digits, causing the now revered Fed Chief to double the benchmark interest rate in order to break the back of inflation. Using the methodology in place at that time puts the CPI back near those levels.

Inflation, using the reporting methodologies in place before 1980, hit an annual rate of 9.6 percent in February, according to the Shadow Government Statistics newsletter.


U.S. Money Supply Gone Wild

“Inflation is always and everywhere a monetary phenomenon.”
Milton Friedman

If uncle Milty is right, we’re in trouble. From the St. Louis Federal Reserve via Zero Hedge:

UPDATE: In comments, Douglas notes that the chart above doesn’t show the x-axis at zero. Fair enough. Here’s another chart that does:

Iran accumulating gold, which is odd since you can’t eat it

Secret Iran Gold Holdings Leaked: Tehran Holds Same Amount Of Gold As United Kingdom, And Is Buying More:

“Market observers believe Tehran has been one of the biggest buyers of bullion over the past decade after China, Russia and India, and is among the 20 largest holders of gold reserves… with an alleged 300 tons, big enough to challenge the UK at 310 tons, and more than Spain!”

Now why would Iran want a barbarous relic like gold when they could buy Apple stock, which is sure to go up up up forever?

Don’t laugh. The U.S. is next.

UK Surpasses Zimbabwe In Annual Inflation

And here I’ve been worried about inflation

Obama: “We’re not seeing a broad-based inflation trend.” I guess inflation hasn’t reached the arugula market.

Effect of Food Inflation in the U.S. vs the World

Zero HedgeA Tale Of Two Inflations: Why US CPI Is Flawed And Why Bernanke Will Maintain ZIRP As Revolutions Rage:

For all those wondering why the Federal Reserve will likely never hike rates on the basis of undisputed surging food and energy prices, here is the reason: in the US, the food component as a percentage of overall CPI is 7.8%. In China it is 31.4%. In India 47.1%! The US CPI, therefore, is a completely irrelevant metric when it comes to measuring the one factor that has been responsible for two revolutions already year to date. In other words, if food prices were to double, US CPI would go up by 7.8%, while in China it would grow by nearly 50%.

And as you see revolutions in Egypt, Tunisia, and elsewhere realize that food inflation has a larger effect there than here. But we’re feeling it here, too. Just not to the same degree. Those countries are the canaries in the coal mine.