First, I need to clear the air on an issue that is cited over and over, of which causes me great discomfort. In last Thursday’s Financial Times, Robert Pollin and Michael Ash, the two professors who sponsored graduate student Thomas Herndon of UMass-Amherst–and of recent fame for finding the flaws in Rogoff/Reinhart–published the article heard round the world: “Why Reinhart and Rogoff are wrong about austerity.” I am not disputing the results of their work but I am questioning a causal relationship that they note:
“In fact, since 2009 ,the U.S. government’s interest payments on debt have been at historically low levels, not historic highs, despite the government’s rising level of indebtedness. This is precisely because the U.S. Treasury has been able to borrow at low rates throughout these high deficit years.”
Sorry, but to merely state that low U.S. debt costs are proof of Rogoff being wrong is pure hogwash on its own merit. The FED has been subsidizing the Treasury through its massive large-scale asset purchases (LSAP). This support from the world’s largest monetary authority has meant that the market has not been the mechanism for setting prices. Government intervention with the announced purpose of keeping bond and MBS rates low cannot be cited as a reason that Rogoff/Reinhart are wrong. Come back when the FED removes itself from active involvement and make the case. Artificial price controls do not make an objective study.
***Disconnect number one: The Italian government bonds were well bid today in the face of rolling back austerity after the IMF meeting. In fact, the two-year note yield made a record low, falling to 1.20%. The 10-year yield also dropped 16 basis points to yield 4.05%. If austerity is to be loosened it would make sense that yields would actually rise in the face of larger deficits. Further, if it was foreign buyers of peripheral debt in search of higher yields, the EURO should have been stronger, not weaker. The strength of the BTP was significant as it actually made a new high from February 25, the day Italy failed to elect a government when BTP futures opened strong and then proceeded to precipitously drop. This is a caution flag and we need to wait for clarity.
***Disconnect number two: In a Bloomberg article by Benoit and Sills, it was revealed by Eurostat that Spain’s deficit widened to 10.6% of GDP during 2012. Yes, adverse FEEDBACK LOOPS do take a toll on fiscal policy as a massive economic slowdown pushes tax revenues down leading to larger deficits. As this was announced, yields on Spanish 10-year notes fell 13 basis points, confounding the debt markets even more. Let’s see, higher deficits, less austerity begets lower bond yields. The markets are a ball of confusion. So who is buying peripheral debt?
***The IMF adds to the confusion. For years the FUND has always advised that debt-plagued countries devalue their currency and simultaneously tighten their budgets, usually by raising taxes and cutting spending. Now under Director Lagarde the IMF is pushing for Spain, Ireland, Portugal and others to be given more time in which to rein in their fiscal excesses–that’s where the world is today. The bottom line may be that peripheral debt needs to be watched to see what is the motivating factor for the yields falling. Is it solely the reach for yield?
***From the land of referenda: Switzerland has been the poster child of direct democracy for it takes just a 100,o00 signatures to get an issue to referendum. The NEW ISSUE FACING SWISS CITIZENS IS WHETHER TO ALLOW THE SWISS NATIONAL BANK TO SELL ITS GOLD. The proposed referendum asks that the SNB not be allowed to sell its GOLD and also that it have to keep 20 percent of its assets in the precious metal. Presently, the SNB has 10 percent of its assets in GOLD so it would force the SNB to dispose of some EUROs and other currencies, or purchase more GOLD. The SNB has previously sold GOLD in 2001 and 2006 at much lower prices than today. A Swiss measure that forces the SNB to accumulate GOLD would forestall other central banks from seeking to pull a Cyprus. The timing of calling the vote has a wide window so the result may not be known for a long while.