``By 1991, China's economy was booming because of Deng's abandonment of Marxist economics in 1978. That left only Albania, Cuba, and North Korea. The Marxists had nowhere to turn to that offered evidence of economic success. Overnight, they became a laughing stock on campus. This will be the fate of Keynesians when the governments of the West finally go bust or else abandon the deficits and the fiat money.” Gary North, Invitation to an Anti-Keynes Project, Selling Keynes Short
Many have been puzzled by the broad based surge in the coupon yields of US treasuries.
Media tries to connect the dots to the developments of Greece and Portugal, where the latter has endured a debt downgrade by a credit rating agency last week.
An upsurge in yield, says perma bears, should hurt the markets. My quick retort is, not so fast, as this would largely depend on the degree of spike and the reasons behind it.
Figure 3: Stockcharts.com: Market Turmoil From Yield Spike?
Bernanke Put and The Public Choice
It is public knowledge that the Federal Reserve is slated to end its quantitative easing program or open market purchases of mortgage backed and agency securities.
Perhaps in this instance, the Fed could be testing the market. And should any turmoil emerge from this experiment, the Fed may immediately decide to reinstate its quantitative easing program or to increase purchases of US treasuries through off-balance sheet or indirect channels (indirect bidders) to covertly support the open ended buying by Fannie and Freddie of mortgage securities on the markets.
Given the Fed’s sensitivity to the price performance of assets, which effectively affects the valuations of the assets of the balance sheets of the banking system, as discussed above, the Fed via Bernanke has long been telegraphing that they would remain ultra supportive of the markets through policy accommodation[1].
Hence, the Bernanke Put has clearly been providing implied guarantee on the system against a repeat of 2008, and will continue to do so, until the forces of nature will upend them.
The underlying predicament of policymakers as Bernanke, is that of public choice economics; by taking on politically popular policies with short or immediate term impact that helps advance their careers instead of focusing on the long term upliftment through sound policies. And the economic doctrine espoused mostly by these technocrats appears fundamentally designed for such an outcome.
As William F. Shughart II writes, ``Public choice rejects the construction of organic decision-making units, such as “the people,” “the community,” or “society.” Groups do not make choices; only individuals do. The problem then becomes how to model the ways in which the diverse and often conflicting preferences of self-interested individuals get expressed and collated when decisions are made collectively.[2]” [bold emphasis added]
For some, this is has been hard to comprehend or digest.
Playing Into The Austrian Bubble Cycle
Nevertheless, we expect the next crisis to stem from two possible scenarios: one a bubble bust in Asia and or emerging markets, or two, a sovereign debt crisis in a developed economy. (I am not saying that this is happening soon).
Although one can lead to another; a popping bubble in Asia can lead to a sovereign crisis elsewhere as overstretched and overloaded levered balance sheets of developed economies may find it difficult to engage in another round of deficit spending for “automatic stabilizers”. And if officials frantically and instinctively resort to the same actions as today, then a sovereign debt crisis becomes a clear and present danger.
As Harvard’s Carmen Reinhart in an interview with the Wall Street Journal commented, ``historically, following a wave of financial crises especially in financial centers, you get a wave of defaults. You go from financial crises to sovereign debt crises. I think we’re in for a period where that kind of scenario is very likely. I don’t think a repeat of the fall of 2008 is at stake here, where it looks like the world is going to end.[3]” [underscore mine]
And it is here where the Mises Moment will likely be unleashed. A choice of default or hyperinflation.
Going back to the recent concerns of the soaring US treasuries (TNX), it is quite obvious that there has been little “mayhem” in the markets. US equities (SPX) firmed for the 4th straight week, the US dollar strengthened (USD) largely on a Euro weakness, and importantly Credit Default Swaps (CDS) the insurance premium for debt instruments has revealed little signs of distress.
BCA Research comments on the actions of the treasury market, ``Soaring Treasury supply also appears to have played a major role. Indeed, countries with higher budget deficits tend to have narrower (or negative) swap spreads. Does this mean that investors are finally demanding a higher premium to compensate for default risk in the U.S.? CDS spreads on Treasurys did not rise much and are still well below last year’s peak, suggesting that this week’s Treasury selloff was driven by technical factors rather than by a rising default risk premium.[4]”
On the other hand, what we appears as an important development is the peaking of the yield curve (UST1Y:TNX), from which on our end, represents as a market based “backing up” or in mainstream jingoism the “normalization” of interest rates from today’s accommodative stance.
Since both the short and the long end of the yield curve has risen, but where short term end have risen faster, the market seems to be indicating signs of inflation gradually regaining foothold and diffusing in itself into the economy (a.k.a. economic growth-juiced up by liquidity), instead of a sovereign distress for now.
In short, in contrast to the outlook of deflation looking perma bears, pieces of the puzzle seems falling into place. Higher prices are beginning to manifest itself in the real economy as the reflexivity theory suggests. This is what we have labelled as inflation’s seductive ‘sweetspot’.[5]
So yes, the Austrian bubble cycle appears to be running in full steam.
And perhaps with an additional ingredient into the stew: Obamacare.
[1] Businessweek-Bloomberg, Bernanke Says Economy Needs ‘Accommodative’ Policies
[2] Shughart, William F. II Public Choice
[3] Reinhart, Carmen Q&A: Carmen Reinhart on Greece, U.S. Debt and Other ‘Scary Scenarios’
[4] BCA Research, U.S. Treasury Issuance: Reaching The Choke Point?
[5] See Inflation’s Sweet Spot Augur For A Gold Breakout And Global Equity Market Rally
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