Does Rising US Treasury Yields Today Suggest Sovereign Debt Concerns Or Remergent Inflation?

``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.

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[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

What Obamacare and Rising Yields Mean

``The public will think the health-care system is what Democrats want it to be. Dissatisfaction with it will intensify because increasingly complex systems are increasingly annoying. And because Democrats promised the implausible -- prompt and noticeable improvements in the system. Forbidding insurance companies to deny coverage to persons because of preexisting conditions, thereby making the risk pool more risky, will increase the cost of premiums. Public complaints will be smothered by more subsidies. So dependency will grow.” George F. Will, A battle won, but a victory?

One of the seemingly uneventful but seismic political shifts just occurred in the US.

Last week, President Obama’s signature health reform program, the Obamacare, had finally been forced into a law through procedural manipulations, in both the House of Congress dominated by President’s Obama’s party.

With over a year in power, and with elections drawing nearer, the risks of a decline in the political power held by the Democratic Party eventually prompted a desperate power manuever. As an old saw goes, what are we in power for? Or to quote Emmanuel Rahm, White House’s Chief of Staff popular view on the last crisis, `` it's an opportunity to do things you think you could not do before.” That could have been the rallying cry of the progressives, in passing a highly unpopular law, regardless of the public’s opinion, as manifested in almost every polls.

So only after a year in office has President Obama successfully convinced several dissent partymates to shift sides, after several horse trading and compromises, from initially opposing his European style welfarism.

There could be several reasons why the market seemed to have discounted the enactment of Obamacare.

One, markets already expected the eventuality of this program considering the dominance in the political spectrum by President Obama’s Democratic Party.

Two, markets assumed that since many parts of the law will take place years from now, the adverse affects will unlikely have an impact soon. Besides, with Senate elections slated this year, there could be manifold amendments that result to a massive facelift.

Three, markets may not be the normal functioning markets as we know of. Like most US markets today, they could be under the influence of various agencies of government, just possibly in disguise.

Fourth, the initial impact of the Obamacare, ignored mostly by mass media and the experts, could possibly be the surge in yields of the US treasuries, which came a day late.

Obamacare Equals Greater Risks Of Fiscal Wreck

How can Obamacare be related to rising yields? In essence; increased government spending.

There is one thing we can be sure of; when government promises to curb deficits or produce savings with massive new redistribution program, it is likely to be unfulfilled.

In the case of the US Medicare, which was signed into a law in July 30, 1965[1], the initial estimates and actual expenditures turned out to be…you guessed it, was a mile apart. (see figure 4)

Figure 4: Cato.org: Huge Disparities in Projection and Actual Spending

Cato’s Daniel Mitchell refers to the testimony of Robert J Myers to the Joint Economic Committee as evidence, ``The federal government’s ability to predict healthcare spending leaves much to be desired. When Medicare was created in the 1960s, the long-range forecasts estimated that the program would cost about $12 billion by 1990. It ended up actually costing $110 billion that year, or nine times more than expected.[2]”

Government estimates that Obamacare’s spending will be modest, ``The CBO estimates the bill would cost $940 billion over a decade and that it would cut the deficit by $130 billion in the first 10 years and some $1.2 trillion in the second 10 years” notes the MSNBC.

However, Alan Reynolds of Cato argues otherwise, saying that government spending will vastly accelerate after the next 4 years[3], [bold emphasis mine, italics his]

``In fact, new spending is negligible for four years. At that point the government would start luring sixteen million more people into Medicaid’s leaky gravy train, and start handing out subsidies to families earning up to $88,000. Spending then jumps from $54 billion in 2014 to $216 billion in 2019. That’s just the beginning.

``To be unduly optimistic (more so than the CBO), assume that the new entitlement schemes only increased by 7% a year. At that rate spending would double every ten years — to $432 billion a year in 2029, $864 billion a year in 2039, and more than $1.72 trillion by 2049. That $1.72 trillion is a conservative projection of extra spending in one year, not ten. How could that possibly not add to future deficits?

``Could anyone really imagine that the bill’s new taxes and fines could possibly grow by 7% a year? On the contrary, most of the claimed revenues are either a timing fraud (such as treating $70 billion for long-term care premiums as newly found treasure) or self-defeating. The hypothetical tax on Cadillac plans (suspiciously postponed until 2018), for example, is designed to discourage such plans from being offered by employers or wanted by employees — that is, it’s designed to yield less and less over time.”

Figure 5: US Treasury on Government Debt Estimates and Heritage.org on welfare programs

In the Secretary of the Treasury’s ‘2009 Financial Report of the United States Government’ report which does not include the Obamacare in its estimates, it recently warned (see figure 5 left window), ``But the Government must simultaneously address the medium- and long-term fiscal imbalance resulting from past budget deficits, the impact of the economic downturn, and demands on the nation’s social programs, notably Medicare, Medicaid, and Social Security. As currently structured, the Government's fiscal path cannot be sustained indefinitely and would, over time, dramatically increase the Government's budget deficit and debt.[4]” [emphasis added]

So Obamacare is likely to shorten the reckoning period for the current unsustainable path of growing fiscal risks from a vastly expanding welfare program.

Politicization of US Healthcare

Moreover, the 2,400 page law is a quagmire of bureaucracy[5]. This means much of the America’s healthcare will be politicized and effectively rationed by the unelected officials. And the traditional symptoms from increased bureaucracy will likely adversely impact health care distribution via more red tape, cost overruns, risks of fraud, risks of corruption, shortages, delays in payment, higher taxes on the wealthy, delayed or waiting list treatment, possibly reduced payments to hospitals and physicians, diminished competition and innovation and etc.

Hence, rising taxes, added regulatory compliance and more bureaucracy is likely to lead to lesser productivity, reduced incentives for entrepreneurship and competition or an increase in the cost of doing business or higher economic cost structures.

Protectionists are likely to blame other countries for job losses anew, when redistribution programs as massive as this would likely be a major factor in reducing investments.

This, is aside from, the prospects of heightened inflation and credit risks which may have seminally manifested itself on the treasury markets, last week. Of course as explained above, the sweetspot of inflation may blur such risks for now.

As Robert Higgs aptly explains[6], ``because health-care-related economic activity is such a huge part of the overall economy, what happens in this sector will have significant consequences for the operation of other sectors. For example, when Obamacare turns out to be much more costly than the government has claimed it will be, the government’s demand for loanable funds will be greatly increased, with far-reaching effects on interest rates, investment spending, economic growth, and even the U.S. Treasury’s creditworthiness. It is not inconceivable that the burden of supporting this health-care monstrosity will prove to be the (load of) straw that breaks the back of the government camel in the credit markets, where the U.S. Treasury has long been able to borrow the greatest amounts at the lowest rates of interest because its bonds were considered virtually riskless” [bold highlights mine]

Nevertheless one of the investment opportunities from the pollicisation of American health care, which concerns us non-Americans, should be off shore or medical tourism.

The rest will just be more like today, more offshoring and outsourcing and diversification in search for cost effective ways to maximize profits.

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[1] Medicare, Wikepidia.org

[2] Mitchell, by Daniel J Will Federal Health Legislation Cause the Deficit to Soar? [Joint Economic Committee, “Are Health Care Reform Cost Estimates Reliable?” July 31, 2009. The JEC cites 1967 testimony by Robert J. Myers.]

[3] Alan Reynolds, Cato.org, It’s NOT a Health Bill, NOT a Medicare Tax and It Can’t Possibly Cost Only $940 Billion

[4] Secretary of the Treasury, Director of the Office of Management and Budget (OMB) and and Acting Comptroller General of the United States, “2009 Financial Report of the United States Government,”

[5] Businessweek, Obamacare's Cost Scalpel

[6] Higgs, Robert The Health-Care Reform Act: Que Paso?, Independent.org