QE and the “Crowding Out” of the Bond Market Vigilante
We’ve updated our chart of the sources of financing of the U.S. budget deficit from the Fed’s Flow of Funds data released on September 16th. The chart illustrates how the Fed and foreign central banks have been indirectly fully funding the massive U.S. budget deficit for the last three quarters. It will be interesting to see the data for the quarter ending today as no doubt there will be less yellow with the end of Q2 on June 30 and more “flight to quality” blue (domestic) and red (rest of world).
Ronald McKinnon, professor of international finance at Stanford University, has an excellent piece in today’s Wall Street Journal about the damage the Fed’s zero interest rate policy (ZIRP) is doing to the U.S. and global economy. One of his main points is the Fed and other central banks, who are not yield sensitive, have been financing the U.S. budget deficit and crowding out the now extinct U.S. bond market vigilante.
As you know the Global Macro Monitor is not a fan of ZIRP and believes it one factor that ails the economy not what will cure it. We take comfort to be the same company of such an intellectual heavyweight as Professor McKinnon.
The professor makes several excellent points in his piece,
Without the [bond market] vigilantes in 2011, the federal government faces no immediate market discipline for balancing its runaway fiscal deficits.
…the vigilantes have been crowded out by central banks the world over. [see the yellow/red bars in the chart]
Central banks generally are not yield-sensitive.
True, in the last two months, this “bubble” of hot money into emerging markets and into primary commodities has suddenly burst with falls in their exchange rates and metal prices. But this bubble-like behavior can be traced to the Fed’s zero interest rates.
Beyond just undermining political discipline and creating bubbles, what further economic damage does the Fed’s policy of ultra-low interest rates portend for the American economy?
First, the counter-cyclical effect of reducing interest rates in recessions is dampened…
Second, financial intermediation within the banking system is disrupted…
Third, a prolonged period of very low interest rates will decapitalize defined-benefit pension funds—both private and public—throughout the country…
Perhaps Fed Chairman Ben Bernanke should think more about how the Fed’s near-zero interest rate policy has undermined fiscal discipline while corrupting the operation of the nation’s financial markets.
Amen!
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September 30th, 2011 at 9:13 am
“Without the [bond market] vigilantes in 2011, the federal government faces no immediate market discipline for balancing its runaway fiscal deficits.”
That’s kind of why they are doing what they are doing, pal. Don’t blame the Fed, blame the Congress for not understanding fiscal policy. The Fed is doing what they can, even while knowing that monetary policy is not the optimal policy tool.
At what point do the market utopians raise the white flag of surrender? They have been wrong about everything!
September 30th, 2011 at 12:15 pm
This is absurd.
If we have these type of idiots educating our kids we are in serious trouble.
First of all. The Bond Market and Treasury Auctions don’t finance anything least of all deficits. Not understanding this simple point is the paramount of understanding the Monetary System and how it works and functions. Bond Auctions DO NOT FINANCE DEFICITS!
Repeat after me……
The US Govt/Treasury has monopoly control over its own currency in a non convertible floating rate exchange rate mechanism. There is simply no running out of money. Bond Auctions are done so that there is sufficient reserves in the banking sector. Why do the Chinese buy our Treasuries? Becasue they have to! Its part of their trade policy.
It is not surprising to find drivel like this in the WSJ Opinion Area. We are in a balance sheet recession from day one, this is why treasuries go up every day and yields go down.
Second of all, how in the world is there any crowding out when rates are in fact so low? When will these supply siders realize that the private sector is dead? There is no demand from the private sector.
There is no Bond Vigilantes when looking at countries that have monopoly control over currency. Look to the left..that is where the graveyard is for the ones who shorted JGB’s all through out the 90′s. Look to the right to the ones who short treasuries.
September 30th, 2011 at 12:54 pm
jaytrader,
AMEN!
Over the last decade ROW central banks have been the biggest buyer…BECAUSE THEY HAD TO MAINTAIN THERE CURRENCIES!
This post is a zombie lie that will not die!
September 30th, 2011 at 7:15 pm
surprised to see GMM peddling this ‘viewpoint’..
~~~
some things should be re-Read, and Understood..
jaytrader Says:
September 30th, 2011 at 12:15 pm
This is absurd.
If we have these type of idiots educating our kids we are in serious trouble.
First of all. The Bond Market and Treasury Auctions don’t finance anything least of all deficits. Not understanding this simple point is the paramount of understanding the Monetary System and how it works and functions. Bond Auctions DO NOT FINANCE DEFICITS!
Repeat after me……
The US Govt/Treasury has monopoly control over its own currency in a non convertible floating rate exchange rate mechanism. There is simply no running out of money. Bond Auctions are done so that there is sufficient reserves in the banking sector. Why do the Chinese buy our Treasuries? Becasue they have to! Its part of their trade policy.
It is not surprising to find drivel like this in the WSJ Opinion Area. We are in a balance sheet recession from day one, this is why treasuries go up every day and yields go down.
Second of all, how in the world is there any crowding out when rates are in fact so low? When will these supply siders realize that the private sector is dead? There is no demand from the private sector.
There is no Bond Vigilantes when looking at countries that have monopoly control over currency. Look to the left..that is where the graveyard is for the ones who shorted JGB’s all through out the 90′s. Look to the right to the ones who short treasuries.
~~
esp. .. “…The US Govt/Treasury has monopoly control over its own currency in a non convertible floating rate exchange rate mechanism. There is simply no running out of money…”
~~
not often the *Truth escapes into the Wild, but, when it does, it’s a fine sight, for sure..