Kudlow and Greenspan
I tuned in Larry Kudlow as usual last night and found the lead topic was "do deficit's cause interest rates to rise?" Then I find out that Alan Greenspan earlier on Bloomberg TV was quoted as saying that higher interest rates were "the canary in the mine" that warns against trouble ahead. Now, I know Greenspan could not have read my article "Watch The Birdie", which referred to rising rates being the "canary in the coal mine". And since I wrote the article several days earlier, I found it an interesting coincidence.
Kudlow immediately jumped on Greenspan and explained why there is no connection between rising deficits and rising interest rates. I love a good theoretical argument so here is my response.
Greenspan didn't say that he thought that interest rates would go up in response to higher deficits. he said, higher yields reflect investor concerns over “this huge overhang of federal debt which we have never seen before,” I side with Greenspan. It is the more accurate statement.
In my recent article "Why Prices Are Not Skyrocketing" I point out that rising prices occur at the point of human action — when individuals value each dollar less and begin to dump them. Interest rates are no different. Interest rates are the price for money. If individuals begin to loose confidence in debt they will require a higher price to provide credit.
It is not the increase in deficits as such but the cumulative increases of all outstanding debt, and the concerns about its repayment, that leads to higher interest rates. Larry Kudlow is right when he says that deficits do not necessarily cause higher interest rates. And that inflation usually is the culprit. But consider it. It is not that extra increase in money and credit that starts inflation rolling. It is the suspicion of all previous claims to goods — money itself — that comes into question.
Today, all debt is coming into question, which means not just deficits, which are small compared to the total debt outstanding, but the entire stock of debt owed. Last week long term bonds moved up conspicuously. It could have been in response to concerns of future inflation. It could have been in response to anticipated increasing growth, or it could have been in response to the passing of the health bill.
Why the health bill? The market had before Monday discounted the total debt owed by the US government. On Monday they had to come to grips with the real possibility that the debt would increase by 1 to 2 trillion dollars more over 10 to 20 years. What happened? the 10 and 20 year bonds fell and interest rates went up — possibly discounting this now confirmed new possibility.
For the first time since the Great Depression some corporate bonds fell to yield less than government bonds. This means that the markets are more secure with private debt than government debt. And well they should be. The US is rich. Household net wealth is some 54 trillion dollars. US government wealth is a negative 67 trillion dollars in unfunded liabilities. And now add a deficit that will total 10 trillion dollars in 10 years — at least! In my article "Big Bank, Little Bank" I pointed out that the real money is in the private sector and the government is going to make a run at it. It is the government that is technically insolvent — not the private sector.
Mr. Kudlow, you are right. The lack of confidence in money – inflation will always and everywhere lead to higher interest rates. But today, the loss of confidence in money is not coming from the increase of money supply or higher prices but the possibility of non- repayment of money in real terms. BOTH can lead to higher interest rates as all creditors begin demanding a premium to hold any additional debt.
Debt is the new real threat to the world. If individuals begin to distrust money the threat is not progressive inflation, it is that the entire stock of money becomes suspect. That's how you get Zimbabwe. The same is true with debt. The stock of government bonds is some 88 trillion dollars world wide. About a third of it is held inside US borders. Two thirds of debt is held abroad. 88 trillion dollars is an uncontrollable sum of money. If for any reason the stock of debt held becomes suspect, the entire stock of debt reacts. Last week that debt was devalued. The world took heed. And so should we.