Monday, June 1, 2009

Assorted Musings

Here are some assorted musings:
  1. First there was the interest-rate conundrum in the mid-2000s that stumped the Fed, now there is the steepening yield curve mystery from last week that has the Fed perplexed. The Treasury yield curve is so frustrating some times for the Fed. Fortunately, Rebecca Wilder has some insights on this latest yield curve development.
  2. Is Paul Krugman throwing the baby out with the bathwater in his latest column? He argues the fundamental reason we are in this bind is that the financial sector was deregulated in the 1980s, financial innovation took off, and as a result there has been too much borrowing since then. I think many observers would agree there has been a lot of borrowing, but does Krugman really want to inhibit financial innovation just because it makes its easier for individuals to make bad financial decisions? Most inventions and innovations have the potential for creating problems, but instead of outlawing them we try to manage them.
  3. Brad Sester notes total U.S. borrowing from the rest of the world is down, even though U.S. government borrowing is exploding. That is because households and business are borrowing a lot less. As a result, government borrowing is offsetting the fall in private borrowing. Here is his summary graph (click on figure to enlarge):

  4. As Sester explains, though, once the economy recovers and the private sectors starts borrowing again, government borrowing must come down to keep total U.S. borrowing in line. Observers like John Taylor, Niall Ferguson, John Maudlin, and others, however, are concerned that future government spending will not be reversed once the economy recovers. If so, the real question becomes what is the U.S. Debt-to-GDP number that is too big?


  1. The fact is that everyone knows that the debt-to-GDP ratio is projected to be over 100% of GDP as far out as you want to stretch your forecasts (St. Louis Fed's quarterly publication had an article last fall on the "Demographic Timebomb").

    So, given that the government HAS to increase its borrowing in the long-run, shouldn't long-term interest rates be much higher than what they are now given that the market is forward-looking?

  2. JDTapp:

    A 100% of debt-to-GDP is not necessarily unsustainable. Japan has been carrying that much or more for some time. I am not saying we should aim for that, but it is not obvious where the magical number is that will cause the markets to become "bond vigilantes".

    Regarding your question, I would say that for now markets are not convinced that debt-to-GDP ratio is too high.