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Your Daily Depression

By Steven Rybicki on 1.19.09 @ 1:00PM

Need a burst of anxiety courtesy of the pitiless abyss that swallowed High Finance? Then let’s talk bonds.

So, what happens when a government creates debt and no one buys it? Specifically, what if the government of one of the strongest economies in the West created debt and no one bought that debt? Well, it’s happened in Germany. The Telegraph’s own Zarathustra (Ambrose Evans-Pritchard) has the details:

The danger became all too real [January 8, 2009] when even Germany failed to sell a full batch of government bonds at its annual `Sylvester Auction', which kicks off the debt season. Investors took up just two thirds of a €6bn (£5.6bn) sale of 10-year Bunds, leading to consternation in the markets. Bund price dropped sharply as the yield jumped 34 basis points to 3.29pc, with copy-cat moves by bonds across the eurozone. "It's very poor," said Marc Ostwald from Monument Securities. "In 20 years covering Bund auctions I can't remember the Bundesbank ever being left with a third of the bonds."

And it’s Britain and Spain on the chopping block next because they may not be able to maintain their credit ratings, which diminishes the attractiveness of their government-issued bonds to potential investors. Obviously, Pritchard sees this as indicative of the shape of things to come. And, for effect, he’s called the top-and-pop of the “sovereign bond bubble.”

This means there’s a horrifying “what-happens-next” narrative emerging for the United States: the government will be the only major, domestic economic actor spending money, but the government will need other international actors to finance the accrued debt. And, according to Pritchard, it may be the case that it won’t be bought by our most vital economic ally:

Beijing needs the money at home in any case to prop up the Chinese economy – now in trouble. Even Japan has slipped into trade deficit. Clearly, the US and European governments cannot rely on Asia to plug the $3,500bn hole in their budgets this year.

Henry Kissinger concurs via an articulation of the conventional geopolitical wisdom on China:

… the Chinese growth rate may fall temporarily below the 7.5 percent that Chinese experts have always defined as the line that challenges political stability. America needs Chinese cooperation to address its current account imbalance and to prevent its exploding deficits from sparking a devastating inflation.

Hoping the depression would improve soon? Breathe a little bit and enjoy the oxygen, because it only gets worse from here on in.

Bob| 1.19.09 @ 1:27PM

Steven, you are absolutely right on this. The largest risk we face today is our debt which has doubled in the last 8 years. As most economists now agree, tax cuts (i.e., supply side thinking) is primarily responsible for this debt since spending is never reduced. Spending is the way that Democrats and Republicans get reelected. Additionally, social security and medicare are now 53% of the budget and are the fastest rising portion. Now that we have experience with the supply side administrations of Reagan, Bush1, and Bush2, we know that GDP, i.e. our economy, does not grow any faster with tax cuts than without them -- that is just fact. We also know that federal receipts also don't grow any more with or without tax cuts.

So what happens if we can't get debt? Well, you can always print money and have inflation. The benefit of inflation is that it reduces the amount of the debt in real dollars. This is sort of a "back handed" benefit.

On the plus side, China needs to keep on purchasing U.S. Debt because their economy is dependent on ours. 70% of their population still lives in poverty. If they stop buying our debt, they will be in an even worse position.

So yes, it gets worse from here. My hope is that both the right and left drop their ideological biases and just do what actually works...

JRS| 1.19.09 @ 2:14PM

Well, I wouldn't say that tax cuts don't result in economic growth--- private consumption and investment is usually thought to be more effective than government spending. The problem is that Art Laffer's theory that tax cuts pay for themselves is unfortunately a conservative daydream. The unfortunate reality is that regardless of the how much "economic stimulus" we engage in (I'll even include the unrealistic option of zero), we'll have to raise taxes and likely cut spending in the future to pay back the enormous amount of debt we've taken on. Of course, most posters to this site would like to say we can just cut spending, but the realistic option is that even if we did that, we'll have to increase taxes (likely on everyone, although disproportionately on the wealthy) to pay back this debt.
One of the largest reasons we'll be limited in spending cuts is the growth of non-discretionary entitlements, namely social security and medicare. After we've witnessed the large plunge in private investment accounts due to the drops in the stock markets, coupled with the inevitable readjustment in actuary tables to account for increased lifespans and diminished stock market returns (on a going forward basis is anyone expects the real returns the US has experienced since 1929, I'll gladly take the opposite side of that bet) that force the few remaining defined benefit plans to collapse, Americans will only continue to demand social security. While there might be some success in cutting benefits (i.e. rate increases lower than CPI and a slow crawl in the age one can collect), across the board increases in payroll taxes can ultimately be expected. This of course will unlikely be sufficient to keep the system solvent enough for my generation to ever collect.
So for all the crying, what are my suggestions:
First, the government needs to continue to step in and encourage lending, strongarming where necessary. Not to subprime borrowers and overleveraged companies, but to the companies that still produce good products that are also negatively impacted by this mess. Note, all the idiots that start saying this is anagolous to the CRA, realize that the CRA wasn't the main reason for the mess. It was the sheer realization that there is money in subprimes and if we lever it there's even more money that we're in this mess, not just a government mandate.
Second, to make smart investments in public goods. Goods such as education, roads, rails, etc... are public goods that benefit the country, have been neglected and require tax expenditures, since by their very definition are neglected by private investment.
Third, reform education. We need to spend more money on education, but simply spending more is like pouring water down a broken drain. Fix the drain, then pour more money. Part of this requires redistribution of resources from richer districts to poorer districts. This by the way isn't socialism, but will result in increasing the production function for the whole country.
Fifth, fix executive compensation. Sorry, the market failed on this, and this is the biggest reason for the mess. I don't care about overall levels, but we need to realign comp with performance to encourage appropriate risk taking and investment. Anyone that thinks the current system is correct is less intelligent than Sarah Palin.
Sixth, allow for government investment in R&D;where necessary. Overall the private sector does a good job but isn't perfect. Anyone that thinks the government is incapable of investment, look at how many innovations came out of NASA and defense research. Failure to invest in alternative energies is a perfect example of a market failure.
Seventh, is to delever. Government must pay down its massive debts and engage in fiscal discipline. Consumers must cut down on spending, pay down credit cards, downsize, etc...
The result is that we need a little bit of both conservative and liberal ideologies. We will need some fiscal stimulus (investment in public goods), but at the same time, lets not waste money we'll never recoup. A short term increase in unemployment and lower growth is definitely painful, but might be exactly what the doctor ordered. But then again, what do I know. I'm only 28; it's not like I'll be the one paying for the mistakes of the generations that make up the majority of the readers.

Bob| 1.19.09 @ 2:37PM

JRS, you are pretty much on target -- and I'm a LOT older than you. Regarding tax cuts, historically, as they have been implemented in reality, have not contributed to economic growth. Take a look at the GDP trend over many administrations:

http://www.data360.org/dsg.aspx?Data_Set_Group_Id=230

Entitlements are 53% of the total budget and interest on the debt is at least 8% with military at 20%. So cutting the budget significantly means cutting entitlements -- something neither side wants to do because they will lose votes.

Regarding education, we need to focus more on trades. Given the rise of computerization and resultant increases in productivity, there will be fewer knowledge based jobs. We have a severe need for health care workers. I see no reason not to start nursing courses in high schools as well as plumbers, electricians, etc.

As to economic growth, I don't expect to see significant growth for 6 to 10 years.