Entrenched Is the New Transitory
Entrenched Is the New Transitory
It’s been said: if you can’t convince them, confuse them. When it comes to Jerome Powell discussing inflation, he is never in short supply of words. At the first Federal Open Market Committee (FOMC) meeting of the year, the Chair of the Fed set the stage for an end to easy money policies and voiced concerns over a new economic threat: entrenched inflation.
With transitory inflation becoming passe in 2021, it was only a matter of time until a new phrase was invented. Like its predecessor, it too is without economic merit. The difference between entrenched inflation, as opposed to transitory inflation, and what can only be called regular or your garden variety inflation, is without delineation.
He introduces the idea, making it seem as though he’s protecting the country from a form of inflation that could persist for long periods of time:
We will use our tools both to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched.
He doesn’t explain how he will fight entrenched inflation differently than other types of inflation. However, the Fed claims when (price) inflation is high, the central bank will raise interest rates. Despite the questionable theory behind this, it’s a long-standing belief held by central bankers worldwide. So far, the Fed has done a poor job fighting all forms of inflation. Consider the puzzling scenario when the Consumer Price Index (CPI) reached 7% in December, its highest level in 40 years, well past the arbitrary 2% target. Yet, Powell refused to raise rates this January.
Referring to inflation, Powell admits the Fed’s previous take was wrong, but offers assurances that this time they’re prepared to fight the economic phenomenon of rising prices, saying:
We do realize that… inflation has persisted longer than we thought. And, of course, we're prepared to use our tools to assure that higher inflation does not become entrenched.
Reiterating a third time how the Fed will utilize their tools to ensure inflation doesn’t increase too much implies that the current 7% inflation rate is not high enough. A state of confusion is really all that remains:
I think the path is highly uncertain in that we're committed to using our tools to make sure that inflation, high inflation that we're seeing does not become entrenched.
To add insult to injury, the money supply continues to have no effect on price increases. Powell’s aloofness on the connection between the money supply and prices is put on display when he tells us:
…the drivers of higher inflation have been predominantly connected to the dislocations caused by the pandemic, price increases have now spread to a broader range of goods and services.
As far as they’re concerned, inflation must exist in a Goldie-locks zone, or a sweet spot where it is not too high or too low. After a couple of decades of persistently low inflation numbers, the Fed finally got what they desperately desired. Unfortunately, they’ve failed to inform society why 7% is an acceptable inflation rate, especially since the Fed takes credit for managing inflation.
Last year inflation was transitory, this year it could be entrenched. Regardless of what modifier is used, (price) inflation compounds. Unless there is negative inflation, or deflation, the compounding effects only exacerbate year over year.
Unfortunately, the Fed will never be able to fight inflation because they do not understand inflation. New phrases like entrenched inflation or transitory inflation are used to create an air of confidence for those who don’t understand economics and confusion for those who do.
India’s Monetary Blunders
In 2016 India’s Hindu fundamentalist Modi government abruptly banned the use of 500 and 1000 rupees notes to curb corruption, black money, counterfeit currency, and to combat terrorism. Within a month’s time the government realized their demonetization policy had failed so they very conveniently changed the objective to a cashless digital economy. Within a year’s time almost all cash was back with RBI suggesting a total failure of demonetization! In the aftermath of such a knee-jerk policy decision the economy tanked and unemployment shot up.
As if such a blunder of demonetization was not enough, the Indian central bank RBI immediately started issuing a totally new 2000 rupees notes. As per the RBI governor: “Rs 2000 bank notes were introduced primarily to replenish the notes withdrawn following demonetization.”
This policy decision made no sense. If the original purpose of demonetizing 500- and 1000-rupees notes was to curb black money and corruption, then how would replacing those denomination notes with an even bigger denomination 2000 rupee note help solve the problem of black money and corruption? Or counterfeit currency and terrorism? Will doing corruption and stashing away more black money not become easier using 2000 rupees notes instead of 500 and 1000?
Remonetizing the economy with 2000 rupees notes defeated the whole purpose of tackling black money, corruption etc. And if the worry of the RBI was deflation and disruption of day-to-day exchanges, which were guaranteed, then there was no need to deflate the money supply by demonetizing 500 and 1000 rupees notes in the first place.
When people were slowly forgetting and recovering from the wounds of demonetization and other policy blunders, government dealt another blow in the form of a sudden announcement of the withdrawal of those remonetized 2000 rupees notes few days back. This time the reason for demonetizing 2000 rupees notes is different. RBI’s communique said:
The ₹2000 denomination banknote was introduced in November 2016 under Section 24(1) of RBI Act, 1934, primarily to meet the currency requirement of the economy in an expeditious manner after the withdrawal of legal tender status of all ₹500 and ₹1000 banknotes in circulation at that time. The objective of introducing ₹2000 banknotes was met once banknotes in other denominations became available in adequate quantities. Therefore, printing of ₹2000 banknotes was stopped in 2018- 19.
About 89 percent of the ₹2000 denomination banknotes were issued prior to March 2017 and are at the end of their estimated lifespan of 4-5 years. The total value of these banknotes in circulation has declined from ₹6.73 lakh crore at its peak as on March 31, 2018 (37.3 percent of Notes in Circulation) to ₹3.62 lakh crore constituting only 10.8 percent of Notes in Circulation on March 31, 2023. It has also been observed that this denomination is not commonly used for transactions. Further, the stock of banknotes in other denominations continues to be adequate to meet the currency requirement of the public.
In view of the above, and in pursuance of the “Clean Note Policy” of the Reserve Bank of India, it has been decided to withdraw the ₹2000 denomination banknotes from circulation.
Again, this reason of clean note policy makes no sense. As per RBI’s own communique they were already demonetizing 2000-rupee notes quietly since 2018-19 when they stopped printing those notes. They should’ve continued to replace 2000 notes without putting people in a panic mode like this again. The whole logic of withdrawing 2000 rupees notes from circulation also doesn’t make any sense because RBI is saying that these notes will continue to be legal tender even after the deadline of depositing or exchanging them passes on 30th September 2023! If a currency will be legal tender, then why would anyone exchange or deposit it back with the RBI? In that case notes will not be withdrawn from the economy.
We don’t yet know the ulterior motives of the government behind this policy. Maybe they will abruptly cancel 2000 notes after the September deadline to surprise the public again.
If they decide to cancel these notes past the deadline, then the ensuing recession will be severe as these notes represent some 10 percent of the present money supply. The abrupt withdrawal is already disturbing the economic exchanges in the market as many traders and common people have stopped accepting those notes immediately. People overnight rushed to buy gold using 2000 rupees notes which has locked up a sizeable amount of savings in nonproductive gold, starving the economy of important productive investment.
Money is the life blood of the body economic. By making market exchanges easy, money makes progress and civilization possible. Without direct exchange money economy there will be no specialization and division of labor, and without them there will be no progress and civilization. Such illogical monetary experiments of the Modi government have deadly consequences for the people of India, but then government doesn’t care about such things, and they aren’t even capable of foreseeing such consequences. As long as Indians continue to vote for socialism, politicians will continue to implement their whimsical ideas to wreck peoples’ lives.
QT or QE: Revisited
It’s been nearly three months since the Federal Reserve provided a modest multi-billion-dollar bailout to a few struggling banks. Despite the ongoing process of reducing government debt and mortgage securities in its portfolio, the Fed’s balance sheet increased by $400 billion in March, to bring the total up to $8.7 billion by March 22.
In the article titled QT or QE: What Is This? I raised the question of how this period will be characterized. Since then, we have witnessed a gradual decline of the balance sheet and it's now nearing levels that resemble those prior to March, as illustrated below:
As for whether this can be categorized as Quantitative Tightening or a temporary Quantitative Easing, hindsight will have to be our guide. However, if we examine the Fed’s holdings of US Treasuries (UST) and Mortgage-Backed Securities (MBS), it becomes clear that they consistently reduced holdings of both during the last several months.
Since the peak on March 22, the UST balance decreased by approximately $165 billion:
During the same period, the balance of Mortgage-Backed Securities (MBS) decreased by approximately $89 billion:
Where the Fed reduced its holdings in certain areas, it increased them in others, particularly in the Bank Term Funding Program and Other Credit Extensions. Both programs were implemented to assist troubled banks.
The Bank Term Funding Program currently stands at nearly $94 billion and is expected to remain in effect for the entire year, as outlined in the program's term sheet.
Likewise, Other Credit Extensions, with an outstanding amount of $188 billion, are also expected to be repaid in full. But the timeline for repayment remains uncertain.
Beneath the chart is the following note:
The value of loans made by Federal Reserve Banks that are not categorized elsewhere on this balance sheet. Recently, this line included emergency credit to Bear Stearns that was announced on March 16, 2008, and, before the credit extension was listed separately, the credit extended to AIG.
The granting of this specific credit extension by the Fed has rarely been seen, but somehow the Fed always manages to find a way to provide credit to troubled banks.
Despite March being just a few months ago, it already feels like a forgotten chapter in history. With discussions in various news outlets, such as the New York Times today, focusing on the S&P reaching bull market status, it's easy to overlook the actions of the Fed. Even though there was a $400 billion mini bailout not long ago, the credit extended to these struggling banks will eventually need to be repaid; the source of this money must be identified.
And remember: the Fed continues to reduce its holdings of UST and MBS. Perhaps due to the gradual nature of this process or because the mainstream refuses to grasp the totality of the situation, the significance of these actions is hardly mentioned. It's also important to remember that the mere contraction of credit is enough to bring about the inevitable bust, so the reduction of credit only worsens the situation. Amidst the euphoria of green days in the stock market, it's easy to lose sight of the fact that any upward trend may only be transitory in nature.
The Fed Fights COVID Largesse
While hope springs eternal that bank run troubles and tightening bank credit will make Jerome Powell and company come to their senses and stop the rate hike madness, there is a not so tiny problem the Fed knows and the average Joe and Jane doesn’t. Former Dallas Fed President Robert Kaplan was interviewed by Praxis Financial Publishing and said the inflation fight is being undercut by expansive fiscal policy.
While we’ve all moved on from COVID, the government’s COVID largesse has a long tail. Kaplan’s been talking to mayors from around the country and they tell him “American Rescue Act (ARPA) money must be spent by states and municipalities between now and the end of 2024 or it’s lost. If you live in Las Vegas and wonder why seemingly every street in town is a cone labyrinth with construction to break out any minute, that’s the reason, use it or lose it. Government never likes to lose it when spending it helps one or more of its constituents.
So the Fed is trying to cool demand for goods, services, and labor at the very same time local spending is increasing the demand for goods, services, and labor. Kaplan added, “Also, certain portions of the infrastructure bill and Inflation Reduction Act funds are earmarked for projects that are increasing demand for labor.”
With all of this fiscal spending, as well as higher interest rates, the Congressional Budget Office expects the federal government to run a deficit of almost $2 trillion dollars in fiscal 2024, nearly 10 percent of GDP. As every Keynesian knows, running a deficit of this size now is stimulative to the economy, again, at a time when the Fed is trying to cool the economy.
No wonder the Federal Reserve Bank of St. Louis President James Bullard said he is backing two more rate increases. Even the dovish Neel Kashkari said if the Fed does pause, it should signal tightening isn’t over, reports Bloomberg.
After the personal consumption expenditures price index, the Fed’s preferred inflation gauge, rose a faster-than-expected 0.4% in April, Cleveland Fed President Loretta Mester told CNBC, “When I look at the data and I look at what’s happening with inflation numbers, I do think we’re going to have to tighten a bit more.”
She said, “Everything is on the table in June.”
Everything but market price discovery.
Entreprenuership Breaks Out at Taylor Swift Concert
The flowers of entrepreneurship bloom in the strangest places. Misesian entrepreneurs attending the rain soaked Taylor Swift concert at Gillette Stadium in Foxborough, Massachusetts determined there would be a market for rain which had fallen near the pop diva.
The New York Post reported “some entrepreneurial fans are capitalizing on and trying to flog online for $250.” This brings to mind what Ludwig von Mises wrote in Human Action, “The only source from which an entrepreneur’s profits stem is his ability to anticipate better than other people the future demand of the consumers.”
To that point, it would take a Swifty to know Swifties and their individual demand curves. Upon seeing pictures of the collected moisture one person commented “I know a weed container when I see one lol.” I can hear Murray Rothbard saying “So what, they dumped their pot in a dry place and used what they had to collect. Bravo!” In print, he wrote in Economic Thought Before Adam Smith, “[I]t is the function of the businessman, the ‘undertaker,’ the entrepreneur, to meet and bear that uncertainty by investing, paying expenses and then hoping for a profitable return.
Another online commenter (obviously not an Austrian) left the entrepreneur completely out of the process, “When the stoners and the swifties unite.” Yes, but it was entrepreneurship that brought the two worlds together. It didn’t happen magically by itself. It took forethought and action. While many are snickering at all this, we should be reminded, “No dullness and clumsiness on the part of the masses can stop the pioneers of improvement,” wrote Mises. “There is no need for them to win the approval of inert people beforehand. They are free to embark upon their projects even if everyone else laughs at them.”
“Jealous I didn’t come up with this scam first,” one user commented on an Instagram post showing a screenshot of the optimistic seller. Selling water honestly harvested from a Swift concert certainly would not be a “scam.” However, fraudsters might collect rain at another place and time and peddle the liquid as having fell ever so close to Ms. Swift. Fraud or entrepreneurship. A fine line indeed.
The World According to a Fed Governor
On Wednesday, Federal Reserve Governor Philip N. Jefferson offered insights on the economy and the role of the Fed. The irony is evident as we find that those entrusted with overseeing the economy appear to be continuously involved in a journey of self-discovery, yet their understanding often lacks any connection to the real-world economy.
He begins with an overview of the Federal Reserve's approach to financial stability:
A stable financial system is resilient even in the face of sharp downturns or stress events. It provides households and businesses with the financing they need to participate and thrive in a well-functioning economy. It is difficult to anticipate or prevent shocks, but sound policies can mitigate their impact.
At the Federal Reserve, we work hard to make sure that an initial shock in one area of the financial system does not spill over to other markets or institutions and cause severe or widespread strains.
According to the Fed, when there are “sharp downturns or stress events” in the financial system, it is expected that a central bank will intervene to address and resolve the issues. However, what caused these events in the first place is often left unexplored, and there seems to be a reluctance to even consider the possibility that the Fed itself could be a contributing factor to such occurrences.
It is unlikely that the Fed would openly acknowledge itself as the cause of a financial crisis, as doing so would reveal a truth that those in positions of power would prefer to conceal from the public.
And so, we are often presented with red herrings like the narrative of corporate greed or inept bankers, even if only subtly implied, as the Governor illustrates.
The Federal Reserve, using existing regulatory and supervisory tools, is working to ensure that banks improve and update their liquidity, commercial real estate, and interest rate risk-management practices.
These distractions divert our attention from the underlying systemic issues as they put the fault in poor practices by banks, rather than the market distortions caused by the Fed.
The Governor offered little in the way of explanation for the deceleration in the pace of rate hikes, even in the face of ongoing high levels of (monetary) inflation.
Since late last year, the Federal Open Market Committee has slowed the pace of rate hikes as we have approached a stance of monetary policy that will be sufficiently restrictive to return inflation to 2 percent over time.
Despite the Core Personal Consumption Expenditure reaching 4.7% over the course of a year, as reported by CNBC, it’s perplexing that a more aggressive approach to raise rates until the 2% target is achieved hasn’t been implemented. Instead, there is a growing sense that a rate pause, or cut is on the horizon.
Perhaps this is why he reiterated:
A decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle.
This follows the idea of not believing anything until it has been officially denied. However, it is important to recognize that the statements made by the Fed Governors often serve as a form of damage control, quasi-economic propaganda, or a means to alleviate the press burden on Chair Powell. With the upcoming June 14 meeting just two weeks away and the current probability of no rate hike standing at 62% according to the CME FedWatch Tool, it remains to be seen whether the Fed has finally abandoned its pursuit of raising rates to “fight inflation.”
Fewer Americans Say They Are Doing "Okay" Financially
In a 2022 survey of over 11,000 respondents, it was found that:
… 73 percent of adults were doing at least okay financially, meaning they reported either “doing okay” or “living comfortably.”
This is 5 percentage points lower than the prior year and one of the lowest observed since 2016.
These findings were published by the Federal Reserve in the report titled Economic Well-Being of U.S. Households in 2022. The report attempts to examine the financial lives of U.S. adults and their families. With the data collection occurring in October of last year, the time lag is considerable.
Overall, the report shows that higher prices have negatively affected most households and overall financial well-being declined over the prior year…
Notable highlights from the fact sheet include:
- The share of adults who said they were worse off financially than a year earlier rose to 35 percent, the highest level since the question was first asked in 2014.
- Some renters indicated they had difficulty keeping up with their rent payments. Seventeen percent of renters were behind on their rent at some point in the prior year.
- Nearly two-thirds of adults stopped using a product or used less because of inflation, 64 percent switched to a cheaper product, and just over one-half (51 percent) reduced their savings in response to higher prices.
The focus of the report primarily revolves around capturing sentiments, emotions, and perspectives on financial well-being, but it fails to delve into the underlying causes of any of the hardships noted. For example, one finding is that:
… higher-income adults were more likely than lower income adults to mention financial challenges related to retirement…
Yet this is hardly a new concept as the Austrians explained how the expansion of the money supply affects people and prices differently over a century ago. Certainly wealthier individuals tend to be more insulated from currency debasement, but it is also because those who receive newly created money first benefit at the expense of all others.
The report does support the idea that year after year life becomes increasingly difficult as dollar purchasing power continues to decline. This can manifest as unaffordable rents, price increases, and a general sense that the future looks bleak. All the while, the increase in interest rates, as we’ve been told is necessary to combat high prices, has only made the cost of carrying debt even more burdensome.
At best, the findings inadvertently shed light on the merits of Austrian economics, revealing the inherent issues arising from the problem with controlling the money supply and interest rates, both of which fall within the purview of the Fed. It serves as a stark reminder that a fairer world would exist if the global financial system did not rest on the whims of a select few individuals. And so, we find ourselves living under the plan of a central bank that continues to examine the detrimental consequences of its own policies, more for public spectacle than anything else.
Doubts Raised About Secretary Yellen’s June 1st Deadline
House Speaker Kevin McCarthy (R-CA) and President Joe Biden have nine days left to reach a spending deal before the U.S. defaults on the debt and everything falls apart… or do they? Three weeks ago, Treasury Secretary Janet Yellen announced that the so-called X-date, when the U.S. would begin to default, would be Thursday, June 1st.
As of last week, that projection was widely accepted. Speaker McCarthy told reporters he trusted Yellen: “Whatever Janet Yellen says is the date. I’m not going to argue about that.”
But this week the tune has changed. Today a handful of Republicans voiced skepticism about the accuracy of Yellen’s deadline.
Rep. Matt Gaetz (R-FL): “I don’t believe that the first of the month is the real deadline. I don’t understand why we’re not making Janet Yellen show her work.”
House Majority Leader Steve Scalise (R-LA): “We’d like to see more transparency on how they came to that date.”
Rep. Ralph Norman (R-SC): “June 1st? Everybody knows that’s false.”
In an interview on CNBC this morning, Senator Ted Cruz (R-TX) accused the Biden Administration of trying to “scaremonger” and “threaten default.”
Rep. Chip Roy (R-TX) today called the warnings of default a “manufactured crisis” to force Republicans to step back from some of their demands.
And it’s not just Republicans. Goldman Sachs says the actual deadline is likely June 8th or 9th. Morgan Stanley says June 8th. And the Congressional Budget Office (CBO) states there is an “elevated risk” of payment default in the first two weeks of June.
All this comes one day after a puff piece in Politico celebrated the “civil servants” at Treasury who stand above politics and “whose only real interest is the health of the financial system.” The evidence for this? Secretary Yellen isn’t directly involved in negotiations with Republicans.
The White House is taking a somewhat arms-length approach to how Treasury goes about its work. The two operate closely on messaging, but one White House official told [Politico] that the intention is for Treasury to be seen as having a degree of independence. It’s so Yellen’s default warnings are taken seriously and so the “X-date” — the projection of when the government can’t pay all its bills — doesn’t become politicized.
This is just the latest example of a common cliché in political media whereby some executive agency or federal department staffed primarily with unelected bureaucrats is falsely praised for being “non-political.”
Usually, this depiction is false because it equates being non-political with being non-partisan. But on many of the most important political issues of the day, the two parties are unified. Still, it’s understandable why people fall for the trick.
But here we’re talking about a member of the President’s Cabinet. That’s about as nakedly partisan as it gets.
The debt ceiling showdown is a game of chicken—what in game theory is called a hawk-dove game. The ideal outcome for each player is for the other player to yield, while the worst outcome for all is if neither yields by the time the game reaches a critical juncture—be it a head-on car collision or a debt default.
Thanks to negotiations, the debt ceiling showdown is less binary in its outcomes than two teenagers driving straight at each other. But the basic hawk-dove structure is still at play. As such, it puts one side at a serious advantage if the other side believes the critical juncture will be reached sooner than it actually will.
Is that what Yellen is doing? We can’t know for sure without seeing how Treasury arrived at a June 1st deadline and without knowing what Yellen has been telling Biden’s people behind closed doors. But, at the same time, let’s not pretend the Treasury Secretary—appointed by the President to sit on his Cabinet—is impartial to Biden’s efforts.
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A Voluntaryist's Addition to the State Capitalist Tradition
State capitalism is typically viewed as anathema to the voluntaryist tradition. However, there are takeaways from the idea that might prove useful for our tradition. Particularly, I am concerned with our inability to counter certain critiques coming from the “libertarian” left. In this article, I am proposing a new system of governance that would address these critiques.
Well, first let us start with what critiques need discarding. Among those to discard, parents who sell their young into labor and being underpaid or worked overtime. We should not dignify these questions; they detract from one major critique- that our society might empower a business entity to act and serve as a de facto government.
Now if there is no state, there is no rent seeking, and we very frequently point this out to our detractors. However, political ecosystems are organic and that makes self-interest a bending will in anarchy too. So, what is the alternative?
First, imagine there is a charter in the proposed society. A charter is a document that grants rights to the public, to individual constituents of that society. It is essentially a constitution for all intents and purposes. Now, this charter establishes a company. So, a chartered company does not define any limitation or minimum as to its size, but it does establish an unchangeable structure with its board of directors.
This chartered company would be classified as “the government.” It is where the semantics kill, as “the government” would be forbidden from obtaining and exercising police powers, taxation or anything else that implies infringement. It is in essence, a nominal government and placeholder at that. It is a placeholder, to preclude another company from acting as substitute authority and nothing more.
This is important, particularly as it pertains to a lack of power to tax. Why? Not only is taxation theft, but it also means a lack of fiscal responsibility or general merit. If the state can extort to cover its shortcomings, it isn’t incentivized to check itself. So, this problem is averted. This is averted, that matters because "the government" here will be operating like a business.
Why then define “the government” in my proposed system as a chartered company? If it is simply a state without a social contract, that question probably runs through your mind. Easy, it operates as a business does in the way it will sell its services. Think of welfare as a private good that competes with its competition on the market. If it has no power to extort to cover its losses, it must appeal to the consumer.
That is not irrelevant in the system I propose, because there are private businesses all around “the government.” “The government” does not have a monopoly, the way other forms of state capitalism do. So, it is certainly competing inside the marketplace, now it hopes to make a profit. These profits are a substitute for taxation. Profits, not taxation, make sure “the government” stays in-business.So for instance, one of the products that "the government" wants to sell is healthcare. It must do better than Aetna or Blue Cross, that is earn a bigger profit by catering to its audience and double-checking any loose expenses.
Simple enough, right? Aside from establishing “the government,” this charter document establishes a protocol for its own nationalization. Here, nationalization of “the government” means the assumption of direct democratic control over itself. The common public would oversee and operate for each transaction or managerial decision in “the government” by referendum, in other words. The protocol is this- a popular referendum may be called by any citizen, should “the government” fail in keeping its finances from bankruptcy.
This nationalization could only happen at that point. Further, any direct democratic control would be forbidden from changing the terms in the charter document. Purely, it gives them control over its operations and employment but nothing else. It is here, the fun begins as it is not meant to check against power. Rather, it is expected that nationalization could only reinforce a cyclical bankruptcy that empowers a growth of private competitors to outcompete “the government.”
Most important in all of this might be that it gives the “libertarian” leftist a sense of control with which to keep himself comfortable. Further, its "nationalization" protocol ensures that any demand that a state be invented should operate wholly within a controlled paradigm. Because any scandal or failure is easily exploited to that end, it is time that this be planned for.
U.S. Treasury Bailouts Aren’t What They Used to Be
United States citizens are watching a deteriorating tango between banks and the federal government. Bank depositors have been losing confidence in the value of their bank deposits, while credible market signals flag higher concerns about the credit quality of the United States Treasury.
In recent months, credit default swap spreads for Treasury debt have risen significantly. They are based on financial instruments that yield information about the implied probability of default. For the U.S. Treasury, that implied probability remains low, but it has been climbing to recent-record-high levels.
In the latest collection of market information reported at “WorldGovernmentBonds.com,” the United States ranked 16th among 25 countries in terms of the implied probability of default on their sovereign debt. In May 2020, after the market (and credit rating agencies) had begun to digest the implications of the COVID pandemic for economic and government finances, the United States ranked fourth on that list.
Appraisals of the probability, value, and wider implications of future bank bailouts have to consider the decline in confidence in US Treasury credit quality, both in absolute as well as relative terms, in the last few years.
Granted, the recent concerns have been driven in part by a rancorous but possibly temporary debt “ceiling” negotiation process. But these intensified tensions owe no small debt to the real deterioration in the federal government’s financial condition in recent decades.
Can we rely on still-high credit ratings for the US for comfort? Perhaps the wise sages in the credit rating agencies do a good job of “looking through” short-term political considerations in their appraisals of longer-term credit quality. But a careful look at historical experience suggests market signals lead credit ratings, not vice versa. And in the last three years, the distribution of rankings of countries based on the CDS market data did a much better job of anticipating the rankings for current country credit ratings than the three-year-old ratings rankings did in anticipating current rankings on CDS data.
For uninsured bank depositors in a bailout, getting par value may be better than not getting a bailout. But getting paid back “par” value in dollars that aren’t worth what they used to be generates real economic losses – for depositors as well as all of us.