Tuesday, June 25, 2013

The Bond Market Is Not Our Friend

Pundits are up in arms about falling bond prices: The End of the Bond Bubble! Unintended ramifications around the world! Bernanke misfires!

We should not care about the fate of bond investors or, even less, leveraged bond investors. Screw them. They made money on the same trade for thirty years and now the pond is fished out. The lowest bond yields in U.S. history may actually prove to have been historically low. Yes, I suppose we could peg to the yen and see even more miniscule yields. But if that happened, we’d be Japan, Land of Zero Growth and uncontrollable debt.

The bond market is not our friend, it is our enemy. It might have been our friend in 1980, when we desperately needed higher bond prices. But today, we desperately need  lower bond prices.  

The United States economy has been suffering from Chronic Fatigue Syndrome for the past four years. We have had no energy, and just taking a brisk walk around the block has been a strain. We have been suffering from an ever-growing nominal output gap (and indeed, a real output gap as well).

The economy lost its mojo after the Crash, and can’t seem to get it back. Real growth has been stuck at 2%, half of what we need, and nominal growth has been stuck at 4%, not enough to generate adequate real growth, nor to get us out of our debt trap.

You could say that the US has been suffering from Inflation Insufficiency Syndrome. We will never get 4% real growth with 3.4% nominal growth. If we want to speed up real growth, we will need to get nominal growth about twice as high as it is now. We don’t just need higher inflation, we need higher inflationary expectations. 

But as long as the FOMC goes on about how wonderful it is that “inflation expectations are well anchored”, we won’t get near 4% real growth. Yes, Bernanke knows this, but he lost his intramural war against the hawks. Or rather, he prioritized having a consensus with the hawks over growing the economy and helping the unemployed: the all-important “institutional credibility” mandate that always manages to trump employment.

So please close your ears to the screams of bond investors, and the still-louder screams of highly leveraged bond investors; they are our enemy. Carthago delenda est. Now unfortunately, I'm not predicting such a blessed victory. Certainly the tapering of QE is no reason for the bond market to crater. If the Fed ever really does hit the brakes, bond prices will rise, not fall. We will need much higher inflation for the bond market to really go under, and I don't see much hope of that. But that's what we need.

Pray for a bond market rout, but don't hold your breath waiting for it.

No comments: