Thursday, March 26, 2009

What if they gave a government bond auction and nobody came? Part II 
The UK can't sell new debt.

Liquidity isn't infinite. The only reason the US and UK and other sovereign governments have been able to float as much debt as they have is because assets have been fleeing equities, real estate, mortgage pools, structured debt, and other asset classes as fast as they can go, in a massive flight to safety.

When the owners of capital perceive that other asset classes are more appropriately priced, that process will reverse. Government debt prices will fall, yields will rise, and Obama and his crew will find less and less capital available to fund the massive new debt he is committing to.

When yields fall, capital could leave the government bond markets pretty quickly, as traders seek to avoid being the last guy holding the bag.

There's no way out of that problem, and we can't inflate our way out of it. If we try to inflate our way out, then bond prices will fall and interest rates on new debt will rise as markets build future inflation assumptions into interest rates. (Real interest rates cannot stay negative for very long.)

Watch for a steepening of the yield curve if this should happen, combined with an overall rise in yields. We've already seen one. The other will come.

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>> inflate our way out, then bond prices will fall and interest rates on new debt

How do you pick up this stuff?! I can’t recall if you received a formal economics education, or if you are mostly self taught?

I’m economically illiterate. Can you suggest 2 or 3 books one can read, to start to get up to speed?
Mr. Kiyonaga's Economics class. Sophomore year of high school at Kalaheo High School in Kailua. :-)

Self-taught, but I worked as a financial industry journalist from 2000-2007.

My single favorite econ book is "Secrets of the Temple: How the Federal Reserve Runs the Country" by William Greider. It's just a history of the Fed under Volker, but there's a wonderful economics history and background section at the front of the book. Well worth the price of admission.
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