“It’s not as if the bond bubble is fun while it lasts. It’s painful for savers and corrosive for society to have governments systematically punishing thrift. It also encourages reckless governments to spend further beyond their means when they are rewarded for borrowing in this way. Perhaps it’s no surprise that the government-engineered bond bubble hasn’t delivered…

…the promised economic growth. Who can confidently invest when the official price of credit appears to be so dishonest?…Ms. Yellen described the various ways the Fed has intervened and will intervene in the future. She explained that she can’t predict future rates “because monetary policy will need to respond to whatever disturbances may buffet the economy.” Historians may look back on this era and conclude that central bankers themselves were the primary disturbances buffeting the economy. George Gilder notes in his new book, “The Scandal of Money,” how much faster the economy grew in the postwar period before the Fed and other central banks employed such expansive tool kits. Mr. Singer, the hedge-fund manager, wonders why the Fed still enjoys such power even after its “cluelessness” before the last crisis. Instead of monetary extremism he recommends reforms in tax, regulatory, education and trade policies to spur growth. Investors are left with the hope that today’s central bankers have achieved a wisdom that somehow eluded other policy makers for 5,000 years.”, James Freeman, “The 5,000-Year Government Debt Bubble”, The Wall Street Journal, September 2, 2016

“This massive bubble is in plain sight and yet many, if not most, even many of the top economists and institutional investors make arguments for why its not a bubble. The minority, like this article are issuing warnings….but a 35 year bond bull has destroyed the will of most of those concerned about this bubble. This is exactly why, while most everyone knew pre-crisis home prices were high, they couldn’t “decide” that it was a bubble until after the fact. As the article notes, this bubble is much, much larger than the pre-crisis worldwide housing (and other asset) bubble and it seems like this one will end badly also. Clearly, these bubbles aren’t being caused by imprudent lenders…as the article notes, imprudent lending and borrowing is just a symptom of central bankers’ distortion of the free and fair markets.”, Mike Perry, former Chairman and CEO, IndyMac Bank

Opinion

The 5,000-Year Government Debt Bubble

Should investors buy the most expensive bonds in recorded history?

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PHOTO: GETTY IMAGES

By James Freeman

Politicians playing by their own rules is an old story. But it should count as news that politicians have lately been rewriting a rule in place since 3,000 B.C.

This rule of history is that savers deserve to be compensated when they loan money. Not anymore. In much of the developed world lenders are the ones paying for the privilege of letting governments borrow their cash. Through the magic of modern central banking, countries in Europe and elsewhere have managed to drive their borrowing rates not just to historic lows but all the way into negative territory. As of Monday almost $16 trillion of government bonds world-wide were offering yields below zero.

Amazingly, governments have managed this feat even as they have become more indebted and even as slow economic growth undermines their ability to repay. Such conditions normally suggest a less creditworthy borrower and therefore a higher interest rate to compensate investors for the risk. But sovereign debt has become more expensive. Governments have succeeded in making their bonds more expensive in part by printing money and buying the bonds themselves via their central banks. Commercial banks are all but required to buy them too.

In the new political economy—or alchemy—the more unsustainable a government’s finances, the less it pays to borrow. Japan’s government debt amounts to more than 200% of its economy. The yield on Japan’s 10-year bonds recently clocked in at negative 0.06%.

What does history have to say about this? In the Swiss financial publication Finanz und Wirtschaft, James Grant notes that as far as he can tell it’s never happened before. He cites the work of New York University Prof. Richard Sylla, who wrote “The History of Interest Rates” along with Sidney Homer. Mr. Sylla tells me there are “precious few minus signs before any rates” in his book. The only ones he can recall were on U.S. Treasury bills around 1941, just before Pearl Harbor. But “later research showed that anomaly might be explained by an option value embedded in bills then, so the negative yields may have been an artifact.” Mr. Sylla sums it up: “There were no negative bond yields in 5,000 years of recorded history.”

Put another way, government bonds have never been so expensive. Paul Singer, founder of hedge fund Elliott Management, isn’t expecting a happy ending. He believes that because of massive entitlement promises plus huge debt, “the entire developed world is insolvent.” He says that a negative rate on a government bond is “crazier than zero, and zero was crazy enough.”

Not everyone agrees. Ray Dalio, founder of Bridgewater Associates, the largest of the world’s hedge funds, sees diminishing returns from these monetary exertions. But with little inflation in sight he doesn’t see a strong case for lifting rates. He thinks central bankers will be able to manage the transition when the time comes to raise rates.

However it ends, the deflating of the sovereign debt bubble may have us longing for the carefree days of the 2008 mortgage crisis. Internationally tradable sovereign bonds amount to nearly $60 trillion, according to the Institute of International Finance. That’s about six times the mortgage-debt outstanding for American homeowners. But these sovereign bonds are a mere fraction of the liabilities carried by the world’s governments. If you count political promises to support retirees, patients and others, the obligations are hundreds of trillions of dollars higher.

Though the government debt market is significantly larger than the mortgage market, there are similarities. During the housing boom, we witnessed all kinds of innovations in the world of housing finance, such as “no-doc” loans in which the borrower’s income and assets weren’t documented. These were sometimes called “liar” loans.

The sovereign-debt boom certainly has its share of liar loans. European countries routinely violate pledges to limit budget deficits. As for documentation, has anyone found a thorough and comprehensible description of government accounting?

When it comes to income, governments have a great advantage over homeowners because politicians enjoy the power to tax. But who can verify that the Italian government, for example, will be able to collect the revenue to pay its bills?

It’s not as if the bond bubble is fun while it lasts. It’s painful for savers and corrosive for society to have governments systematically punishing thrift. It also encourages reckless governments to spend further beyond their means when they are rewarded for borrowing in this way. Perhaps it’s no surprise that the government-engineered bond bubble hasn’t delivered the promised economic growth. Who can confidently invest when the official price of credit appears to be so dishonest?

The U.S. is just a few steps behind Europe and Japan in its monetary experimentation. Federal Reserve Chair Janet Yellen didn’t advocate for negative rates when discussing her monetary “tool kit” in last week’s speech in Jackson Hole, Wyo., but Fed staff have been studying the issue. And the tool kit is already crowded, as Ms. Yellen described the various ways the Fed has intervened and will intervene in the future. She explained that she can’t predict future rates “because monetary policy will need to respond to whatever disturbances may buffet the economy.”

Historians may look back on this era and conclude that central bankers themselves were the primary disturbances buffeting the economy. George Gilder notes in his new book, “The Scandal of Money,” how much faster the economy grew in the postwar period before the Fed and other central banks employed such expansive tool kits.

Mr. Singer, the hedge-fund manager, wonders why the Fed still enjoys such power even after its “cluelessness” before the last crisis. Instead of monetary extremism he recommends reforms in tax, regulatory, education and trade policies to spur growth. Investors are left with the hope that today’s central bankers have achieved a wisdom that somehow eluded other policy makers for 5,000 years.

Mr. Freeman is assistant editor of the Journal’s editorial page.

Posted on September 5, 2016, in Postings. Bookmark the permalink. Leave a comment.

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