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Chartbook 238: Making & remaking the most important market in the world. Or why everyone should read Menand and Younger on Treasuries.
American public finance has long been closely intertwined with the American monetary framework and that deep and liquid Treasury markets are, in large part, a legal phenomenon. Treasury market liquidity, in other words, did not arise organically as a product primarily of private ordering. Instead, it was actively constructed by government officials. The high degree of convertibility between Treasury securities and cash—the market’s “liquidity”—depends upon entities that can create new, money-like claims to buy Treasuries. Sometimes the government’s central bank has issued these claims directly, as in March 2020; other times these claims were issued by central bank-backed instrumentalities, such as banks and select broker-dealers.
Goodbye to the Bull Market for US Treasury Bonds - Bloomberg
Second, the US government’s fiscal health keeps deteriorating: Last month, the Congressional Budget Office raised its estimate of this year’s federal budget deficit to $1.7 trillion from $1.5 trillion, and no improvement is likely anytime soon given the political deadlock in Washington. The outlook will probably deteriorate further as higher interest rates drive up debt service costs and retiring baby boomers push up Medicare and Social Security expenditures. Larger deficits push up r*, and add to the bond term premium by increasing the risk of long-term lending to the US government.
The Shadow Is Born: How the Fed Helped Spawn a $23.7 Trillion Market - Bloomberg
Dwight Eisenhower ran on a simple platform best characterized by his homey “I like Ike” slogan, but also heavily steeped in dissatisfaction caused by the inflationary resurgence. In echoes of the debate over Modern Monetary Theory, Eisenhower repeatedly cautions against massive federal spending: “I know that anyone who speaks up against deficit spending is accused by the ‘sophisticated’ liberals of being more interested in money than in people. But I ask, what is more inhumane to more people than deliberately taking away the value of the money on which they must live in the future?”
Government has no room to maneuver
the US government is slowly giving up its room for fiscal maneuver. Non-defense discretionary spending made up over 60% of the federal budget in 1962. By 2017, that figure has fallen to 15%, and it’s expected to continue its decline. As that share falls, I wonder how that affects the mindset of legislators, who anticipate diminishing responsibility for allocating funds. In absolute terms, the budget they control is still enormous. But I suspect that it takes away the initiative of US politicians: they can simply let the government go on autopilot, since their predecessors have already committed most available funds. If legislators no longer have room to identify new initiatives for spending, what is there to do except find new things to ban, and then argue with the other side?
