This is in response to Dr. Krugman's May 24, 2011 blog entry: Debt Arithmetic: Wonkish
"Still, Serious People tell us that investors will turn on us unless we slash the deficit immediately — and they know this because, well, um..."
Apparently, these "Serious People" think that investors won't want to buy US Treasury debt at anything like the current, very low, interest rates. Rather, these "Serious People" seem to think that investors will demand much higher interest payments to be willing to loan money to the US Treasury. I think that is the core of Dr. Krugman's argument.
Let's look at that.
Right now interest rates are low, very low. They have been low for a couple of years now. At face value, that sure seems to indicate that investors are willing to loan to the US Treasury for very little nominal return. Case closed.
There is one massive elephant in the room that Krugman, (and the myriad of others who I've seen make this same argument), just ignore. Who are these "investors" that are willing to loan the US Treasury over $1.4 trillion a year for the past 3 years at such low rates?
And this is where it gets interesting, (by "interesting" I mean, "bad").
Last year, the Federal Reserve was the buyer of 60 to 70% of the net US Treasury issuance. In January, they bought ~ 80%. In February their purchase of $94 billion in US Treasury debt exceeded the net debt increase of $85 billion. Via QE2, the Federal Reserve is purchasing $100 billion in US Treasury debt each month. This is at a time when the net US Treasury borrowings are ~ $133 billion a month.
Fully 3/4 of the money the US Treasury is borrowing each month is coming from a single investor.
That investor has no opportunity costs associated with their purchases -- their purchase of US Treasuries does not come at the expense of being able to buy some other asset. The money for these purchases is brand new, created by the Federal Reserve for just this purpose.
Currently, the Federal Reserve intends to let QE2 end in June (as originally planned). Who steps in to fill the gap when they do?
What other investor or group of investors has $100 billion to loan to the US Treasury in July, and August, and September....
"Serious People" are wondering why these investors will suddenly step forward in July to buy US Treasuries at these ultra low rates. After all, if there really was $100 billion in additional demand for US Treasury debt at ultra low rates, why would the Federal Reserve have to "print" up $100 billion in fresh new dollars each month just to buy US Treasury debt?
When you actually look at the really interesting question regarding US Treasuries, what you discover is that the US Treasury market is a whole lot like the mortgage market. Would mortgage rates increase if Fannie and Freddie simply stopped buying mortgages? Even those that aren't "Serious People" recognize that the housing market would more or less collapse overnight if lenders were stuck keeping the mortgages they made or sell them to an investor that can't absorb billions of losses each quarter indefinitely. In fact, it was this exact argument that led to Fannie and Freddie being taken into conservatorship.
There is one thing I would really like to know though: does Dr. Krugman ignore this massive support/intervention in the US Treasury market because he is:
- too lazy to see who is buying US Treasuries,
- too stupid to realize that having the Federal Reserve buy 75% of the net issuance matters,
- or simply lying.
I can't tell. What I do know is that the lazy, stupid, or lying questions keep coming up when I read the stuff he writes.