Crowding Out Not Gonna Happen Soon

With unemployment hovering near 10% for nearly two years now, it should be obvious that the economy is no where near capacity.  Yet, many on Wall Street and in the talking-head TV shows continue to maintain that government borrowing is “crowding out” private investment (or going to soon).  Um, I don’t think so.  Crowding out would be seen in rising interest rates.  But a look at the data shows we’re still hard against the “zero bound”.  In other words, interest rates are still about as low as they can go.

US Government Short run interest rates near zero for 2008-2010

News Flash: US Not Dependent on China

Facts are stubborn things.  For the crowd that believes government borrowing drives up interest rates and “crowds out” private investment, facts and reality are also very inconvenient.  Marshall Auerbach, guest blogging for Yves Smith at Naked Capitalism reports the latest facts:

In a post titled “China Cuts US Treasury Holdings By Record Amount,” Mike Norman makes the excellent observation that while China is moving its money out of Treasuries, interest rates are hitting record lows. In other words, the sky still isn’t falling. So, Mike wonders, “Where is the Debt/Doomsday crowd?” He rightly concludes: “They’re nowhere to be found because they can’t explain this. This is a ‘gut punch’ to them. Their whole theory is out the window. They just don’t understand or don’t want to understand, that interest rates are set by the Fed…PERIOD!!!”

Mike is right, but that won’t stop the doomsayers. They will tell us that we should thank our lucky stars that another source of demand came in to replace China. Even when confronted with facts, the “China will sell off all their treasury holdings and destroy the US economy” brigade is not dissuaded.

As my friend, Warren Mosler, has noted many times, “It’s just a reserve drain, get over it!
And if you don’t understand that, try educating yourself before you sound off.”

Also of note today: Tokyo’s Nikkei QUICK News reports that the #309 10-year Japanese benchmark government bond, the current benchmark, traded to a yield of 0.920% Tuesday morning, down 2.5 basis points from yesterday’s close. This is the lowest yield since August 13, 2003. This, from a country with a public debt-to-GDP ratio of 210%!

The idea of shorting JGBs on the grounds of Japan’s imminent national insolvency has been one of the most “obvious” trades for years, but it’s never worked. And it won’t work because the Bank of Japan, like the Federal Reserve sets rates, not “the markets”. The “national insolvency” brigade doesn’t understand basic public reserve accounting. Plot the rise of Japanese public debt against the fall in Japanese bond yields (the latter which can be seen here since 1985 – http://www.boj.or.jp/en/type/stat/dlong/fin_stat/rate/hbmsm.csv). Where’s the causality?

The problem, as Bill Mitchell has repeatedly noted, is that the credit binge that preceded this crisis has left a lot of private consumers and investors in diabolical straits with too much nominal debt and declining values of the assets the debt backed. The need to remedy this problem led to a widespread withdrawal of private spending as the pessimism of future growth spread and the expenditure multipliers reverberated this pessimism across the world economies. The offset to that has been a rise in public sector debt to facilitate this ex ante desire to save on the part of the private sector. Absent that, you get Fisher style debt deflation dynamics a la the 1930s.

These are facts. Inconvenient for those who like to perpetuate the lie that the US or Japan faces imminent national insolvency as a means of justifying their almost daily attacks on proactive fiscal policy.