The Financial Ninja:The Dangerous Steepening of the Yield Curve

Posted by Kendall Harmon

A quick follow up to yesterday's post With Each Interest Rate Tick Higher Another "Green Shoot" Dies....

We are drowning under the weight of near term supply for sure but I guess I think something else is afoot here.

Look at the breakeven spread on the 10 year TIPS bond. That spread is currently 185 basis points. I do not believe that we have been that wide since the advent of the financial crisis in 2007. I think that investors are uttering a gigantic and collective nyet regarding the implementation of monetary policy and fiscal policy in the US.That is why the curve is steepening so dramatically.

Yuck. Read it all and follow the links.

Filed under: * Culture-WatchGlobalization* Economics, PoliticsEconomyCredit MarketsHousing/Real Estate MarketThe Credit Freeze Crisis of Fall 2008/The Recession of 2007--The U.S. GovernmentBudgetThe National DeficitThe United States Currency (Dollar etc)

Posted May 28, 2009 at 8:08 am [Printer Friendly] [Print w/ comments]

1. Bart Hall (Kansas, USA) wrote:

In any normal inventory-adjustment recession the development of a rapidly steepening yield curve should be taken as a sign of approaching improvement. We are, however, in a balance-sheet-adjustment event, previous versions of which have all been labelled as depressions.

We are furthermore entrained in a somewhat unique situation these days, as this is the first balance-sheet event to be faced with fully fiat money. In such an environment a steeply rising yield curve is correctly viewed with some alarm, for it does indeed presage the abandonment of most longer duration sovereign debt as a productive investment instrument.

Things remain—for now—relatively orderly. They are likely to become rather less so, as last autumn’s rout in equities and commodities demonstrated so clearly. When all manner of investors abandon government instruments as a viable investment vehicle, governments become unable to finance themselves apart from explosive tax increases adding evermore dead weight to the real economy.

Interest rates soar, bleeding the life out of businesses and families. They also crush any hope of improvement in real estate, either residential or commercial.

Banks call or cancel loans—over a trillion dollars in the last two quarters of 2008 alone (even before the current emerging problems with sovereign debt, so that was just a warm-up)—and they certainly refuse to lend any more at terms people can manage.

A year ago four-dollar gas pushed the economy over the edge. Now imagine ... soaring interest rates, soaring taxes, soaring energy costs, and soaring unemployment ... all at once.

May 28, 10:18 am | [comment link]
2. Jeffersonian wrote:

It’s not like we haven’t had plenty of warning, Bart.  People versed in this sort of thing have been sounding the alarm for at least two decades that federal borrowing and spending have been spiraling out of control, yet President after President, Congress after Congress have just kicked the can down the alley, hoping the music doesn’t stop on their watch.  Well, now it’s crunch time.

May 28, 11:42 am | [comment link]
3. Ad Orientem wrote:

Giving credit where it is due the Republican Congress back in the 90’s (back when they still were fiscally conservative) and then President Clinton did a remarkably good job of keeping spending under control.  Taxes went up slightly, some spending was cut and the growth of government slowed.  The budget was balanced and we were even paying down the debt.

Then came eight years of fiscal insanity.  Thank you G. W. Bush…

And now we have Zero…  Who inherits a house on fire and decides to throw gasoline on it.

We are doomed.

May 28, 3:00 pm | [comment link]
4. Jeffersonian wrote:

We thought it was fiscal insanity, AO, until Obama got into office and showed us Bush 43 was just fiscally neurotic.

May 28, 3:52 pm | [comment link]
5. Ad Orientem wrote:

I think Bush’s standing as the most fiscally reckless president in modern American history is still intact.  Zero hasn’t been in office long enough to take that title yet.  But early indications are that he is going to give it a mighty try. 

Most of the country’s mountain of debt still G.W.B. stamped on it.  But at the rate Zero is planning on spending money I don’t think it will take him any wheres near eight years to overtake Bush.  He will likely accomplish as much or more damage in less than than the four years we know we are stuck with him.

Pondering the decline and fall of great republics…

May 28, 7:02 pm | [comment link]
6. Jeffersonian wrote:

As you can see from this chart, Obama’s first year budget deficit (and it is his…Congress deliberately delayed passing this year’s budget on the expectation of Obama being in the White House) nearly totals the sum of all of Bush’s profligate deficits over eight years.  Indeed, Obama is planning on spending enough to double the cumulative debt piled on from every President from Washington to Bush 43 if he, God forbid, remains in office the entire possible eight years.  And that’s before he racks up even more debt by doing for our medical system what Joe Stalin did for Soviet agriculture.

May 28, 9:34 pm | [comment link]
7. Ad Orientem wrote:

Ah.  But this is predicated on accepting the fiscal smoke and mirrors that the Bush Administration played, like keeping the expenses of two wars off budget.  Obama (give the devil his due) put them on the budget.  The figures shown by the chart show those of the official budgets during the Bush years which were in no way an accurate reflection of government spending.  The massive differences from last years budgets and this years is mostly war spending which the White House now is reporting as part of the budget and which Bush vigorously refused to do.

Yes, Zero’s spending is significantly higher. But the difference is not THAT big.  The chart is quite misleading.

“Republics rarely outlive by long the realization on the part of the people, that they can plunder the public treasury for their own uses.”

May 28, 10:38 pm | [comment link]
8. Ad Orientem wrote:

As a followup to my previous post…
I think the one overriding point is that one can not live on borrowed money indefinitely.  Eventually people will realize you are unable to pay them back and will stop lending you money.  I think we are dangerously close to that point now.  The debt load is so massive that when taking into consideration projected entitlements for the next ten years and totally ignoring war and other emergency expenses as also new spending such as national health insurance, we are already so far in the red that we can not hope to pay off what we owe absent the most draconian spending cuts in our nations history coupled with frightening tax increases. 

Since I think we both know this is not going to happen, that leaves us with two options.  Honest default on our debt or the not so honest form of defaulting which is to say printing money and paying everyone in a greatly debased currency.  My bet is on the latter.

May 28, 10:47 pm | [comment link]
9. robroy wrote:

Ad O., are you saying that the graph that Jeffersonian linked does not include monies spent for the military?

Did George Bush under-call his deficits because of military expenses? Perhaps, but those were revised upward and are accurately reflected in the data.

Is Obama under-calling his defiicts in a much bigger way? By all accounts, his pie in the sky estimates are going to be revised upwards in a big way.

May 29, 8:51 am | [comment link]
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