One of the biggest questions right now, especially as yields climb as Joe Biden promises trillions of dollars in additional COVID-19-inspired stimulus spending, is when the Fed and the Treasury, soon to be run by Janet Yellen, will conspire to stop the rise in yields and stave off another eruption of market chaos. With US deficits rising thanks to COVID, and the Fed reviving QE thanks to COVID, the global dollar-based financial system is in trouble, if for no other reason than that Europe, Japan and China are spending so much more domestically, they won’t have as much left over to spend on buying Treasury bonds to finance the US deficit and build up their foreign-exchange reserves.
One of the biggest questions right now, especially as yields climb as Joe Biden promises trillions of dollars in additional COVID-19-inspired stimulus spending, is what’s going on with Treasury yields, and why hasn’t the US dollar strengthened like it’s “supposed to do” (according to the textbook). But in reality, situations can be a lot more complicated than one might expect.
With US deficits rising thanks to COVID, and the Fed reviving QE thanks to COVID, the global dollar-based financial system is in trouble, if for no other reason than that the global economy is slowing (meaning Europe, Japan and China won’t have as much left over to pour back into Treasuries).
And with countries like Russia moving unprecedented amounts of their foreign exchange reserves into gold, like Russia, which now holds more gold in its central bank reserves than at any point in its modern history, there’s a real mutiny against the dollar that’s driving the pace of de-dollarization.
During the latest MacroVoices interview with Luke Gromen, a macro analyst who founded his own shop back in 2014, the longtime macro analyst shared his long-term outlook for the dollar, gold and Treasuries, and how global central banks will drive macro market dynamics during the post-COVID era.
At one point early on during the interview, Gromen said “[w]hat’s been interesting to me in this whole process is that the dollar hasn’t responded to these yield increases at all. And I think Louis Gave said it best a couple of weeks ago in an interview, he said when I see a nation who has rising yields and a falling currency, alarm bells go off. That’s a symptom of a balance of payments problem.”
Using Occam’s Razor, it’s clear: the reason the dollar is sinking is because the puppeteers who run the economy Jerome Powell and the rest of the Fed’s board of governors need it to sink so the US brings more dollars back in trade.
And I think that’s a way – from the yield increases, which I think the Occam’s razor explanation for why yields are rising, particularly post-election, is on expectation of the stimulus.
I think the reason behind the reason is that the reason we need the stimulus is because the US has a balance of payments problem in the aftermath of COVID. When you look at the hole that was blown in the US fiscal budget after COVID, it really looks, to our eyes, irrecoverable without some massive stimulus or a big devaluation in the dollar or something of that sort.
As Gromen reminds us, central banks started pulling back on QE back in 2014 when the Fed said it would start tapering its asset purchases. But even before COVID struck, purchases started trending higher.
The discussion then circles back to “deficits don’t matter…until they do.”
Erik: Now, a phrase that I’ve heard you use a lot before, Luke, is deficits don’t matter until they do. The implication being that, at some point, if you no longer have the position of prominence that the US has enjoyed, with the rest of the world buying up its debt, all of a sudden the game is different.
But, on the other hand, you can spend pretty much an unlimited amount of money if the Fed just buys all the Treasuries and you don’t have to depend on outside investors for that.
How do you see this increased spending, lots and lots of stimulus planned, a growing political sentiment around MMT to say let’s just spend whatever we need to, we can always print the money to buy the bonds if necessary?
How long does that game go on until deficits do matter?
Luke: I think they’ve started to matter already. I think they started to matter in 3Q14 when global central banks stopped buying Treasuries on net.
If you look at what they have bought from 3Q14 to present on net, they have not added any Treasury bonds on net to their FX reserves, which I think that is really the kickoff of when they started to matter.
There have been on this front a couple of interesting op-eds in the Wall Street Journal in the last month, one by former Goldman CEO and Treasury Secretary Hank Paulson, one by former Fed governor Kevin Warsh last week.
And both of them I think are really important op-eds because they both suggest that the Fed and the US government have a problem, which is that the US needs to refinance (call it) $7 to $8 trillion net this year.
So, what does this mean for yields and the dollar?
Readers can listen to the full interview below, courtesy of MacroVoices: