OK, back to economics. The stock market reached a new high of over 19,000, with emphasis on small cap stocks and the Dow, versus the Nasdaq. This indicates a business expectation that infrastructure spending will lift small companies and heavy industry, but not so much on the tech side. That’s all well and good, and not totally unexpected. But what is noteworthy is what is happening to the bond market. This will take some ‘splainin’, so I’ll go slow and break this down a piece at a time.
Within days of DtheT being declared the winner in the race for the worst job in the world, the interest paid on a ten year government bond jumped a full percent. This is fairly extraordinary, and surprised some people. What made it jump? Because people are selling off their bonds. Why? Because when people sell bonds, the price goes down. Lots of sellers means the price goes down a lot. When the price goes down, what happens to the interest rate for the bond, referred to as the yield? It goes up. So yields going up in the bond market means lots of folks are selling these treasuries off. Why? In normal times, a sell off is an indicator of confidence in the market. People buy government bonds as a safe haven in times of trouble – at least you keep your principal, even if you don’t earn much interest. So is that what’s happening here? Well, as I indicated above, enthusiasm for DtheT’s policies is driving the stock market up. But the rationale for selling bonds may be another indicator.
It is a fact that since 2008 and the Great Recession, interest rates have been extraordinarily low. As a result, people all over the world have been borrowing money. In dollars. Lots and lots of dollars. In the trillions. A lot of that money is in cash, but a lot of it bought stuff. And when a lot of dollars buy a lot of stuff, the price of that stuff goes up. Feeling wealthier, folks borrow more. Is this starting to sound familiar? It should: it was a major reason for the big crash in ’08. But that’s not what I’m here to talk about.
All those borrowed dollars have to be repaid. And with DtheT threatening sanctions on China, higher tariffs on imports and a trillion dollar infrastructure plan, what are those three things likely to produce? Inflation. What happens when we have inflation above a reasonable level? Interest rates go up. Interest rates going up means more investors coming to America for those higher yields. That leads to even higher inflation (say it with me: inflation is too many dollars chasing too few goods. Thank you!) Inflation means the Fed will raise interest rates more. Gets to be a bit of a habit, eh?
But what about all those foreigners with debts denominated in dollars? They get paid in zlotys, euros, Turkish lira and Hyvrnias (Ukraine’s currency). A stronger dollar means weaker zlotys, euros, Turkish lira and Hyvrnias. That means those foreigners’ lending costs go up, even if they don’t borrow another dime. So maybe that bond selloff isn’t a sign of confidence – it’s a sign of preparing for bigger bills coming due in the not-too-distant future, and they want to have dollars available to repay those loans.
So what’s my conclusion? People around the world are taking DtheT at his word that he is going to do what he said he was going to do during the campaign. Apparently, folks think Congress will just roll over and play along, unconcerned about increasing the deficit. Won’t that be a big fat kick in the ass? So much for those cuts from “sequestration”. They were never really serious, were they? Time will tell.