Everything Old Is New Again: Ten-Year Treasuries (Briefly?) Pass 5 Percent
The week of Monday, October 16: Free money no more, electric vehicles, welfare reform, fiscal policy, poverty, and much, much more.
The week of Monday, October 16: Free money no more, electric vehicles, welfare reform, fiscal policy, poverty, and much, much more.
The retreat from “free money” continues.
The benchmark 10-year Treasury yield rose on Thursday, hitting a 16-year high as investors pored over remarks from Federal Reserve Chairman Jerome Powell.
The yield on the 10-year Treasury crossed 5% for the first time since July 20, 2007 when it yielded as high as 5.029%. The benchmark rate has climbed for four days in a row, bringing October gains to about 40 basis points.
Why the scare quotes around “free money”? That’s because such money — essentially money borrowed at very low rates — very rarely turns out to be, well, free. That is mainly because the availability of cheap money pushes up asset prices, even more so when interest rates have been pushed quite some way below their natural level by central bank or government action. The prices of houses (obviously) reflect, in part, the cost of financing their purchase. If a 30-year mortgage is priced at 3 percent rather than, say, 8 percent, more people will be able to buy housing (or more substantial housing) than would otherwise be the case. That pushes up the price. Once interest rates have risen beyond a certain point, fewer people will be able to pay those higher prices, which will then start to stagnate or even fall.
That’s the theory, anyway. For the most part, however, we’re not seeing that yet, quite possibly because borrowers with mortgages fixed in recent years are not willing to sell if they will need a fresh mortgage (which, at today’s rates would be much more expensive) to pay for a new property. This cramps the supply of housing onto the market, keeping prices high. This won’t continue forever. The rates on many mortgages will be refixed after a while, people will need to move, and so on. If interest rates remain higher for long enough, property prices are likely to take a hit. In the meantime, home sales for September stood at their lowest rate in thirteen years.
There are other asset classes that are going (or will go) through tough times if interest rates stay relatively elevated. Thus, when bonds yielded next to nothing, investors looking for return were “forced” into shares. With bonds now paying much more, that’s no longer the case, although the stock market remains at a historically high level.
Then there are the business projects that made sense when the cost of borrowing was low, but now do not.
More generally, when asset prices sink, or business projects go south, the loans that financed the purchase or the project have a way of becoming a problem for the lenders as well as for the borrowers.
And then there is the government borrowing that seemed (somewhat) affordable when 5-year Treasuries were yielding 1-2 percent, but now, well, not so much. Sadly and strangely, little effort was made to lengthen the maturity of government borrowing when its cost was so low. Thirty-year treasuries were yielding around 2.4 percent in late 2019. Why wasn’t more of the government’s borrowing refinanced at that rate, and for thirty years or more? After all, Austria was able to issue 100-year debt in 2020 at 0.85 percent, and even Argentina (Argentina!) got in the 100-year game in 2017 (7.9 percent).
As I noted earlier this month, it’s not as if there were not voices advising the U.S. to borrow long. From 2020, John Cochrane:
I argue the US should quickly move its debt to extremely long maturities. The best are perpetuities — bonds that pay a fixed coupon forever, and have no principal payment. When the day of surpluses arrives, the government repurchases them at market prices. By replacing 300 ore more separate government bonds with three (fixed rate, floating rate, and indexed perpetuities), treasury markets would be much more liquid. Perpetuities never need to be rolled over. As you can imagine the big dealer banks hate the idea, and then wander off to reasons that make MMT sound like bells of clarity. That they would lose the opportunity to earn the bid/ask spread off the entire stock of US treasury debt as it is rolled over might just contribute.
But we don’t have to wait for perpetuities. 30 year bonds would be a good start. 50 year bonds better. The treasury could tomorrow swap floating for fixed payments.
Then we would be like the family that got the 30 year fixed mortgage. Rates go up? We don’t care. By funding long, the US could eliminate the possibility of a debt crisis, a rollover crisis, a sharp inflation for a generation.
As I commented, this was an opportunity, expensively missed. And the expense keeps rising.
None of this should be news. At Capital Matters we have been writing about this issue since 2020 (and for those loyally clicking on the links, I’m sure there are more).
Over at the Daily Telegraph, Ben Wright:
Legendary investor Howard Marks has a new conversation starter: “What do you consider to have been the most important event in the financial world in recent decades?”
Most people, he writes in his latest investor letter, tend to pick the global financial crisis when Lehman Brothers went bust and brought the capitalist system to the brink of collapse. Others opt for the bursting of the dotcom bubble or the collective response by global governments to the Covid pandemic.
But it’s still very rare for anyone to name Marks’s own candidate: “the 2,000-basis-point decline in interest rates between 1980 and 2020.”
There are three things that are interesting about this. The first is that it’s not that left field. Everyone knows that we are emerging from an unprecedented era of low interest rates. So, why do so few people mention it?
Perhaps because of the other two interesting points: the sheer size of the fall in interest rates (a full 20 percentage points) and the date range. Many central banks cut interest rates to roughly zero in response to the financial crisis in 2008. But they had already been in decline for more than two decades even before that point.
This means the vast majority of people working in finance (and, one might add, in politics) have never operated in a “normal” interest rate environment. Indeed, you have to be, like Marks, over 65 (and still working) to know what normality even feels like. The rest of us are boiled frogs.
I’ll have something to say on the question of experience a little later, but back to Wright (my emphasis added):
Ultra low borrowing costs caused “things to be built that otherwise wouldn’t have been built, investments to be made that otherwise wouldn’t have been made, and risks to be borne that otherwise wouldn’t have been accepted”, writes Marks.
It also clouded our mental faculties. Remember Modern Monetary Theory?
Apparently intelligent people were genuinely arguing that countries with control of their currencies could disregard their deficits and national debt. We don’t hear so much from those guys these days…
The easy money years were characterised by rapid growth, lax financial management, low levels of risk aversion and a “dearth of prudence”. The global bond market rout of recent weeks suggests this is all in the process of being flipped on its head.
Interest rates aren’t likely to bounce all the way back up to where they were in the 1980s. But, having finally tightened monetary policy, central banks will be extremely reluctant to loosen it again anytime soon. And the price of credit doesn’t have to rise an enormous amount to create massive problems…
Western economies have not only borrowed huge amounts in recent years, they have used this money to finance everyday spending rather than to make long-term investments on building infrastructure and the like. Investors have started to question how sustainable it is to max out your credit card to make mortgage payments.
Not only that, much of the infrastructure in which these Western countries have invested is the result of climate change policy. In many cases this has been a matter of replacing functioning equipment with systems that may struggle to deliver any improvement in performance. The result will be an exercise in capital destruction likely to undermine the growth that could, maybe, be one way to help deal with the indebtedness that governments, business and individuals have built up.
Handling this new old economy won’t be made easier by the fact that many of the people familiar with working under such conditions have left the scene. Writing in The Spectator, Natasha Voase took a look at one example of this: What the absence of (relative) old-timers in the financial markets could mean. She was writing (mainly) about the U.K., but from what she says, it seems that the situation across the pond is not too different from what prevails on this side of the Atlantic.
Voase (my emphasis added):
Since the 2008 financial crisis, expensive and experienced senior bankers have been cast out, replaced by younger, cheaper rivals. Credit Suisse was forced into a desperate rehiring scramble in 2021 after it was criticised for ‘juniorisation’ in the risk department. The report by Paul Weiss, a law firm, found that significant cost-cutting in recent years had led to 40 per cent of senior risk managers leaving Credit Suisse. The bank isn’t alone: Goldman Sachs, Deutsche Bank and Barclays are also staffed by younger employees, according to a 2016 report by eFinancialCareers. At Goldman Sachs, it found that only 6 per cent of staff at the New York office had been in the industry for more than 20 years and over half had less than six years’ experience. In 2017, it was reported that the average age across the bank stood at 28. According to analysis of US-based employees by Zippia, 44 per cent of current Goldman employees are aged between 20 and 30. This stands at 50 per cent for J.P. Morgan and 40 per cent for Morgan Stanley. With banks keen to cut costs while maintaining headcount, ditching the boomers was an easy way to go about it. But there’s no replacement for experience, and many in finance are finding that out the hard way…
A typical managing director at full-service or advisory-only banks, including Goldman Sachs, J.P. Morgan, Barclays, HSBC, Deutsche Bank, Rothschild & Co, Evercore, Jefferies and Bank of America, began their career around 2005. Few managing directors are old enough to have worked in the 80s or 90s. Even bankers of the 2008 vintage are quitting the game. But while their younger replacements have the energy and enthusiasm to work long hours, they have only ever known a world in which interest rates have been rock bottom. The situation is similar in private equity, where many began working in the aftermath of the financial crisis, the era of cheap money…
The past year, when interest rates soared, has caught many of these people on the back foot. The word ‘unprecedented’ has been wheeled out again and again to describe the successive increases in interest rates. However, it is the past 15 years – of low rates – that have been unprecedented, not the situation we’re currently in, where rates are slowly returning to normal.
On the eve of the financial crisis in 2008, rates stood at 5.75 per cent, not a million miles away from our current 5.25 per cent. But during the period when this current generation of bankers clambered into the driving seat, they were below 1 per cent. Those who began their careers earlier would have been able to tell tales of interest rates well over 10 per cent and how this impacted their calculations.
The link between experience and being able to hold the fort is well-known. It is best seen amongst the traders who, when their seniors run for the hills in August, are more likely to panic as soon as markets go down. Way back in 2016, the International Capital Markets Association said that the ‘attrition of experienced talent’ on bond-trading desks had added to volatility. Of this, we now have regular proof…
If we are about to enter a period in which higher rates are about to bite hard, some relevant experience on the part of those working in the financial markets would be likely to come in handy. It seems as if we will have to do without. The results may not be pretty.
ESG Talk in Miami
On Wednesday, November 8, we will, together with the Economic Club of Miami, hold a discussion on ESG. This will be held at 5:30 p.m. at the new location of Biscayne Bay Brewing, in the Old Post Office building in downtown Miami. I will discuss this vexed topic with Siri Terjesen, Associate Dean at Florida Atlantic University. Anyone interested in attending this event can find out more details here.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and National Review Institute trustee, David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 141st episode, David was joined by David Malpass, immediate past president of the World Bank, and long-time distinguished economist through multiple presidential administrations. They discuss the role of excessive government debt in impeding developed and developing nation’s growth, the underrated need for a strong and stable currency, and the lessons learned out of his extensive public- and private-sector service when it comes to optimal conditions for economic growth.
No Free Lunch
Earlier this year, David Bahnsen launched a new six-part digital video series, No Free Lunch, here online at National Review. In it, we bring the debate over free markets back to “first things” — emphatically arguing that only by beginning our study of economics with the human person can we obtain a properly ordered vision for a market economy…
The series began with a discussion with Fr. Robert Sirico of the Acton Institute. Later guests include Larry Kudlow, Dennis Prager, Dr. Hunter Baker, Ryan Anderson, Pastor Doug Wilson, and Senator Ted Cruz.
Yes, the six-part series now has seven parts.
Enjoy.
The Capital Matters week that was . . .
Banking
Politicians and regulators are famous for giving themselves power to “fix” the problems that they themselves created. The rallying cry in Washington always seems to be the same: Send in the arsonists to put out the fire.
Here we go again. Earlier this year we had a mini-banking panic as interest rates rose and several big banks — most notably Silicon Valley Bank and Signature Bank — went out of business…
FSOC’s proposal would give regulators greater discretion to identify, regulate, and potentially break up non-bank SIFIs. This is especially concerning because regulators have misused such authority in the past: There are far too many examples of regulators using their discretionary powers to reward groups they like and punish those they dislike…
Adam Smith
Smith’s foresight into the potential for increasing standards of living, egalitarian in nature, before the Industrial Revolution took hold is remarkable, then and now. His understanding of what we now call economics relies on personalism; the human being is conscious, social, and purposeful and is the locus of analysis. We are inherently social rather than atomistic individuals and must habituate virtue over time, which begins in the family and extends to our community and commercial relationships. Adam Smith provides a cohesive framework for what we now call the economic way of thinking.
Transportation
U.K. prime minister Rishi Sunak announced that his government is canceling the second leg of a high-speed rail project because of spiraling costs and years of delays. The High Speed 2 project would have connected London with Manchester, by way of Birmingham. Sunak said that now, only the London-to-Birmingham portion will be built.
The timeline of the project will sound familiar to American ears. A north-south high-speed rail project was first proposed in 2010. Thirteen years later, the project is nowhere near completion, and estimated costs had more than tripled.
Electric Vehicles
There is nothing wrong with EVs in principle, and I am confident that they will get better in time. But the idea that “only” taking 30 minutes to charge a car is something to boast about is yet another reminder that those objecting to the coerced switch to EVs are against not technological advance but rather what is, for now and under certain circumstances, mandated technological regression. Forcing a switch is objectionable for any number of reasons, but to compel a switch into what is (for now and for some) an inferior (but expensive!) product, well . . .
Welfare Reform
An exciting new law in the Show-Me State is promoting a pathway to self-sufficiency. Government-welfare programs are meant to be a safety net and not trap families in dependency. Missouri is showing other states how to avoid the poverty trap, an issue I have been working on for over 40 years…
Argentina
With Argentina facing the third-highest inflation rate in the world at 250 percent per annum (as measured by Hanke), many Argentines have thrown their weight behind presidential candidate Javier Milei. Indeed, Milei is currently expected to garner the most votes in the October 22 general election. Milei’s support has surprised many. It centers on the fact that he has promised to officially do what Argentines do every day: Dump the peso and replace it with the U.S. dollar…
Fiscal Policy
“In all, the experience with successful fiscal consolidations suggests they should be gradual and spending-focused, with careful consideration of the growth effects of selected policies,” Durante writes. Sadly, the evidence he surveys only highlights how far away Congress currently is from having that kind of a discussion.
Labor
The Taft-Hartley Act of 1947 is one of the greatest conservative legislative victories of the past 100 years, and it has been so successful that many have largely forgotten about it. Michael Watson of the Capital Research Center has done valuable public service by writing a series of four articles on the history of Taft-Hartley and why conservatives should stay the course in the fight against organized labor…
Free Trade
Free-trade supporters sometimes make utopian arguments that, like all utopian arguments, fall apart when they confront reality. Some free-trade proponents have seen trade as a means to world peace. Others believe free trade will mean the abolition of national borders, as the entire human race enters into one commonwealth of commerce. A milder form of this argument is the belief that economic liberalization necessarily means political liberalization, and that more countries would become democracies on account of free trade.
Free trade is good, but it’s not a panacea…
Pharmaceuticals
To be sure, it would be good if people (if I!) took more exercise, or ate more healthily, but, particularly where the former is concerned, incentives, as Philipson explains, are pushing the other way. For example, as he notes, taking exercise “costs” more (sometimes literally) than it did when it was a natural part of the working day. Good medical practice obviously includes giving patients advice on improving their eating habits, but, ideally, doctors should work with human nature rather than against it.
Poverty
Economists have had a few weeks to digest the latest poverty figures. Those, by definition, reflect the recent past, but the outlook too is extremely grim. Inflation makes the purchase of necessities more costly, forcing those with less means to make difficult trade-offs. Poverty and deprivation can also create secondary effects driven by despair or necessity. Teenagers may drop out of school to get a job, undermining their long-term prospects. And depression about difficult circumstances can lead to substance abuse and separation from the labor force, and from society more generally.
The States
We used to think that there might be a unicorn in Colorado — Jared Polis, the Democrat governor who supports tax cuts and limited government. This year, he proved unicorns don’t exist after all…
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