I’ve been in several conversations over the past few days with generally reasonable people who are still worried that markets might turn on U.S. bonds any day now. I don’t think they’re right; but even if they are, I’m not clear what they believe would happen next.If it is as good as his expectations for Argentina (and it's probably worse), we are in very big trouble.
Sunday, November 11, 2012
For the Krugman File
He thinks there is no problem with the bond market:
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"The fundamentals of our economy are strong"?... What's next? He'll be telling us that we have reached a new level of permanent prosperity?
ReplyDeleteThe man is blissfully ignorant of the interest rate swap, FX Swap, and Credit Default Swap markets. He's basically using the Taylor Rule to explain
ReplyDelete"Now ask, what happens if there’s a loss of confidence, causing the risk premium ρ to rise? The answer is that the currency depreciates for any given domestic interest rate, increasing demand and shifting the IS curve out. That is, the effect on the economy is expansionary."
What he's saying is that because we have a floating exchange rate, the loss confidence in the US credit rating will result not in an increase of interest rates, but a devaluation of the currency. That devaluation is a "good thing" because it increases demand for exports under his simpleton GDP model.
Here's a major problem: a devaluation of the US dollar causes anyone who played the carry trade with US Treasury bonds to get absolutely monkeyhammered. A major devaluation of the US dollar will cause anyone holding on to US debt who has cash demands in something other than dollars to liquidate their positions. Thus the reason we are seeing global central banking coordination. A devaluation puts in place major cash demands on underwriters of derivatives for IRS, FX, and CDS, to which we learned under AIG, the Fed will always bailout.
Any theoretical increase in demand for exports (which in the real world take TIME to materialize) will be dwarfed by the short-term liquidations of benchmark debt instruments and subsequent cash demands of derivatives underwriters (the banks).
It's a debt trap no matter how you look at it.
DeleteThe fact that Krugman felt the need to share this story scares me that it might happen sooner than we think. A spike in rates, could with a selloff would be a disaster.
DeleteKrugman is a wacko left wing extremist. He gave up being a credible economists many, many years ago.
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