Follow The Money

See the WSJ article below of 4/2/2024

Why Treasury Yields Are Rising Despite Rate-Cut Expectations – (Paywall, Subscription Required for full post. Link opens in new window.)

It is an embarrassment of the poor education in economics possessed by leading journals’ feature writers particularly in modern macro economics when they opinion-ate on fundamental issues such as inflation. They seem to be unaware that current issues have rich legacies that identify clear policy dilemmas with important consequences.

In the late 1970’s and 1980’s, the “rational expectations” revolution plugged many of the holes in post WWII macroeconomics. There are, of course, many variations to take into account how and when the public incorporates public information into its expectations. Surely daily information on the economy is actually doing, and which policies are being implemented at Federal and State level must enter their expectations. It is quite reasonable to suppose that they take these data into account.

Those expectations have a meaningful, non-trivial impact on the decisions of private economic agents. The implications for inflation and deflation should not be ignored. Policy makers who ignore this aspect of the private sector’s behavior are doomed to make policy errors. We may well be on that course again.

We are now foundering in the wake of a Fed, determined to bring inflation rates down into the 2’s, while at the same time buying large parts of the Treasury’s massive issuance of debt that finances untempered, politically driven, Federal Budget deficits. In recent years the Federal Debt has doubled from 17 trillion to 34 trillion in response to this unrelenting bi-partisan appetite. The parties differ on who the winners and the losers should be, but they agree on view that the Federal Debt Level should never be a compelling reason to limit “what your country can do for you!” (The conclusion of JFK’s remarkable 1961 Inaugural has surely been forgotten in recent Administrations).

It should be required reading (and hopefully understood) by economically inclined journalists to study the magnificent little volume by Nobelist Tom Sargent (“Rational Expectations and Inflation”) published in 1986.

The dilemma of monetary policy when singly focused on interest rates or HPM, with no consideration for the excessive fiscal expansion of recent years comes out of the closet in this economically cogent gem!

You might be surprised to learn that in 1923/1925, five European countries stopped their inflations cold (even hyperinflation) by tight budget control and restraint of HPM. Plugging one hole is not enough. The public has to believe that policy has been changed in both domains. The Central Bank cannot do it by interest rates alone, and The Treasury has to control excess spending which means either raising more tax revenues or not funding every political whim.

When the public catches on, tighter HPM will and does work, but what is needed is strong evidence that the Treasury is not marching to a different drumbeat. Sadly, our Fed and the Treasury have been reading different musical scores!

Keynes knew that and said so in his 1924 book, MONETARY REFORM. The French knew it when trying to stop an inflation before it blossomed into a full hyperinflation in Post WWI.

In Sargent’s tour d’force are featured the abrupt stop of hyperinflation in Germany, Austria, Poland and Hungary; and, the prevention of inflation in Czechoslovakia.

Keynesian theory labored in the 1960’s thinking that Fiscal Economics was like Coach Lombardi’s “only thing.” Friedman’s 3% annual expansion of the Money Supply presumed a non-inflationary excess in the Federal Budget. But, current Fed policy labors because excessive spending is not a little “mouse that roared.” It is a rather big Lion that will eat our lunch and us too if not controlled.

Perhaps the saddest part of the lack of budgetary control is the continued bribery paid to Congress members in the form of Earmarks, even for legislators that in the end don’t vote for a “negotiated“ budget agreement. That kind of political payoff is emblematic of the true lack of a national interest in DC. Both sides of the aisle need a Civics lesson, a modern course in macro economics and some common sense about budget restraints.

The geopolitical world is much less friendly to the self-image of American democracy. We are troubled by Russian aggression in the Ukraine; by the increased likelihood of a Chinese military takeover of Taiwan; and, by Iranian proxies in Lebanon, Syria, Iraq and Yemen. Some of us worry that our open border in the South is a door through which terrorists with designs on US locations have now passed and through which they will likely attempt to open in the near future. The US needs a flexible Treasury, not an overspent one and immediately needed fiscal restraint The public will get the message if political leaders start playing the right music.

A few correspondents at Fed Chairman Powell’s news conferences have tried to question Powell directly with this issue. Powell is notably discrete about his luncheon partners, but this creates dubious expectations by the public. The public’s expectations about future tax and spending policies count significantly for ending inflation. Cautious ambiguity is not helpful.