The burgeoning US government budget deficit problem seems to be coming to a head. Whilst the bond market has been making its point with rising yields, ironically, it is the US government’s reaction to it that looks likely to trigger a crisis. First, its unusual intervention in the currency markets earlier this month, propping up the Yen lest Japan sells its holdings of US bonds driving up yields. More crucially, its decision last week to buyback long dated bonds in an attempt to put a cap on the yields (though in vain). To help us understand what this means and how this is likely to transpire, we have someone who has made a killing in the market taking on governments trying to artificially influence market prices. Stanley Druckenmiller who has the enviable track record of not having lost money in any calendar year for decades, famously alongside his boss George Soros, bet the house shorting the British Pound, shares his thoughts in this piece for the WSJ.
“I have spent five decades trading on a simple premise: Markets aggregate information no committee possesses, and prices are how that information reaches decision makers. The long-term Treasury yield is the most important price in the world. It is also the only fiscal disciplinarian the U.S. has left. Neither party will run on entitlement reform. Both have spent the past decade expanding commitments while ignoring arithmetic. Democracies don’t repair their finances because a budget office publishes a table. They repair them only when the cost of inaction becomes visible and immediate, when mortgage rates bite, when auctions tail, when the political price of a rising long bond finally exceeds the political price of touching spending.
Every basis point of artificial yield suppression is a subsidy to procrastination. Suppressed long rates sugarcoat the interest-cost projections, shrink the apparent urgency, and let incumbents assure voters the debt is someone else’s problem. If Congress and the administration are unlikely to touch entitlements even with the market’s signal, they are certain not to touch them without one. Whatever this operation saves in basis points, it will cost multiples in delay.”
He gives us a sense of history when the US actions to cap yields ended up in financial repression (which looks likely this time around as well): “From 1942 to 1951, the Federal Reserve capped long Treasury yields to finance World War II. The cap outlived the war, financed deficits with printed money, and fueled double-digit inflation. It took the 1951 Treasury-Fed Accord to dismantle the cap, followed by years of financial repression that quietly taxed a generation of savers. U.S. policymakers built the wall between debt management and price management for a reason. This intervention starts dissolving it.”
And he reckons there’s another reason why this is bad – loss of credibility: “Buying back long bonds while funding the purchases with bills shifts duration, or long-term interest-rate risk, out of public hands—economically, a small dose of quantitative easing run out of the Treasury rather than the Fed, easing financial conditions while inflation sits above target. These enlarged operations happen to run through the final stretch of a midterm campaign. Debt management that even appears to follow the political calendar spends the one asset that took two centuries to accumulate: the credibility of the Treasury market. That asset doesn’t regain its value so easily.”
He notes how Janet Yellen missed an opportunity to cap interest costs: “In 2023 I said Washington was spending like drunken sailors, with federal outlays up from 20% of GDP before Covid to 25% after, and I called Secretary Janet Yellen’s failure to term out the debt at generational-low rates the biggest blunder in Treasury history. Every household and corporation in America locked in low rates, and the one borrower that needed to most, didn’t.”
So, what’s his solution? “Return buybacks to their stated purpose: small, scheduled, off-the-run liquidity operations announced at quarterly refundings, never off-cycle responses to yield levels. Term out the debt honestly and pay the price the market sets. If the 30-year must trade at 5.5% to clear, that isn’t a crisis. It is an invoice. Then do the only thing that durably lowers long-term yields: address the primary deficit. Reform entitlements gradually and honestly, through means testing, indexing changes, eligibility adjustments phased in over decades—so that the burden is shared across generations instead of dumped on the youngest.”
Whether through persistent high inflation, a weaker dollar or reduced entitlements or some combination, the American saver looks likely to bear the burden of financial repression in the coming years
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