the most likely–possibility is that the fact that r < g for the government is a byproduct of an extremely large outsized risk premium because of private financial markets’ failure to mobilize the risk-bearing capacity of the public and failure to establish trust and overcome moral hazard in the credit channel. Thus more government debt provides the private sector with something that it is willing to pay through the nose for: a low-risk way to transfer purchasing power into the future.
Pointer from Mark Thoma.
Imagine you had a bank that, whenever it got into trouble through bad investments, could pay off its creditors by taking wealth from people at gunpoint. Such a bank could issue debt with a low risk premium. It is not as clear to me as it is to Brad that the social optimum is for this bank to be very large. Particularly when its “investments” may earn so little in return that at some point even taking wealth at gunpoint may not be enough to enable the bank to meets its obligations.
Agree with you, his conclusion is entirely backwards.
This sentence basically makes zero sense to me- if you are paying through the nose for something, you are not finding a low risk way to transfer purchasing power into the future.
It’s an unintentional absurdity — the boiled down reduction of monetary policies which mandate purchasing power reduction unless one undertakes financialization and risk.
It embodies the rat race or Lewis Carroll’s queen, where everyone has to run faster and faster just to stay still. Except worse because of the necessary undertaking of risk, where one stumble puts you horizontal on the treadmill, which then fires you off the track and into the arms of state dependence.
Of course, this system yields wonderful benefits for a Man Of The System.
Upon reflection, I suppose the conundrum is that long-term rates are very resistant to Funds rate targeting. And I gather that Arnold thinks that Funds rate targeting doesn’t control market loan rates anymore. It’s certainly true that long term bond rates are only faintly linked to short term loan rates, generally. But does this take into account the full impact of the Fed’s open market operations for Funds rate targeting (or any other treasury purchases)?
Is it possible the Fed is stealthily buying?
Because if it’s not the Fed driving the demand at these rates, I’d like to understand who is. It’s hard to understand the appeal over cash. Cash makes for much better insurance. Even assuming an ultraliquid 30Y secondary market, you will take a major hit if you have to sell when the SHTF. Likewise cash is dry powder for opportune moments and unexpected hurdles.
It makes sense. You are buying that low risk, near certainty, as opposed to gambling, low cost but high risk, with high uncertainty, especially when you would need certainty the most, insurance when disaster hits.
One is not trying not to lose money, Lord. Overpaying for the investment increases that risk. At best, all one is doing is transforming one type of risk into another- transforming default risk into interest rate risk. Now, there is nothing wrong with doing this, but I don’t see how increasing the amounts of government debt can be a good thing in that case- all you are doing is undermining the people who have already made that deal in the past. An argument for increasing government debt needs to be based on something else.
Not exactly. “Overpaying” up front does not increase risk. You are taking the known hit to acquire the less risky asset. It wasn’t clear to me at first that “paying through the nose” referred to the surprisingly low interest rate demanded for long term Treasuries.
What are the major substitutes for Treasury bonds anyhow? What are the long term rates for private, market-based instruments with a higher perceived default risk?
The closer those people are to being the creditors the better, but it does emphasize the malleable nature of money and that transfer into the future is essentially problematic.