America’s new fiscal stimulus package has attracted a chorus of warnings about the risks of rising federal deficits.
It is understandable to question whether the US economy really needs the extra boost given, for example, the encouraging increase in labour-market participation seen in the July jobs report. Some concern is defensible, to the extent that fiscal stimulus now could drain policymakers’ willingness to take further action when the economy really needs it. But discussing such policy choices without acknowledging the underlying political perspectives is over-simplistic at best, and disingenuous at worst.
A prime example of this can be found in the warnings from some fiscal hawks about how financial markets would be overwhelmed by the wave of government bonds needed to fund the stimulus. Seven months later, 10-year Treasury yields are hovering around 2.8 per cent. It is true that short-term rates are higher, and there has been some strain in the markets through which the Fed implements its policy, but demand for Treasuries has remained persistent.
There have been more than $2 of bids for every $1 of Treasury notes sold this year, even with the Federal Reserve stepping back from auctions as it shrinks its balance sheet. Broker-dealers have actually been purchasing less than they have historically, even as foreign investors also buy less. So why the demand if the US government is flirting with disaster by swelling its budget deficit during an economic expansion? Where are the storied bond vigilantes?
It turns out that if short-term Treasury bills are a good investment at low yields, they are a better investment at higher yields. As the Fed has raised rates, demand for short-term bills has remained robust even as most of the US Treasury’s increase in issuance this year came in short-term securities. Institutional investors have purchased 30 per cent of the $3.8tn Treasury bills auctioned this year, nearly twice their long-term average since 2009, according data from the Treasury Department.
The same goes for longer-term notes and bonds, which haven’t seen commensurate increases in yields. Institutional investors have purchased 41 per cent of Treasuries sold at auction this year, up from the long-term average of 33 per cent.
The failure of a fierce sell-off in Treasuries to emerge could be a good opportunity for fiscal hawks to be more forthcoming about the assumptions implicit in their concerns over the federal budget.
Because the US borrows in its own currency, warnings about too much Treasury issuance are in reality about two spectres: harmful increases in inflation, or a dose of political mismanagement so severe it would lead to a technical default by the US. The word “technical” applies here because, unlike corporate debt, there is no legal framework for the Treasury to default on its securities, according to the Congressional Research Service.
Over the past decade, the US has only come close to experiencing one of these fiscal doomsdays, and it was prompted by an overly hawkish perspective on public finances. Congress came dangerously close to breaching the debt ceiling, as some Republicans argued that the federal government needed to balance its budget like a household.
For their efforts, US lawmakers have now educated a generation in the risks of dogmatic opposition to government debt, and made austerity a more tangible threat to young Americans than harmful inflation. Small wonder then that Alexandria Ocasio-Cortez, the self-described democratic socialist, was recently nominated to represent New York in Congress. She has backed the increasingly popular view that restraints on a government’s spending are primarily set by the amount it can borrow in its own currency without fuelling inflation — not its annual tax revenues.
Some economists may find this perspective uncomfortably liberal, but it is not necessarily inaccurate. It acknowledges global demand for US Treasuries, which is a more honest depiction of the government’s finances than a Treasury that is only capable of spending the amount it raises through tax revenues in any particular year.
Milton Friedman famously said inflation is “always and everywhere a monetary phenomenon”. So those who argue that government borrowing causes an acceleration in inflation implicitly acknowledge that Treasuries more closely resemble money than a highly burdensome debt load.
Beyond that, when it comes to rising prices, more evidence is required to argue that wage-driven inflation hurts consumers. Particularly because it is shareholders whose companies’ margins are dented by rising wages, and bondholders who get hurt by inflation regardless of its source.
Americans, particularly young Americans, are starting to question the assumptions that underlie some policymakers’ categorical opposition to federal government borrowing. For those hawks who make politically motivated forecasts of doom for the US’s fiscal health, it may be their own credibility that ends up paying a price.
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