Hiding in the Treasure Room
Predictive economic news has been dire, lately. If the dark notes weren’t so broadly being sounded, one might suspect a Republican conspiracy to keep a nascent recovery from helping the Democrats. The alternative explanation is that conservatives have been correct in their concerns about the Democrats’ method of “stimulating” the economy and that the consequences have begun to appear a few months earlier than government incumbents would prefer.
Of course, such reliable left-wing Democrat voices as New York Times columnist Paul Krugman are doing their best to run that hypothetical conspiracy in reverse, as Stephen Spruiell points out in a recent National Review (subscription required). But the left-right battle is secondary to Spruiell’s main topic. Krugman points to the stability of government security interest rates as evidence that people aren’t really all that worried about federal debt, to which Spruiell replies:
In some ways, gold is a better indicator of investor concern about the government’s finances than are interest rates on government bonds, because at least two forces are keeping those rates irrationally low. First, since the crisis began, the Federal Reserve has injected over $1 trillion of new money into the economy, mostly in the form of loans to the nation’s commercial banks at 0 percent interest. Over that same period, these banks have increased their purchases of U.S. government bonds by $500 billion.
David Smick, a financial consultant and author of The World Is Curved, explained the phenomenon in an article for Commentary earlier this year: “The perception now is that Washington has entered a new era of ‘political banking.’ . . . [Banks] can borrow from the central bank for next to nothing [and] use that borrowed money to buy guaranteed government debt, taking the difference in yields as riskless profit.” This is not a bug in the government’s strategy for dealing with weakness in the banking system; it is the strategy’s central feature. The banking sector’s demand for low-risk securities, and the Fed’s willingness to finance that demand at 0 percent, have helped banks repair their damaged balance sheets while so far keeping the government’s interest rates manageable. With virtually no perceived risk and a Fed eager to finance the purchases, banks don’t mind a low return on their investment.
That sounds more than a little like GM’s proclamation that it would be paying of government loans ahead of schedule… using other money procured from the federal government. It doesn’t take much deep economic thinking to see that one cannot borrow to pay of debts for an extended period of time.
As I’ve said before, such a strategy only makes sense if the person or entity engaged in the financial activity has reason to expect an increase in income or, in the case of the government, in economic activity. Otherwise, the interest will eat an increasing amount of funds that were already too limited and, in the case of the government, the distortion of market forces will dissuade the sorts of behavior that can create or discover unforeseen economic expansion.