Albert Edwards isn’t optimistic about… well, anything really, but this week he’s concerned about America’s fiscal trajectory.
As far as I’ve been able to discern over the years, Albert’s an affable soul and seems to generally enjoy life. (In stark contrast to myself.) It’s hard to know, on any given week, whether the often dour message conveyed by his musings is genuine disdain or just Edwards staying “in character” for his readership.
Complicating interpretation is the almost jovial cadence Albert adopts while delivering apocalyptic prognostications. It’s (always) the end of the world as we know it, but by appearances anyway, Albert (always) feels fine.
“Who could have forecast that the US administrations (both Republican and Democrat) would go bonkers?” he wondered Thursday, commenting on fiscal profligacy in America.
He was joking. Or at least I hope so. To the extent you think America should concern itself with deficits and debt, everyone could’ve predicted successive rounds of “bonkers.” “Bonkers” is one of just two bipartisan issues inside the Beltway (the other is a hawkish approach to the bilateral relationship with the Xi regime in Beijing).
The US is a fiscal outlier, Albert suggested, referencing the visual above. As ever, Germany stands as a bastion of relative restraint. A bout with honest-to-God hyperinflation isn’t easily forgotten. The specter of the wheelbarrow cash haunts the Germans to this very day (along with a few other demons).
Albert went on. “Maybe when the Fed was throwing QE like confetti huge deficits were financeable, but those days are long gone,” he wrote. “Despite this, curiously few in the US seem scared (for now) that ‘bankruptcy’ lies ahead.”
That’s because the US can’t go bankrupt. Countries which issue hard currencies have a lot of leeway in that regard. The country which issues the reserve currency has unlimited leeway. In theory. And, frankly, by definition.
But, as we saw in Albert’s beloved UK 13 months ago, there are limits in practice. Edwards and I have different interpretations of Liz Truss’s mini-budget boondoggle, but it’s hard to escape the notion that the gilt crisis (and the near implosion of the UK LDI complex) was an example of what can happen when the market is given free rein to opine on fiscal policy unchecked by the central bank. The BoE ultimately stepped in, but not in time to save Truss who, rightly or wrongly (I think Albert would suggest wrongly) took the blame. And the fall.
Anyway, the point is that theory and practice are two different things, and when everyone believes debt and deficits matter, and the central bank is constrained by an inflation problem in its capacity to perpetuate a glorified Ponzi scheme, yields can rise sharply even for hard currency-issuing sovereigns.
Since August, that’s the story in the US: A shifting buyer base for Treasurys collided with increased supply (to fund large deficits) to push up yields via higher term premia. The situation was exacerbated by some of the worst slapstick, Beltway “bonkers” in living memory.
Mercifully, Janet Yellen and Treasury got the message. The financing estimate was lower than anticipated and more importantly, the refunding announcement came with smaller-than-expected increases to long-end sales, a tacit nod to the rapid repricing of the term premium.
Those concerned about the situation ostensibly have reason to fear a Bank of Japan exit from yield-curve control. I say “ostensibly” because explaining and forecasting Japanese demand for foreign fixed income is considerably more complicated than simply suggesting that higher JGB yields will reduce demand for Treasurys. I’d point readers to Brad Setser on that.
This week, the BoJ adjusted its YCC framework in what was widely viewed as the beginning of the end (the yen was unimpressed, but that could change). Albert, who does know a thing or two about Japanese macro, wondered if the BoJ backing away from YCC could “be the straw that breaks the back of the unsustainable US debt situation.”
“The BoJ’s recent YCC tweaks certainly reduce the attraction of US bonds, but could the BoJ go much further and halt YCC?” he asked, noting that “some who think so have focused on Japan’s core CPI having converged with core inflation elsewhere.”
Edwards quoted SocGen’s Japan economist in noting that supercore inflation (or whatever they call the ex-all food measure) in Japan will probably peak at just 2.5%, two full percentage points lower than the ex-fresh food metric that markets tend to focus on.
If that’s the case (i.e., if the ex-all food measure has seen the highs at just 2.5%), it could buy the BoJ some time, which in turn might buy the US Treasury some time “to get its fiscal house in order,” as Albert put it, on the way to quipping that he’s “100% confident” no such housecleaning will take place in D.C.
On Thursday, Reuters reported that the BoJ will in fact work towards dismantling its ultra-easy monetary policy regime in 2024, including negative rates. The plan, Reuters said, is “inherently risky” and will “require skillful execution.”