Concern #4: Will Massive Fiscal Deficit Spending Drive Price Inflation and Long-Term Interest Rates Skyward?

November 10, 2009

Of the four concerns that I’ve raised today, this one is creating the loudest din in the public discourse.  First, government deficits have soared just about everywhere.  Britain and the United States lead the pack with double-digit imbalances this year expressed as a percentage of GDP.  The red ink in the cases of Japan, the euro area, Australia and India lies between 5% and 10%.  The Chinese and Canadian deficits are somewhat less than 5%  but represent enormous incremental growth from their prior levels.  As widespread as the upward thrust in the deficits has been is public and market skepticism that this increase can or will ever be reversed.  I think that remains an open question.  The gloom ignores 1990s history that saw a huge surplus emerge in the United States from the ashes of chronic deficits for over 20 years and also saw European nations reduce their government imbalances very sharply to qualify for the European Monetary System’s stipulation that deficits of entering nations not exceed 3.0%.  Also ignored is the fact that a slow and aborted fiscal response to the downturn that began in 1929 was a causal factor in the Great Depression. In time, the deficits must be attacked with hard decisions on both taxes and spending.  But it’s clear that no effort in that regard will succeed without the precondition of sustained decent economic growth.  To everything there is a purpose, and now is not the season to shut down fiscal support.

I’ve stated often on this blog that one lesson from Japan’s experience is that it takes a long time to recover from a recession caused by a malfunctioning financial system.  Japanese Cassandras including many at the Ministry of Finance and Bank of Japan were warning more than fifteen years ago about the risk of soaring JGB yields.  Markets are still waiting for that Godot.  The table below documents the trend in 10-year bond yields in the United States, Germany, Japan, Canada and Britain.  Figures shown are period averages (2009 to date for row five) and are compared to current levels in the final row.  There is no evidence of rising inflation expectations to match the shrill tone of the fiscal fear-mongers.  Now one might say, sure, but what about gold?  I believe the climb in gold reflects pessimism about the dollar, not fear of inflation.  Since March 9, gold has risen 20% in comparison to rises of 56.4% in the DOW, 61.4% in the S&P 500, and 69.6% in the Nasdaq.  In the 1970’s when inflation was a real, not imaginary problem, gold climbed sharply, but stocks performed poorly as one would expect.


10Yr Yields U.S. Germany Japan Canada U.K.
1994-03 5.68% 5.34% 2.10% 6.22% 6.31%
2004-06 4.44% 3.73% 1.54% 4.29% 4.59%
2007 4.63% 4.23% 1.68% 4.29% 5.01%
2008 3.65% 4.00% 1.49% 3.60% 4.49%
2009 3.20% 3.27% 1.37% 3.21% 3.57%
today 3.48% 3.28% 1.48% 3.49% 3.79%

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.


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