The Economic Blind Spot

debt and deficits

Oh no! The US Fed has a problem: there’s not enough US government debt to go around. Apparently, that’s something we should be worrying about.

You’d think with a $4 trillion portfolio chock full of US Treasuries, the Fed has plenty already. I’m confused. Aren’t we supposed to be worried about the US national debt being too big anyway? What’s the story?

Well, according to the Wall Street Journal this week, the number of all government bonds up for grabs in global markets is falling. That’s because central banks around the world are snapping them up as part of their QE programs.

And in the US, the government deficit is going down (for now), meaning it needs less money to finance it. That means less US bonds are issued.

The ‘problem’ for the Fed, according to the writer, is that the current dynamic means the central bank can’t affect long term interest rates in the way it would like too. The danger for the market, the argument goes, is it could fuel asset speculation and a bad environment for banks.

Or, as the WSJ puts it:

For investors, that portends a friendly market environment, but also raises the risk of assets overheating. Recall how persistently low long-term yields in the mid-2000s despite Fed tightening—a situation then-Fed Chairman Alan Greenspan labeled a “conundrum”—helped fuel the housing bubble.’

Here’s the real deal: the Fed does not set long term rates — the market does. And besides, the Fed reacts to rates, not the other way around.

Take, for example, the current concern about when the Fed’s next rate hike comes. Some people are worried that this will be bad news for US stocks.

If you’re one of them, maybe the table below will put your mind at rest.

Source: A Wealth of Common Sense, The Altucher Report

Click to enlarge

This shows the effect the biggest rate hikes had on stocks and corporate bonds going back to 1956. Some of the gains in the share market look pretty good, historically speaking.

The point for today is that the Fed is BEHIND the curve on this. It raises rates when it sees the economy improving. An economy on the move is usually good news for shares. Or, to put it another way, high growth leads to high interest.

Mainstream economists like you to think interest rates are the key variable. They’re not. In fact, they like you to think lots of things, most of them financially suicidal.

My colleague Terence Duffy recently sent me one cracking example of this via a Wall Street Journal article headlined: ‘The Economy is Fine (Really)’.

The article starts off and ends like this:

It is hard to imagine any time in history when such rampant pessimism about the economy has existed with so little evidence of serious trouble…

Keep the faith and stay invested. It’s a wonderful buying opportunity.’

The date of the article: January 2008! That was right before the GFC meltdown. It could not have been a worse call. Terence burrowed around the archives and found out this wasn’t some crank on the fringe, either.

The writer, Brian Wesbury, is an esteemed economist, whose CV includes being a member of the Academic Advisory Council of the Federal Reserve Bank of Chicago.

He was at one time Chief Economist for the Joint Economic Committee of the US Congress and is currently chief economist for a company with assets of over $100 billion. The Wall Street Journal ranked him as the nation’s number one economic forecaster in 2001.

Hey, I’m no financial genius myself. But how could such a well-credentialed individual get it so terribly wrong? Actually, the clue is right in the article.

Our man Wesbury wrote at the time in 2008:

The good news is that the U.S. financial system is not as fragile as many pundits suggest…Because all debt rests on a foundation of real economic activity, and the real economy is still resilient, the current red alert about a crashing house of cards looks like another false alarm…

There’s a blind spot here that afflicts practically every economist. And that’s the fact that not all debts rest on a foundation of real economic activity at all.

In fact, most of the debts — especially in Australia — rest on property prices, or land value. And while land has an exchange value, it has no production value.

Lending on a non-productive value is all good while land values continue to rise. However, when land price is bid up so high that the productive economy cannot support it, a predictable economic downturn then follows. That causes land prices to fall to less speculative levels and creates bad debts in the banking system.

This is why it is so critical to study land values. To see the economy from this viewpoint is to see what few others ever do. This is the reason the above-mentioned economist can get it so wrong and for the same reasons such economists will miss the next bust as well.

After all, compare Wesbury with what land economist Fred Harrison wrote in 1997, eleven years before the 2008 collapse.

By 2007 Britain and most of the other industrially advanced economies will be in the throes of frenzied activity in the land market equal to what happened in 1988/9.

Land prices will be near their 18-year peak, driven by an exponential growth rate, on the verge of collapse that will presage the global depression of 2010. The two events will not be coincidental: the peak in land prices not merely signalling the looming recession but being the primary cause of it.’

But hey, don’t take my word for it. Get the rest of the story here.


Callum Newman+,
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Callum Newman

Callum Newman

Callum Newman is the editor of The Daily Reckoning and Associate Editor of Cycles, Trends and Forecasts. He also hosts The Daily Reckoning Podcast. Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect. To have Callum’s thoughts and insights on the current state of the currency, commodities and stock markets delivered straight to your inbox, take out a free subscription to The Daily Reckoning here.

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4 Comments on "The Economic Blind Spot"

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deToke deVille
deToke deVille
1 year 3 months ago

I am clicking my heels 3X and wishing that the writer had addressed the AGENDA of the WSJ article (assuming he has the ability to notice it, recognize it, and deconstruct it).
What WSJ agenda?
Please! Think for yourself!

slewie the pi-rat
slewie the pi-rat
1 year 3 months ago
slewie the pi-rat
slewie the pi-rat
1 year 3 months ago
here’s a Paste, from the link: [} ‘We may very well [resign in the case of a “yes” vote], but we’re going to do it in a spirit of cooperation with whoever takes over from us,’ he said. ‘We are not going to scuttle it. We’re not going to do anything to stop the implementation of the agreement the Greek people will have favoured if the “yes” vote goes ahead.’ A former University of Sydney economics lecturer, Mr Varoufakis said Greece does not have the technical capacity to allow Greek-Australians and overseas citizens to vote in Sunday’s referendum. But questioned… Read more »
peter h moore
1 year 3 months ago

I AM NOT WORRIED ABOUT GREECE OR CHINA.The event in question has not been announced official yet.I speak of the oct.20,2015 reduction in value of USD as Yuan takes its place for currency transfers.About time really.

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