WEBVTT - This Is What's Actually Happening When The Government Auctions Bonds 0:00:10.720 --> 0:00:14.360 Hello, and welcome to another episode of the Odd Lots Podcast. 0:00:14.440 --> 0:00:19.239 I'm show Wise and I'm Tracy Alloway. Tracy, there's a 0:00:19.280 --> 0:00:24.680 lot of talk about the deficit and the debt these days. 0:00:24.720 --> 0:00:27.520 For a long time, maybe that sort of story went away, 0:00:28.120 --> 0:00:31.560 but with the tax cuts and people wondering when the 0:00:31.560 --> 0:00:35.159 next downturn comes back, it really feels like a government 0:00:35.200 --> 0:00:39.199 debt is a big story again. Yeah. Absolutely, We've seen 0:00:39.240 --> 0:00:43.040 lots of talk about bond vigilantees staging a comeback. We've 0:00:43.080 --> 0:00:46.920 seen lots of forecasts from various analysts about just how 0:00:47.000 --> 0:00:51.040 big the US deficit is going to get. Given Trump's 0:00:51.120 --> 0:00:55.640 propensity to borrow and also enact fiscal stimulus. There is 0:00:55.720 --> 0:00:58.360 a lot to discuss when it comes to the world 0:00:58.560 --> 0:01:02.840 of US government debt nowadays. There absolutely is, And I 0:01:02.880 --> 0:01:05.600 think one of the things that's always driven me crazy, 0:01:05.680 --> 0:01:08.240 I think both of us crazy, is the sort of 0:01:09.000 --> 0:01:13.440 naive view about how people talk about government debt, particularly 0:01:13.560 --> 0:01:17.520 US government debt. There's this view often that sort of 0:01:17.560 --> 0:01:20.760 sees the government as just sort of a typical borrower, 0:01:20.959 --> 0:01:23.800 like a household or a person trying to borrow money 0:01:23.920 --> 0:01:27.560 to buy a car. And as we know, it doesn't 0:01:27.600 --> 0:01:30.679 really work that way, and that can really lead people 0:01:30.720 --> 0:01:33.800 to a lot of false assumptions, like about what interest 0:01:33.840 --> 0:01:35.520 rates are going to do and what the market is 0:01:35.560 --> 0:01:37.600 going to do. So, I know you say it's a 0:01:37.720 --> 0:01:40.759 naive viewpoint, but I'm going to make a confession here 0:01:40.959 --> 0:01:44.640 and say that you know, in my head, I understand 0:01:44.680 --> 0:01:47.640 the point that the US government is not the same 0:01:47.680 --> 0:01:50.600 as you know, the head of a household who's tatting 0:01:50.680 --> 0:01:55.520 up their income versus their expenditure every month. But deep 0:01:55.600 --> 0:01:59.640 down in my gut, I have always been uncomfortable with 0:01:59.680 --> 0:02:03.520 the no shin that the US can borrow extraordinary amounts 0:02:03.520 --> 0:02:07.960 of money and not have major major impacts. So I'm 0:02:07.960 --> 0:02:11.799 actually really excited to dig into this subject because hopefully 0:02:12.120 --> 0:02:15.960 it'll make me feel better. Yeah, I agree, there's a 0:02:16.000 --> 0:02:20.280 non intuitiveness about it. And even if you say, like, oh, 0:02:20.320 --> 0:02:23.119 you know, the US creates its own money and borrowing 0:02:23.160 --> 0:02:25.160 for the government is not the same as it is 0:02:25.200 --> 0:02:28.640 with the household, I know what you're saying about your like, well, yeah, 0:02:28.680 --> 0:02:31.480 surely we must be still getting close to some risk. 0:02:31.760 --> 0:02:35.520 So hopefully we can maybe usual this episode to get 0:02:35.560 --> 0:02:39.720 a little more comfortable with thinking about what government did 0:02:39.880 --> 0:02:43.680 means in a slightly different manner. Yeah, that sounds great. Great, 0:02:43.720 --> 0:02:47.480 So today I'm very excited to welcome to the podcast 0:02:47.560 --> 0:02:50.520 Brian Roman Chuck. He is the author of the Bond 0:02:50.560 --> 0:02:54.280 Economics blog. He's a financial consultant. He's written about the 0:02:54.320 --> 0:02:57.360 bond market and what really happens. He's a veteran of 0:02:57.440 --> 0:03:00.520 the financial industry, and he is going to help us 0:03:00.880 --> 0:03:05.760 understand what's really happening when the government issues all this debt, 0:03:05.880 --> 0:03:09.160 which of course is a major theme of the news 0:03:09.240 --> 0:03:21.000 these days. Ryan Romantric, thank you for joining us on 0:03:21.120 --> 0:03:25.000 odd lots. Let's start with the big question when someone 0:03:25.720 --> 0:03:29.320 or a bank or an investor is buying a government bond, 0:03:29.680 --> 0:03:33.600 what does it actually happen? On paper, it does look 0:03:33.720 --> 0:03:37.560 similar to buying another bond. You know, you transfer money 0:03:37.600 --> 0:03:41.120 to someone in exchange for a security which has a 0:03:41.200 --> 0:03:45.360 que sip, so there is some similarity. You're you're going 0:03:45.360 --> 0:03:48.520 through the same Selman process, and you know, you you 0:03:48.640 --> 0:03:51.240 end up with rights. If you buy a ten million 0:03:51.760 --> 0:03:53.240 you know, once you have control of it, then you 0:03:53.320 --> 0:03:57.240 get you know, a certain contractual payments, you know up 0:03:57.320 --> 0:04:01.080 until the bond maturity. And any bond, uh, well standard 0:04:01.120 --> 0:04:03.480 bonds all have the same source of structure will give 0:04:03.520 --> 0:04:06.080 you a certain coupon and then there's a final principal payment. 0:04:06.400 --> 0:04:09.760 So the cash flow perspective, all bonds are similar in 0:04:09.800 --> 0:04:14.600 that sense. So, at the risk of using a terrible cliche, 0:04:14.800 --> 0:04:17.960 you know you're getting this IOU from the government essentially, 0:04:18.200 --> 0:04:21.240 um it comes with a coupon, which kind of informs 0:04:21.520 --> 0:04:24.720 the yields that you're going to get. Most people when 0:04:24.720 --> 0:04:26.840 they think of US government debt, they're going to think 0:04:26.839 --> 0:04:30.920 of treasuries obviously, and they're going to think of the U. S. Treasury. 0:04:30.960 --> 0:04:34.280 Is it the US Treasury who is actually selling these things? 0:04:34.360 --> 0:04:38.960 Or are there other entities involved? The U? S. Treasury? 0:04:39.040 --> 0:04:42.919 The auction it as a Canadian I forgot the exact details, 0:04:42.920 --> 0:04:46.279 but it's done there. There's an auction and the the 0:04:46.360 --> 0:04:49.839 auction is they say there's gonna be a certain number 0:04:49.839 --> 0:04:54.360 of bonds and then at a certain maturity, and then 0:04:54.440 --> 0:04:57.640 the line of bidders and most of the bidding comes 0:04:57.720 --> 0:05:01.600 from there. They're called the primary dealers, mainly banks, but 0:05:01.640 --> 0:05:06.240 they're security dealers deal with the FED and they're obligated 0:05:06.279 --> 0:05:09.920 to bid and they do most of the bidding. Other entities. 0:05:09.960 --> 0:05:12.279 You can do a non competitive bid, but that's usually 0:05:12.279 --> 0:05:15.440 a small part of the market. And once all the 0:05:15.480 --> 0:05:18.120 bids come in, you don't give a price. You just 0:05:18.160 --> 0:05:20.760 say I want to buy it at this yield. And 0:05:20.800 --> 0:05:24.760 then you once all the bids come in, you say 0:05:24.839 --> 0:05:28.520 the you know, it's a lower yield is essentially higher price. 0:05:29.000 --> 0:05:32.039 The lowest yields to buy all the bonds win the 0:05:32.080 --> 0:05:35.080 auction and they get the bonds delivered to them, and 0:05:35.120 --> 0:05:38.800 then usually the primary dealers sell them on to other, 0:05:39.040 --> 0:05:41.440 you know, investors like pension funds, people like us and 0:05:41.560 --> 0:05:45.640 in the secondary market. Now, one of the things that 0:05:45.680 --> 0:05:48.400 we talked about this in the intro is that we 0:05:48.480 --> 0:05:52.280 have to dispel the myth that the US is just 0:05:52.320 --> 0:05:56.599 like any other private sector borrower. And so we've established 0:05:56.640 --> 0:06:00.000 that the bonds on paper look the same. It looks 0:06:00.040 --> 0:06:02.840 like any other corporate bond or alone that might get 0:06:02.880 --> 0:06:07.080 turned into a bond like instrument, but it's fundamentally different 0:06:07.279 --> 0:06:10.479 and the key difference is the source of fund So 0:06:10.600 --> 0:06:14.000 explain to us structurally why the US is a different 0:06:14.040 --> 0:06:18.479 kind of borrower. Well, the key difference, and you know, 0:06:18.560 --> 0:06:22.200 for the US, the US controls the central bank, and 0:06:22.320 --> 0:06:25.600 as the horrible counterexample is a place like the Euro Area, 0:06:25.640 --> 0:06:29.479 where the countries don't control their central bank. And because 0:06:29.760 --> 0:06:33.560 ultimately all these bonds say we're paying you U S 0:06:33.600 --> 0:06:37.800 dollars and the US dollars a liability of the US 0:06:37.880 --> 0:06:41.680 Federal Reserve, and the US Federal Reserve the FED is 0:06:41.760 --> 0:06:45.920 owned by the Treasury. So that gives you the one 0:06:46.040 --> 0:06:50.800 big picture difference than any other borrower, and the other 0:06:50.960 --> 0:06:57.920 the other issue is for the government, there main concern. 0:06:58.000 --> 0:07:01.760 They're more concerned a bit about the macro consequences of 0:07:01.839 --> 0:07:06.320 spending and not so much the financial A smaller borrowing 0:07:06.520 --> 0:07:08.760 an individual bank, you know, how big they might be, 0:07:09.120 --> 0:07:12.040 aren't really worried about the fact that they're spending on 0:07:12.120 --> 0:07:17.440 the overall economy. And that is a key difference in understanding, Well, 0:07:17.720 --> 0:07:20.440 you know, why are they different? Okay, so I'm gonna 0:07:20.520 --> 0:07:23.640 let my gut talk now, which is probably a mistake, 0:07:23.760 --> 0:07:27.360 but here we go. So, why why can't the US 0:07:27.440 --> 0:07:30.800 government just borrow as much as it wants, you know, 0:07:30.920 --> 0:07:33.720 enormous amounts of money? Uh what what? What are the 0:07:33.760 --> 0:07:36.240 negative effects that are going to happen if it does that? 0:07:37.480 --> 0:07:41.280 It's not the borrowing per se, that's the problem because 0:07:41.480 --> 0:07:44.680 the it's you would say, if there's a problem, it 0:07:44.720 --> 0:07:48.480 would be on the spending, because you say, what is 0:07:48.520 --> 0:07:51.480 the government buying? I mean, maybe they're buying good things, 0:07:51.520 --> 0:07:55.480 maybe it's bad things, but uh, one can always debate, 0:07:55.680 --> 0:07:58.080 you know, what the the spend money on. But from 0:07:58.120 --> 0:08:01.200 a macro perspective, what the worry is if the government 0:08:01.240 --> 0:08:04.679 starts buying too much stuff, they drive up the price 0:08:04.720 --> 0:08:09.600 of everything, i e. There's inflation, and they spend a 0:08:09.600 --> 0:08:15.480 lot and causes inflation. But the borrowing is the flip 0:08:15.560 --> 0:08:20.280 side of the spending because if they're spending more than 0:08:20.480 --> 0:08:24.440 coming in from taxes, there's a fiscal deficit, and the 0:08:24.480 --> 0:08:28.640 way that that's matched in practice is well that that's 0:08:28.680 --> 0:08:35.000 covered by borrowing. And so the borrowing comes with the spending. 0:08:35.360 --> 0:08:38.400 And so it's a mistake to worry about the borrowing 0:08:38.440 --> 0:08:41.240 and say what what is the government spending on. So 0:08:41.800 --> 0:08:44.000 this is the part that I think people really have 0:08:44.480 --> 0:08:48.040 a hard time, is why we shouldn't worry about the 0:08:48.120 --> 0:08:52.079 borrowing because in theory you would think, Okay, people are 0:08:52.120 --> 0:08:55.800 buying government dead, and the government dead just keeps going 0:08:55.880 --> 0:08:59.960 higher and higher, and that maybe one day these buyers 0:09:00.200 --> 0:09:02.880 will say whoa, You guys are spending so much money, 0:09:02.920 --> 0:09:04.679 You're never gonna be able to pay it back. Tax 0:09:04.720 --> 0:09:07.439 revenues aren't coming anywhere close. I'm not going to buy 0:09:07.480 --> 0:09:10.880 government debt anymore. So this issue, I think is still 0:09:10.920 --> 0:09:14.280 what we need to address, which is why is that 0:09:14.400 --> 0:09:19.200 not a risk that one day lenders just won't show up? Well, 0:09:19.240 --> 0:09:22.400 I mean that that is a worry, and it was 0:09:23.280 --> 0:09:26.520 anyone's being around the markets that was a worry. I 0:09:26.559 --> 0:09:31.160 started in finance about Japan and even that was a 0:09:31.160 --> 0:09:34.600 big worry. And that continued and it was called the 0:09:34.600 --> 0:09:37.840 widow maker trade people and all Japan is gonna default 0:09:38.080 --> 0:09:41.040 within months, and they short a Japanese government bonds and 0:09:41.080 --> 0:09:44.360 they kept losing money. By now people have largely given 0:09:44.440 --> 0:09:48.600 up on that. But the reason why the governments can 0:09:48.600 --> 0:09:54.440 get away with this, uh generally is they're spending creates 0:09:54.640 --> 0:09:57.880 the money that then is sucked back in by the 0:09:57.920 --> 0:10:03.480 bond auction. It's a circular flow. And this is why, yes, 0:10:03.800 --> 0:10:06.360 there's a demand for like you know, the demand for 0:10:06.440 --> 0:10:09.240 borrowing for the government at the same time they're supplying 0:10:10.120 --> 0:10:14.200 money that then is recirculated back into the bond market. 0:10:14.480 --> 0:10:16.640 I think this is the just sort of the really 0:10:17.000 --> 0:10:19.640 key point here, and I want to sort of really 0:10:19.679 --> 0:10:23.080 dive into this. So let's say the government wants to 0:10:23.480 --> 0:10:28.920 spend ten billion dollars more on some new aircraft program 0:10:29.000 --> 0:10:33.200 for the military. That ten billion dollars that they spend, 0:10:34.040 --> 0:10:36.320 I think, as you're saying, winds up in the bank 0:10:36.360 --> 0:10:40.320 account of some private defense contractor, and then that money 0:10:40.360 --> 0:10:46.000 in the bank ends up going perhaps a security circuitous route, 0:10:46.640 --> 0:10:50.120 ends up back being invested in government bonds. Do I 0:10:50.160 --> 0:10:52.840 have that right? Yeah, that's basically it. I mean, now 0:10:52.960 --> 0:10:55.839 it's it's a bit more common because you have excess reserves. 0:10:55.880 --> 0:10:59.040 But what happens is if the government sends a defense 0:10:59.080 --> 0:11:03.080 contractor ten billion, they'll have a ten billion deposit on 0:11:03.120 --> 0:11:07.079 the bank. The bank in return, they get ten billion 0:11:07.240 --> 0:11:09.960 transferred to them from the FED and they have ten 0:11:10.000 --> 0:11:13.400 billion as a deposit the Fed. I mean, these are reserves, 0:11:13.760 --> 0:11:17.240 and you know, because the Federals is a bank and 0:11:17.320 --> 0:11:21.640 so but the bank doesn't really want I mean, independent 0:11:21.720 --> 0:11:23.760 of what them, the customer and what might want, that 0:11:23.800 --> 0:11:26.720 ten billion UH is sitting in the bank account because 0:11:26.720 --> 0:11:30.000 they will have expenses. But the bank itself, what's it 0:11:30.000 --> 0:11:31.800 going to do with the ten billion it has an 0:11:31.840 --> 0:11:34.360 asset on balance sheet which is a deposit of the FED, 0:11:34.720 --> 0:11:39.200 which is a low risk asset which pays you used 0:11:39.200 --> 0:11:42.200 to pay nothing but now very little, and say we 0:11:42.240 --> 0:11:44.240 want to do something else with this asset in our 0:11:44.240 --> 0:11:47.800 balance sheet, And so they then go out and say 0:11:47.880 --> 0:11:51.960 we want something and gives a higher return, and essentially 0:11:52.240 --> 0:11:54.480 how the loop gets closed and say, look, hey, there's 0:11:54.720 --> 0:11:57.920 you know, treasury bonds. We buy them. They should have 0:11:58.000 --> 0:12:00.520 an expected return higher than lee ving the money on 0:12:00.559 --> 0:12:04.079 deposit the FIT. And so the bank will go out 0:12:04.400 --> 0:12:08.200 and buy the treasury bonds in the auction because otherwise 0:12:08.240 --> 0:12:10.360 they're stuck with the deposit the FED that's paying them 0:12:10.400 --> 0:12:15.839 very little. So Brian just on the money creation point 0:12:16.240 --> 0:12:20.040 when it comes to the US is government borrowing. A 0:12:20.080 --> 0:12:23.480 lot of people will often point to the special privilege 0:12:23.600 --> 0:12:27.200 that America enjoys by virtue of the fact that the 0:12:27.280 --> 0:12:30.720 US dollar is the world's reserve currency. In other words, 0:12:30.760 --> 0:12:32.959 other countries need it, and so they're going to keep 0:12:32.960 --> 0:12:37.079 buying US treasuries in order to stabilize their own accounts 0:12:37.120 --> 0:12:40.240 and their own currencies and things like that. How much 0:12:40.280 --> 0:12:43.640 does that play into the ability of the US government 0:12:43.640 --> 0:12:48.080 to keep borrowing. And you know, you mentioned the Japan example. 0:12:48.160 --> 0:12:51.319 People have been worried about Japanese government debt for ages. 0:12:51.480 --> 0:12:55.040 The end certainly is not the world's reserve currency. So 0:12:55.080 --> 0:12:57.720 how come they're able to do that as well as 0:12:57.760 --> 0:13:01.600 the US the reserve currency when you had to fix 0:13:01.760 --> 0:13:04.880 fixed exchange rate regime. It did make a difference in 0:13:04.920 --> 0:13:08.480 Bretton woods, but it's been a long time. Canada, Australia, 0:13:08.640 --> 0:13:12.000 United Kingdom, I mean, they're not really reserve currencies, but 0:13:12.200 --> 0:13:15.280 they're pretty much in the same position as the US 0:13:15.280 --> 0:13:19.800 from the perspective economic perspective. Let's say you have an 0:13:19.800 --> 0:13:24.080 Asian central bank. They look as far as the U S. 0:13:24.120 --> 0:13:27.800 Domestic economy is concerned, they're a private sector borow and 0:13:27.840 --> 0:13:30.200 they have the same choices to do, you know as 0:13:30.240 --> 0:13:32.360 any other private sector investor. What do we do with 0:13:32.400 --> 0:13:35.840 our with our U S. Dollar assets? And you know, 0:13:35.920 --> 0:13:38.439 they could hold cash, they could they could leave money 0:13:38.440 --> 0:13:41.480 on deposit the bank, or we could buy a treasury. 0:13:41.559 --> 0:13:45.000 So they don't really have a choice if if they 0:13:45.040 --> 0:13:48.720 want to hold US dollar reserves, they have to do 0:13:48.840 --> 0:13:52.720 something with it. And by convention, you know, they don't 0:13:52.800 --> 0:13:57.240 run around. It's it's it's frowned upon for central banks 0:13:57.240 --> 0:13:59.880 to run and run around and buy private sector ass 0:14:00.000 --> 0:14:02.920 it's like equity easy. There's a little bit of dabbling 0:14:02.960 --> 0:14:06.559 in equity markets, but that's only a tiny fraction. They 0:14:06.640 --> 0:14:09.760 keep their money in fixing comme assets, and they want 0:14:09.800 --> 0:14:12.760 safe ones. I mean they don't because they might need 0:14:12.800 --> 0:14:15.880 to call on their reserves if their currency is under attack. 0:14:16.440 --> 0:14:20.040 And then you know, they don't want a private debt 0:14:20.200 --> 0:14:23.600 that's in the process of defaulting when they need liquidity, 0:14:23.720 --> 0:14:26.800 and so by default they tend to end the treasury. 0:14:26.880 --> 0:14:29.720 So it's a two way street, and a certain extent 0:14:29.760 --> 0:14:35.320 they're trapped into the treasury holdings as well. And in theory, 0:14:35.640 --> 0:14:39.520 if a foreign holder of dollars, let's say they did 0:14:39.600 --> 0:14:44.960 want to buy equities instead of treasuries just for whatever reason, 0:14:45.560 --> 0:14:49.480 that would create some new holder of those dollars at 0:14:49.520 --> 0:14:51.960 some other bank. And so it's not like the dollars 0:14:52.000 --> 0:14:55.120 would just sort of disappear. It would be yet another 0:14:55.280 --> 0:14:58.560 buyer somewhere else would show up who would have dollars 0:14:59.120 --> 0:15:01.840 on reserve at a AC and then would theoretically go 0:15:01.880 --> 0:15:05.320 into treasuries. Yeah, it's it's for everybodyer. There's a seller 0:15:05.880 --> 0:15:11.600 and scare stories often revolve around forgetting that that basic principle. Yeah, 0:15:11.640 --> 0:15:15.440 there's someone with the dollars has to buy, so yeah, 0:15:16.120 --> 0:15:18.360 you know, the pricing can change, of course, I mean 0:15:18.360 --> 0:15:20.520 that's the thing if you're worried about pricing. Yes, treasury 0:15:20.560 --> 0:15:23.920 prices would go down relative to other things, but the 0:15:24.360 --> 0:15:28.520 flows will still cancel out. So how come Japan can 0:15:28.560 --> 0:15:33.400 borrow enormous amounts of money, Well, it's the same same issue. 0:15:33.440 --> 0:15:38.600 There's excess again. They're creating again and um I even 0:15:38.600 --> 0:15:41.280 looked at the latest data, but they're roughly a trade balance, 0:15:41.320 --> 0:15:45.520 so it's mainly domestic owners. Very few people want to 0:15:45.520 --> 0:15:48.160 go in and buy Japanese bonds. I mean people buy 0:15:48.240 --> 0:15:52.160 Japanese equities, but not bonds. People just think they're ridiculous, 0:15:52.160 --> 0:15:55.760 although now maybe not so as much. But the you know, 0:15:55.800 --> 0:16:00.480 the yen has is somewhere in the system and Happanese 0:16:00.480 --> 0:16:04.080 banks basically have no choice, but they buy the bonds, 0:16:04.080 --> 0:16:08.680 although recently it's been the Bank of Japan. They've basically 0:16:08.760 --> 0:16:11.160 bought most of them up and now the banks just 0:16:11.360 --> 0:16:14.360 have deposits of the Bank of Japan. But in the 0:16:14.440 --> 0:16:17.200 in the end, it's just that if they spend the 0:16:17.400 --> 0:16:19.600 end end up in the system, and the end has 0:16:19.640 --> 0:16:23.480 to go somewhere, and that drain is the Japanese government 0:16:23.520 --> 0:16:28.040 bond market. So doesn't matter if the buyers of your 0:16:28.080 --> 0:16:32.120 debt are more domestic or more foreign. Is one group 0:16:32.160 --> 0:16:35.280 better than the other. If you're borrowing in your own currency, 0:16:35.360 --> 0:16:38.440 I mean, this is very different. If you're like an 0:16:38.440 --> 0:16:42.080 emerging market borrowing in another country's currency, then you have 0:16:42.200 --> 0:16:45.600 to be very worried about foreign holders. Or if you 0:16:45.600 --> 0:16:49.200 have any fixed exchange rate pig and you see that 0:16:49.240 --> 0:16:53.600 in the Euro area, then you like domestic things, domestic 0:16:53.600 --> 0:16:56.960 buyers of your debt because you have more control over things. 0:16:57.000 --> 0:17:01.160 But for a floating currency sovereign if you have a 0:17:01.160 --> 0:17:03.240 lot of fire and foreign buyers, if you do, it 0:17:03.240 --> 0:17:07.600 means you're running big current account deficits. And is that good? 0:17:07.760 --> 0:17:11.879 Is that bad? You know, the US, their industrial strategy 0:17:12.160 --> 0:17:16.560 since being the World War two, has been running trade 0:17:16.600 --> 0:17:21.919 deficits with you know, strategic partners. And you know the 0:17:22.040 --> 0:17:24.359 U s has costs, and there's benefits for the US 0:17:24.480 --> 0:17:26.560 right now that people are focusing on the cost, but 0:17:26.680 --> 0:17:29.600 there's there are benefits the way the US runs a system. 0:17:29.720 --> 0:17:33.200 But the foreign buyers. In theory they could panic more, 0:17:33.280 --> 0:17:35.679 but at the same time they don't want to lose money. 0:17:35.880 --> 0:17:37.880 You know, it's very you know, if you're a big 0:17:37.880 --> 0:17:41.320 holder of bonds, you can sell in a panic and 0:17:41.359 --> 0:17:43.200 you can lose a lot of money. You know. I 0:17:43.480 --> 0:17:45.760 worked for firm which was large, and if we wanted to, 0:17:45.880 --> 0:17:47.960 we could lose a lot of money very quickly by 0:17:48.000 --> 0:17:52.119 selling our our assets and a panic. Well, that's not 0:17:52.200 --> 0:17:55.720 our job. Your job is not to lose money very quickly, 0:17:56.200 --> 0:17:59.640 so you generally avoid doing stuff like that. So that's why, 0:18:00.600 --> 0:18:04.160 on paper, the foreign investors could get spooked more, but 0:18:04.240 --> 0:18:06.720 they still want to make money, so it's not clear 0:18:06.960 --> 0:18:12.320 that they're much different than domestic investors in that respect. Okay, 0:18:12.359 --> 0:18:17.840 so we've established that for the US credit risk isn't 0:18:17.880 --> 0:18:20.320 really a thing because the dollars that come to buy 0:18:20.600 --> 0:18:24.520 treasuries come from the spending. And we've also established that 0:18:24.720 --> 0:18:27.920 you don't even need to be a reserve currency for 0:18:27.960 --> 0:18:31.800 this phenomenon to exist, because it's in Japan, which has 0:18:31.840 --> 0:18:35.040 lots of debt, and Canada, which is not anyone a 0:18:35.119 --> 0:18:39.800 reserve currency, Australia and New Zealand. Then the obvious question 0:18:39.920 --> 0:18:44.240 is why can't all countries do this? And so people think, 0:18:44.280 --> 0:18:47.840 to the extreme example of a country like Venezuela and 0:18:47.920 --> 0:18:51.480 the debt they have, why can't they just spend and 0:18:51.720 --> 0:18:55.919 keep a stable currency and a stable market. I'm not 0:18:56.480 --> 0:19:02.240 an emerging market person, but there's policy differences between Venezuela 0:19:02.280 --> 0:19:05.000 and the US coming down to the strength of the 0:19:05.040 --> 0:19:09.240 tax system. The i r S, as everyone knows, is 0:19:09.280 --> 0:19:15.360 a powerful organization, and it has the income tax, has 0:19:15.400 --> 0:19:20.560 the ability of damping economic activity, and so it controls 0:19:20.600 --> 0:19:25.359 inflation better than in the country with a weaker tax system. 0:19:25.480 --> 0:19:29.760 And my pet theory is that the difference comes down 0:19:29.800 --> 0:19:34.080 to the effectiveness of the tax regime for for inflation control. 0:19:34.119 --> 0:19:37.600 I mean, that's a major difference, but there is also 0:19:37.640 --> 0:19:40.680 a question of what is produced. If you if you're 0:19:40.720 --> 0:19:45.760 dependent on foreign imports for a lot of goods, then 0:19:46.080 --> 0:19:52.120 your domestic inflation is driven by your exchange rate. Whereas 0:19:52.200 --> 0:19:55.919 the US is largely a closed economy I mean, relatively 0:19:55.920 --> 0:20:00.000 a closed economy when compared to other countries, and change 0:20:00.080 --> 0:20:02.640 is the exchange rate don't have much of an effect 0:20:02.680 --> 0:20:06.399 on prices, so you can largely ignore I mean, if 0:20:06.520 --> 0:20:13.080 US dollar falls ten, it's not really noticeable in domestic prices. 0:20:13.160 --> 0:20:16.640 So with all the talk of the US deficit growing 0:20:16.760 --> 0:20:20.520 and the US government borrowing more under the current administration, 0:20:21.240 --> 0:20:24.480 lots of auctions happening, not just a longer term treasuries, 0:20:24.520 --> 0:20:28.240 but also t bills. What are you looking out for 0:20:28.320 --> 0:20:31.400 when it comes to US auctions to sort of gauge 0:20:31.840 --> 0:20:35.359 the health of the market and to determine how successful 0:20:35.400 --> 0:20:39.959 an auction is in terms of successive auctions. That was 0:20:40.080 --> 0:20:43.719 something that that was a technical detail I didn't worry about. 0:20:44.200 --> 0:20:48.680 But the the overall trend it's going to be. Are 0:20:48.720 --> 0:20:51.879 these deficits going to cause rapid growth? If you're if 0:20:51.880 --> 0:20:54.760 you're worried about the pricing which is the usual word, 0:20:54.840 --> 0:20:57.919 what's gonna happen to bond yield? If the government spending 0:20:57.960 --> 0:21:01.000 a lot, they'll will have inflation your pressure, and that's 0:21:01.000 --> 0:21:04.040 going to force the Fed to hike rates and that 0:21:04.200 --> 0:21:06.840 if you know from a bond market, uh, you know, 0:21:06.920 --> 0:21:10.720 pricing perspective, that's your worries that the Fed gets more 0:21:10.760 --> 0:21:14.960 aggressive with rate hikes and pushes up bond yield. That's 0:21:15.800 --> 0:21:18.119 going to be you know, much much more of a 0:21:18.119 --> 0:21:23.440 concern than the just supply demand. So the big picture, 0:21:23.800 --> 0:21:25.680 and if we sort of wrap it all up here 0:21:25.840 --> 0:21:29.480 is that it's not the borrowing per se. It's not 0:21:29.600 --> 0:21:34.720 the gap between the government's expenditures and its revenues via taxes. 0:21:35.119 --> 0:21:38.720 It's really about the capacity of the economy to absorb 0:21:38.760 --> 0:21:41.720 all that spending. That sort of is what theoretically would 0:21:41.760 --> 0:21:45.399 drive inflation, and then the link between inflation and what 0:21:45.440 --> 0:21:48.400 the Fed does that would sort of be what ultimately 0:21:48.960 --> 0:21:53.640 determines what long term rates are going to do. And 0:21:53.680 --> 0:21:56.320 then that you know, once you answer that, then you 0:21:56.359 --> 0:21:58.240 can decide whether it makes sense to buy a bond 0:21:58.320 --> 0:22:01.480 or not. Yeah, that's basically I mean, And the question 0:22:01.560 --> 0:22:04.200 is will I mean, it's not just a simple difference. 0:22:04.560 --> 0:22:07.520 I mean, this is the question. With the tax cuts, 0:22:07.880 --> 0:22:10.440 how much for stimulative impact have they had. I mean, 0:22:10.680 --> 0:22:14.399 there's been not much of an inflationary impact. It's been 0:22:14.440 --> 0:22:16.280 good for the stock markets, a lot of money got 0:22:16.280 --> 0:22:20.480 funneled into into stock buy backs, but by itself, that 0:22:20.640 --> 0:22:24.040 isn't that isn't putting inflationary pressure on the economy. So 0:22:24.400 --> 0:22:27.840 there's a big difference between what the deficit is doing 0:22:27.960 --> 0:22:30.040 and the effect on the economy. And it's hard to model. 0:22:30.160 --> 0:22:32.439 I mean, it's it's it's not an easy thing to 0:22:32.560 --> 0:22:35.560 say what the effect on the economy is gonna. Presumably 0:22:35.760 --> 0:22:39.480 there's a big inflationary difference between say, rich people are 0:22:39.480 --> 0:22:44.280 getting a tax cut versus a policy that said, everybody 0:22:44.280 --> 0:22:46.600 in the country gets a new bicycle, even if it's 0:22:46.600 --> 0:22:50.080 on a dollar amount, it costs the same. That's presumably 0:22:50.080 --> 0:22:53.000 the difference. I mean, you might have political this is 0:22:53.000 --> 0:22:55.879 where sort of politics comes in. People might disagree, but 0:22:55.960 --> 0:22:59.040 that's certainly my view that you you know, hand the 0:22:59.119 --> 0:23:02.280 tax cut to the bottom twent or you buy stuff 0:23:02.480 --> 0:23:08.640 much more inflationary than capital gains tax cut. Brian Roman Chuck, 0:23:08.800 --> 0:23:12.480 thank you very much. Very interesting conversation, and I think 0:23:12.640 --> 0:23:15.320 these sort of this guts of how this all works 0:23:15.320 --> 0:23:18.680 out very rarely discussed when people talk about the bond market. 0:23:18.720 --> 0:23:21.800 So appreciate you coming up. Thanks thanks to It's nice 0:23:21.840 --> 0:23:36.840 to be on so Tracy. Are you convinced that it's 0:23:36.880 --> 0:23:40.760 not a big existential threat for the government to run 0:23:40.960 --> 0:23:44.520 what's on paper very large deficits. I feel like I 0:23:44.600 --> 0:23:47.919 have a better intellectual grasp of what's going on, and 0:23:48.000 --> 0:23:51.080 the idea that you know, borrowing from the government isn't 0:23:51.119 --> 0:23:55.200 actually about moving money from one entity to the other. 0:23:55.320 --> 0:24:00.240 It's actually about creating money. I get that, but I 0:24:00.320 --> 0:24:03.080 gotta be honest, Joe, part of me is still thinking 0:24:03.359 --> 0:24:06.680 there have to be some consequences. I think there's two 0:24:06.920 --> 0:24:09.520 things that I think we're really useful there. So one 0:24:09.600 --> 0:24:13.160 is obviously just really understanding this idea of the closed loop, 0:24:13.280 --> 0:24:17.400 this idea that money never leaves the banking system, because 0:24:17.440 --> 0:24:19.080 I mean, for one thing, we know that all money 0:24:19.320 --> 0:24:22.840 is digital basically, and so kidd just disappear, and so 0:24:22.920 --> 0:24:24.760 if it's going to stay in a bank, and a 0:24:24.760 --> 0:24:28.040 bank will ultimately put it into treasuries, even if it 0:24:28.600 --> 0:24:31.880 caused many hop skips in a jump. I also think 0:24:31.960 --> 0:24:35.160 that point that he made about the strength of institutions 0:24:35.400 --> 0:24:40.120 is really important, and this idea that it's not necessarily 0:24:40.119 --> 0:24:42.439 the borrowing per se that you want to worry about, 0:24:42.800 --> 0:24:45.280 but if you want to look at sort of institutional 0:24:45.440 --> 0:24:50.760 degradation in developed economies, you could certainly point to a 0:24:50.760 --> 0:24:53.480