Market Update – March 11, 2012

2013 March 10
by SJ Leeds

Austin or San Antonio finance job needed!  I have a former student who is moving back to Austin because her husband is joining that faculty at UT.  She’s done really well.  She has significant experience in corporate banking, customer relations and quantitative research.  She’s progressed rapidly in her career and her current responsibilities include providing data-driven strategic direction to the CFO and other executives of a large US-based bank.  I know her well and highly recommend her.  If you want her resume, send me an email.


Two parts to today’s blog…(1) summary of a recent paper that received some press; and (2) a few great stories and videos.  If nothing else, you MUST watch the one from CBS Sunday Morning.


I recently read an interesting paper that was presented at a Fed Conference.  It was titled, “Crunch Time: Fiscal Crises and the Role of Monetary Policy” and was written by David Greenlaw (Morgan Stanley), James D. Hamilton (UCSD), Peter Hooper (Deutsche Bank) and Frederic S. Mishkin (Columbia University).  (No need to email me – I’m aware of Dr. Mishkin’s role in “Inside Job”.)  It was a long paper (90 pages), but I want to share some of the ideas that I found interesting.  As usual, these are their ideas (and often their wording).



1. High borrowing costs can make fiscal policies unsustainable (if a country already has high debt).  Monetary accommodation can lead to a tipping point in inflation and currency flight.


2.  In order to maintain a consistent debt-to-GDP ratio, a country must run a surplus (as a percentage of GDP) that is equal to the difference between the nominal interest rate minus the nominal GDP growth rate.  (If growth > interest rate, a country can run a deficit in that amount.)  See figure 3.2.


3.2 copy
3. As the debt-to-GDP ratio increases, the cost of borrowing can increase.  At some point, creditors may fear inflation in the U.S. (rather than default).  This could happen if the market decides that fiscal reforms (necessary to return to a sustainable path) are unlikely to occur.


4. Emerging market countries can handle less debt because their debt is often denominated in foreign currencies.  Currency depreciation increases the debt burden and can lead to crisis.


5. When the Fed buys debt, the Treasury no longer has to pay interest to the private sector.  But, when the Fed buys the debt, they take on a liability: either reserves or currency.  Currency does not have an interest cost.  Reserves do.  When the Fed buys debt and creates a liability (reserves), the government has effectively swapped long-term debt for short-term debt.  This increases the risk of a financial crunch – where money flees and the government has trouble rolling over their debt.


6. The greater the current account deficit, the greater the potential problems from high debt levels.  Typically, this means that the government is financing their debt by borrowing from abroad.  The more debt held by foreigners, the greater the likelihood to default (and this threat should raise the cost of borrowing).


7. Gross debt is more indicative of the cost of borrowing than net debt.  In other words, when thinking about how much debt we have, you should include the debt held by the trust funds.  It may be that net debt is easier to manipulate.


8. Japan has very high gross debt (230%) and lower net debt (126%).  But, they seem to benefit from their citizens’ bias to invest domestically.


9. The U.S. benefits from being a reserve currency (resulting in great demand for our Treasuries).  In addition, approximately one-fourth of our outstanding debt is in the form of short-term T-bills with a cost close to zero.


10. The CBO assumes that our long-term rates will return to 5.2%.  But, rates could go much higher and cause huge problems.  See Figure 3.11

3.11 copy


11. Our current account deficit should not be a huge problem because we will become energy independent.


12. If Congress eventually engages in fiscal consolidation (balancing the budget), the question is what the Fed should be doing during this process.  Some people think expansionary policy increases future expectations (helping growth) and makes it more likely that fiscal consolidation will succeed.  Others think that expansionary policy reduces the incentives for fiscal consolidation.  They also argue that tight monetary policy will limit inflation expectations (which could be a risk since debt is high).


13. Simple “across-the-board” spending cuts are typically short-lived because it does not engender sufficient political support.  We need permanent, structural changes.


14. If Congress does come up with a “Grand Bargain” of entitlement and tax reforms, the Fed would probably slow their exit from their current extraordinary accommodation.


15. In the extreme, unsustainable fiscal policy means that the government will either have to issue monetary liabilities (known as fiscal dominance) or default.  The U.S. is unlikely to default.  Ultimately, the central bank has no power to avoid the consequences of unsustainable fiscal policy.


16. The duration of the Fed’s portfolio will peak at 11 years in 2013.  (As a really rough estimate, you can think of this meaning that if interest rates increase 1%, the value of the Fed’s portfolio will decrease by 11%).  While the Bank of Japan and the ECB have expanded their balance sheets, they’ve kept their durations close to 3 years.  (One reason that our duration has increased is Operation Twist.)


17. If interest rates increase or if the Fed incurs losses from the mortgage-backed securities that they hold, the Fed will not be able to remit payments to the Treasury (as the Fed has been doing recently).  (The Fed remits earnings to the Treasury.)


18. The inability to remit payments to the Fed could create political pressure or could impact Fed policy (timing of shrinking their balance sheet).




Part 2: Videos / Articles


I’ve got three videos / articles for you.  You might want to close the door to your office if you don’t want anyone to see you cry…


3. Husband sinks shot to help pay wife’s cancer bill.  This is a good video.  (You should read the short article – it will make more sense.)  This video could have been higher in my rankings if the guy had hugged his wife after hitting the shot!  (On average, it costs me about $20K to get Jenny to hug me, so maybe that’s what I’m thinking about.)  Here’s the link.


2. We all get frustrated with the airlines.  We don’t hate them like we hate Time Warner Cable, but we do get frustrated with them.  (I’m now with AT&T U-Verse and pretty happy.  Now, Jenny tells me to watch Cinemax and leave her alone.)  Lest I digress, this is a really cool story about United.  Here’s the link.


1. This is just an absolutely awesome video.  If you don’t like this one, there’s something wrong with you.  Here’s the link.


Have a great week.  It’s Spring Break in Texas.  Yes, I still get Spring Break.  Woo hoo!


Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:


1. click on this link  (or type into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.




Comments are closed.