Justin Goldberg on Nostr: A little post on 'real rates' and how they will inflate the debt away: Because of the ...
A little post on 'real rates' and how they will inflate the debt away:
Because of the fiscal picture, the US now requires negative real rates.
The real rate of return (in reference to treasuries) refers to the spread between the yield on a bond, and inflation
So, a 4.5% 10yr treasury returns a 1% real return when inflation is 3.5%
On the other side, if the 10yr treasury is yielding 4.5%, but inflation is 6.5%, the real rate is a negative -2%
The implication here, is that when real returns are positive, the government is losing money and debt load is getting worse
When real rates are negative, that means the government is making money off its debt and debt load is getting better
Example:
Say govt sells a 1yr bond for $100
The inflation rate is 10%
The yield on that 1yr bond is 1%
That means at the end of this period, the govt has paid out the initial principal ($100) + $1 of interest for a total of $101
However, because inflation ran at 10% over that year, it now requires $110 to equal the purchasing power of that initial $100
That bondholder got his principal back, and he also got his yield.
However, he lost money ($110-$101= $9 loss)
When real rates are positive, the bondholders are making a positive real return. That positive return is coming from us (mainly through an increase in the debt and deficit, since we run a twin deficit).
It's not like that real return is being paid for via taxes...
We, the taxpayers, are on the side of a losing trade. And the result of that losing trade, is an increase in the debt and deficit since we cannot afford to pay for that out of GDP or GDI
When debt to GDP is 125%+, nominal debt is $35T, interest expense alone is 25% of tax receipts, this is unsustainable and just plunges the US further into fiscal dominance
The longer this goes on, the worse the deleveraging will have to be
In this chart, we can see the real rate of return on the 10yr treasury, minus the Core CPI YoY.
Any positive real return is green, negative real rate is red
White line shows the govt debt to GDP
We see a very obvious inverse correlation
As debt/GDP goes higher, real returns fall (they must)
We also see that the decrease in debt/GDP from 2021-2023 corresponded, directly, to significantly negative real rates
Now, what bond holder is going to want to lose money on their trade? None of them.
No one wants to be a sucker.
[Remember, value of a bond is inverse to the yield - as the value of a bond goes down, the yield goes up and vice versa]
Bond holders will sell their bonds when they think inflation will outpace the yield. This means that yield goes up.
It's a self-correcting market. If the bond market sees inflation picking up and thinks that inflation will leave them with a negative real return in the future, they will sell the bonds that they believe have too low of a rate which drives the yields up.
We see the US 2yr yield (blue line) increasing in 2017-18 before inflation data showed an increase in inflation.
This works the other way, too. If the bond market thinks inflation will fall (economic slowdown), the bond market will buy bonds that it believes have a higher yield than the future economic growth.
We also see the 2yr yield (blue line) topping in Sept 2018 and falling, before the CPI data showed a fall in inflation
This is why the bond market is so important.
Now, what this means is that to get a significant real return for any meaningful period of time, the bond market cannot be allowed to function freely.
It needs to be controlled.
Yields need to be capped like Japan did with Yield Curve Control (YCC)
How do you do this?
Well, the central bank prints money and uses that money to buy bonds (sending yields lower)
They print as much money as needed to keep the yield at whatever level they are targeting
So far in 2024 (just 4 months), the US has sold $9.7 trillion of government debt.
Yes, some of this is rolling off old debt and not necessarily a net increase in debt.
But, in terms of YCC, it doesn't matter. It doesn't matter if we are rolling old debt, or issuing new debt-
In order to get the yields down, the Fed will have to print money to buy the bonds to bring the yields down
The sheer volume of money that will be needed to printed to buy this debt will be enormous. Obviously it won't be buying every single bond, but even if it's 50%, the numbers are staggering.
This is what is coming, because it has to
Because of the fiscal picture, the US now requires negative real rates.
The real rate of return (in reference to treasuries) refers to the spread between the yield on a bond, and inflation
So, a 4.5% 10yr treasury returns a 1% real return when inflation is 3.5%
On the other side, if the 10yr treasury is yielding 4.5%, but inflation is 6.5%, the real rate is a negative -2%
The implication here, is that when real returns are positive, the government is losing money and debt load is getting worse
When real rates are negative, that means the government is making money off its debt and debt load is getting better
Example:
Say govt sells a 1yr bond for $100
The inflation rate is 10%
The yield on that 1yr bond is 1%
That means at the end of this period, the govt has paid out the initial principal ($100) + $1 of interest for a total of $101
However, because inflation ran at 10% over that year, it now requires $110 to equal the purchasing power of that initial $100
That bondholder got his principal back, and he also got his yield.
However, he lost money ($110-$101= $9 loss)
When real rates are positive, the bondholders are making a positive real return. That positive return is coming from us (mainly through an increase in the debt and deficit, since we run a twin deficit).
It's not like that real return is being paid for via taxes...
We, the taxpayers, are on the side of a losing trade. And the result of that losing trade, is an increase in the debt and deficit since we cannot afford to pay for that out of GDP or GDI
When debt to GDP is 125%+, nominal debt is $35T, interest expense alone is 25% of tax receipts, this is unsustainable and just plunges the US further into fiscal dominance
The longer this goes on, the worse the deleveraging will have to be
In this chart, we can see the real rate of return on the 10yr treasury, minus the Core CPI YoY.
Any positive real return is green, negative real rate is red
White line shows the govt debt to GDP
We see a very obvious inverse correlation
As debt/GDP goes higher, real returns fall (they must)
We also see that the decrease in debt/GDP from 2021-2023 corresponded, directly, to significantly negative real rates
Now, what bond holder is going to want to lose money on their trade? None of them.
No one wants to be a sucker.
[Remember, value of a bond is inverse to the yield - as the value of a bond goes down, the yield goes up and vice versa]
Bond holders will sell their bonds when they think inflation will outpace the yield. This means that yield goes up.
It's a self-correcting market. If the bond market sees inflation picking up and thinks that inflation will leave them with a negative real return in the future, they will sell the bonds that they believe have too low of a rate which drives the yields up.
We see the US 2yr yield (blue line) increasing in 2017-18 before inflation data showed an increase in inflation.
This works the other way, too. If the bond market thinks inflation will fall (economic slowdown), the bond market will buy bonds that it believes have a higher yield than the future economic growth.
We also see the 2yr yield (blue line) topping in Sept 2018 and falling, before the CPI data showed a fall in inflation
This is why the bond market is so important.
Now, what this means is that to get a significant real return for any meaningful period of time, the bond market cannot be allowed to function freely.
It needs to be controlled.
Yields need to be capped like Japan did with Yield Curve Control (YCC)
How do you do this?
Well, the central bank prints money and uses that money to buy bonds (sending yields lower)
They print as much money as needed to keep the yield at whatever level they are targeting
So far in 2024 (just 4 months), the US has sold $9.7 trillion of government debt.
Yes, some of this is rolling off old debt and not necessarily a net increase in debt.
But, in terms of YCC, it doesn't matter. It doesn't matter if we are rolling old debt, or issuing new debt-
In order to get the yields down, the Fed will have to print money to buy the bonds to bring the yields down
The sheer volume of money that will be needed to printed to buy this debt will be enormous. Obviously it won't be buying every single bond, but even if it's 50%, the numbers are staggering.
This is what is coming, because it has to