Spring 2024 Alumni Newsletter

2000 onward, the U.S. debt continued to grow at an historically rapid pace. Despite
From
growing debt, inflation remained low and long-term interest rates continued their
the
answer is that the domestic and global demand for U.S. Treasury securities (USTs)
One
rapidly over this period of time. There were several forces driving this demand. First, a
grew
growth in the demand for USTs for use as collateral in credit derivative and repo
secular
began in the 1970s. Second, many emerging countries began to load up on USTs
markets
safe stores of value, especially after experiencing or witnessing several financial crises.
as
Asian financial crisis of 1997, for example, motivated China’s rapid accumulation of
The
The Chinese demand for USTs was accommodated by China’s entry into the World
USTs.
Organization in 2000. In effect, China exported cheap goods and services (a
Trade
demand for USTs continued to grow, spurred on by events like the 2008-09 financial
The
which saw the evaporation of a large supply of private-label safe assets, leaving
crisis,
seeking safe havens to reach for USTs. In the aftermath of the financial crisis, a
those
of important regulatory reforms (e.g., Basel III and Dodd-Frank) contributed to a
number
demand for USTs. More recently, the establishment of the Fed’s Standing Repo
regulatory
and the FIMA repo facility permit UST holders to borrow USD using USTs as
Facility
further enhancing the attractiveness of USTs. Together, these developments
collateral,
to a secular deflationary force in the United States. The downward pressure on
contributed
upshot of this interpretation of U.S. interest rates and inflation is that while the supply
The
USTs (deficit) matters, so does the domestic and foreign demand for USTs. To infer the
of
path of interest rates and inflation in the future, it will be important to account for the
likely
likely to impinge on the future supply of and demand for USTs.
forces
March 2020, parts of the economy were shut down to “flatten the contagion curve.” The
In
emergency lending facilities stabilized financial markets and the CARES Act (with
Fed’s
from the Federal Reserve) injected close to $2.5 trillion (10% GDP) of support
support
targeting mainly to those who needed the money. Although these support
payments
could have been designed better, they were obviously necessary and desirable.
payments
while there was good reason to believe that the policy would drive up the cost of
And
I explained in the Fall of 2020 how inflation was an unfortunate byproduct of a
living,
policy financed by printing money instead of raising tax rates and/or interest
redistribution
The alternative methods of financing the necessary transfers would likely have
rates.
even more pain on the economy, primarily though a persistently higher rate of
afflicted
secular decline. How was this possible?
disinflationary force) to the United States in exchange for USTs.
interest rates and inflation were largely offset by an accommodating fiscal policy.
Events since 2019
unemployment.