Wednesday, November 26, 2008

Roubini: Policies will lead to "much higher real interest rates on public debt"

by Calculated Risk on 11/26/2008 03:52:00 PM

From Dr. Roubini: Desperate Measures by Desperate Policy Makers in Desperate Times: the Fed Moves to Radically Unorthodox Policies as Economy Is in Free Fall and Stag-Deflation Deepens

Another batch of worse than awful news greeted today Americans getting ready for the Thanksgiving holiday: free falling consumption spending, collapsing new homes sales, falling consumer confidence, very high initial claims for unemployment benefits, collapsing orders for durable goods. It is hard to get any worse than this but the next few months will serve even worse macro news. At this rate of contraction as revealed by the latest data it would not be surprising if fourth quarter GDP were to fall at an annualized rate of 5-6%.
And Roubini concludes:
[T]he Fed, together with the Treasury, started to implement some of the “crazier” policy actions that we discussed last week: a) outright purchases of agency debt and MBS to the tune of a whopping $600 billion; b) another $200 billion of loans to backstop the consumer and small business credit markets (credit cards, auto loans, student loans, small business loans); c) an effective policy of aggressive quantitative easing as the balance sheet of the Fed – already grown from $800 billion to over $2 trillion – will be expanded further as most of the new bailout actions and new programs will be financed via injections of liquidity rather than issuance of public debt.

Effectively the Fed Funds rate has been abandoned as a tool of monetary policy ... the Fed is now relying on massive quantitative easing and direct purchases of private sector short term and long term debts to try to aggressively push down short term and long term market rates.
Desperate times and desperate economic news require desperate policy actions ... The Treasury will be issuing in the next two years about $2 trillion of additional debt ... These policies – however partially necessary – will eventually leads to much higher real interest rates on the public debt and weaken the US dollar once this tsunami of implicit and explicit public liabilities and monetary debt driven by rising twin fiscal and current account deficits will hit a world where the global supply of savings is shrinking – as most countries moves to fiscal deficits thus reducing global savings – and foreign investors start to ponder the long term sustainability of the US domestic and external liabilities.
To continue to attract massive inflows of capital, the U.S. might have to start paying higher interest rates on the public debt. This is one of the concerns that Volcker (previous post) expressed in early 2005.