06 July 2011
The note at the end says that DeLong is a professor of economics at the University of California, Berkeley. The content of the column makes this a bit difficult to believe but if Bloomberg says so it must be true. It also adds that he was deputy assistant secretary of the US Treasury. This is perfectly believable when you remember that it was during the time he served in office that the Glass-Steagall Act was finally killed.
This is what DeLong says in his column:
There is only one real law of economics: the law of supply and demand. If the quantity supplied goes up, the price goes down.
Back in the third quarter of 2008, the public held about $5.3 trillion of U.S. Treasury bills, notes and bonds. As the recession hit, tax revenue plummeted, and government spending rose, that total reached $9.4 trillion by mid-2011.
We're on target to have $10.7 trillion outstanding by mid-2012 -- doubling the Treasury debt held by the public in just four years. Supply and demand tells us that a steep rise in Treasury borrowings should produce a commensurate fall in Treasury bond prices and thus higher interest rates -- and that increase should crowd out other forms of interest-sensitive spending, slowing productivity growth.
Yet the market has swallowed all these issues without so much as a burp. By all accounts, it's smacking its lips in anticipation of the next tranches.
"If the quantity supplied goes up, the price goes down." Is this the law of supply and demand? I should think even a raw undergraduate knows that there is a proviso. If the quantity of a good supplied goes up while its demand stays constant, the price goes down.
So what makes DeLong think that the demand for government debt has remained constant? If you accept his figures then between the third quarter of 2008 and the middle of 2011, government debt increased by $4.1 trillion. During that period the two bouts of quantitative easing put about $2.1 trillion of cash into the hands of various players. That leaves $2 trillion to be accounted for. During the period the cumulative current account deficit was about $1.1 trillion and it's not too much to assume that a large chunk of this was used to purchase US debt. So that leaves just $0.9 trillion. And this is just peanuts when you remember the amount of cash sloshing around; US pension funds alone had about $9.9 trillion in assets as of 31 March 2010. [Flow of Funds Accounts of the United States quoted in Wikipedia Pension Fund]. Why wouldn't fund managers park some of their cash temporarily in US debt given the riskiness of other assets?
In other words just a couple of simple additions combined with the law of demand and supply (the real one, not DeLong's version of it) can easily explain why large issues of US debt have not raised interest rates much.
But since DeLong does not understand, or perhaps does not want to understand, demand and supply, he is surprised that interest rates have not gone up. To explain it he has to bring in the history of the Clinton and Bush administrations, the liquidity trap, the IS-LM diagram and much else, stopping finally only to scratch the back of Paul Krugman, a favour that will no doubt be returned next week.
Sometimes I am tempted to share Krugman's opinion of PhD economists. Never having learnt economics formally I am not in a position to say, but perhaps there is a sign at the entrance to university economics departments that says: "Abandon common sense, all ye who enter here."
Incidentally, according to Debt to the penny, between the start of 2011 and the middle of 2011 debt in the hands of the public has gone up from $9.4 trillion to $9.7 trillion, an increase of only $0.3 trillion, probably less than the amount of quantitative easing during that time.