The relationship between high total public debt and interest rates is controversial (to some); and in today’s Outside the Box Van Hoisington and Dr. Lacy Hunt of Hoisington Investment Management tackle the subject head-on, in their “Quarterly Review and Outlook” for Q2 2012. They bring important new evidence to the debate, citing three academic studies (including an April 2012 paper coauthored by Rogoff and Reinhart) and an historical retrospective that focuses on the debt-disequilibrium panic years of 1873 and 1929 in the US and 1989 in Japan. In their view, the onus of responsibility for the “Panic of 2008” falls on the sometimes-slumping shoulders of the Federal Reserve, for making money and credit too easily available, and then “[failing] to use regulatory powers to check the unsound lending and the concomitant buildup of non-productive debt.”
It gets worse: “The average low in interest rates in these cases occurred almost fourteen years after their respective panic years with an average of 2% … Amazingly, twenty years after each of these panic years, long-term yields were still very depressed, with the average yield of just 2.5%. Thus, all these episodes, including Japan’s, produced highly similar and long lasting interest rate patterns… The relevant point to take from this analysis is that U.S. economic conditions beginning in 2008 were caused by the same conditions that existed in these above mentioned panic years. Therefore, history suggests that over-indebtedness and its resultant slowing of economic activity supports the proposition that a prolonged move to very depressed levels of long-term government yields is probable.”
It is a constant pleasure to be able to bring work of this quality to the attention of my readers, and I thank Lacy and Van for their help in doing that. Hoisington Investment Management Company (www.hoisingtonmgt.com) is a registered investment advisor specializing in fixed-income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4 billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies.
I am in Newport at the Department of Defense Net Assessment Office gathering of a small group of fascinating and forward-thinking individuals working on developing alternative scenarios as to how the future will unfold. It is quite multidisciplinary. This is a very eclectic group and not what one would normally picture as military (witness that I am here). There is a group of officers from various branches, tasked with thinking about the future, as well as experts from a variety of fields. At some point, when the time is appropriate, I hope to be able to share some of what I am learning, as I am simply fascinated with the discussions and debates. Long days, though, so I will hit the send button and get on to bed. These guys believe in early mornings. As those who know me know, I really don’t like to experience what 6 AM feels like. I am more of a late-night guy. But these meetings get the juices flowing, so it is worth it.
Your seeing a much larger puzzle analyst,
John Mauldin, Editor
Outside the Box
Hoisington Quarterly Review and Outlook
Second Quarter 2012
Interest Rates and Over-indebtedness
Long-term Treasury bond yields are an excellent barometer of economic activity. If business conditions are better than normal and improving, exerting upward pressure on inflation, long-term interest rates will be high and rising. In contrary situations, long yields are likely to be low and falling. Also, if debt is elevated relative to GDP, and a rising portion of this debt is…