Managing Covid debt mountains is a key task for the next decade

Treasury bond issuance and central bank QE must work in tandem for economic recovery

Gavyn Davies

Tug of war, two businessman pulling a rope in opposite directions over defocused background with copy space
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The surge in government borrowing in all the major advanced economies due to the pandemic has had few precedents, even in wartime. In the US, for example, public borrowing in the quarter from April to June 2020 alone is expected to reach $3tn, almost 15 per cent of this calendar year’s gross domestic product.

The IMF estimates that US government debt will exceed 130 per cent of GDP after the recession, more than 30 percentage points higher than a decade ago. As the world’s largest borrower, the country will no doubt influence how other nations manage their debts, in terms of the quantity and duration of the instruments issued by governments, and any bonds purchased by central banks.

Assuming countries are unwilling to introduce “debt jubilees” to write off their obligations, or swap them into equity, the public debt mountains will need to be managed indefinitely, with little immediate prospect of reducing their size. The larger the scale, the greater the economic costs of debt mismanagement.

So far, markets have been able to absorb the rise in US public debt with few serious hiccups, though the Federal Reserve has injected emergency liquidity to prevent dislocation in longer-term government bond markets.

The government’s need for finance has been met largely through issuing short-dated bills, which have mopped up the rise in household savings driven by unemployment support. In addition, the Fed is resuming its regular programme of debt purchases, in an open-ended manner.

There has been no panic about the sustainability of government debt, either in the US or elsewhere. This is a big success story.

The combination of short-term bill financing plus central bank purchases of longer-dated debt could persist for a long while. However, that is not what happened to debt management in the years following the financial crisis in 2008.

Then, the Treasury initially responded to its higher budget deficit by issuing bills, but that debt was refinanced with much longer duration notes and bonds. This extended the weighted average maturity of market debt from 46 months to 66 months (see box).

Recent advice to the Treasury suggests the same thinking might apply this time.Why does the Treasury generally prefer longer-duration debt?

After all, since there is usually a positive “term” premium in long-bond yields, the cost of servicing it is generally higher than the cumulative cost of continuously rolling over those of shorter terms.

History shows that the Treasury can usually reduce service costs markedly with short-dated debt issuance, but only by accepting much greater interest rate risk if inflation or real bond yields suddenly rise sharply.

In such circumstances, the need to refinance maturing short-dated debt would quickly lead to a spike in net interest payments, adding to the budget deficit — probably in adverse economic conditions. A preference for long-dated debt therefore smooths interest rate payments in crises, albeit by raising the average debt service costs over many decades.

The Treasury normally errs on the side of taking out this insurance policy, especially when long-term bond yields are abnormally low, as they are now. The economist John Cochrane argues that bond duration should now be extended very aggressively because in his opinion the recent surge in debt makes a US fiscal crisis possible in coming years.

But this may make it more difficult for the Fed to ease monetary conditions by purchasing Treasury debt to reduce yields and cut bond duration, as it has done in past periods of quantitative easing. The outcome in the 2010s was a conflict, in which the Treasury extended the duration of bonds held by the public, while the Fed acted to shorten duration.

Estimates suggest that the central bank’s QE reduced 10-year government yields by 1.37 per cent, but the Treasury’s bond issuance eliminated about 60 per cent of this decline. As the Treasury and the central bank are two parts of a single public sector balance sheet, it makes little sense for them to pull in entirely different directions.

If secular stagnation deepens in coming years, as many expect, the Treasury should focus on shorter-term funding to help the Fed reduce bond yields and support economic growth.

Will the Treasury extend the duration of the public debt in the 2020s?

Following precedent, the US government has initially funded an unexpected surge in the budget deficit by relying on the bill market.

Bill issuance reduces the maturity of its overall debt, but the Treasury may consider extending duration in coming years, as it did in 2013-17.

This could conflict with the Fed’s monetary policy if secular stagnation persists.

There Are No More Recessions

By E.B. Tucker, senior analyst, Casey Research

In the summer of 2006, I took a weekend trip to Miami Beach.

It was my first experience with what we later called the credit bubble.

I had dinner at a restaurant called Tantra.

It went out of business the following year. I’ll never forget the scene.
After walking in the front door, I said, “Smells like a grass lawn in here.”

The hostess told me Tantra appeals to all the senses.

Every day, they laid fresh sod in the bar area to stimulate their guests’ sense of smell.
The visual appeal of the place was obvious. Miami Beach is already a spectacle. Here, it looked like they hired dozens of scantily clad models to parade around.
There was a large rope cargo net hanging from the ceiling in one room filled with pillows.

The hostess told me it’s where guests could “frolic.”
The weekend I visited, there was a bikini convention in town.

One of the companies rented out the side dining room for a private party.

It was chaotic.

Finally, I sat down at a table for two next to the kitchen.

Younger at the time, I cringed at the menu prices.

The food was not great.

Overall, it was a total bust.

However, it was highly amusing.

                Fresh sod laid daily on the cocktail lounge floor

Tantra doesn’t work in a normal capitalist economy.

Nobody uses hard-earned savings to lay fresh sod on the floor of a cocktail lounge every day.

That only happens with borrowed money in the absence of consequences.

This was a sign of what we now know was a credit bubble... and it’s happening again today.

Bad Incentives Create Bubbles

A bubble is what you get when you prevent natural capitalist forces from sorting out excesses in the economy. In short, when the money flows unnaturally, it ends up in odd places.

The problem with credit bubbles is they grow large, then bust. When politicians pressure the Federal Reserve for extra help to soften the pain of the bust, it plants the seeds of a larger bust to come.

The U.S. economy used to have recessions. That’s a normal part of a capitalist system. I call what we have today a “crisis system.”

The 2002 recession was the last one of our time. The Fed got involved by lowering interest rates from 6.5% to 1%. At the time, that was unprecedented.


That meant borrowers all of a sudden paid a lot less interest on loans. It helped them survive the recession. The problem is, some of them deserved to fail.

I know it sounds inhumane. However, recession is the most humane way to rid the economy of bad operators.

Take Tantra, for instance. While I can’t know for sure, my guess is the owners benefited from dirt-cheap borrowing costs. I don’t know anyone who’d spend hard-earned savings to lay fresh sod on the floor daily.

In a recession, business activity slows. Fewer people eat out. That means it’s harder for the restaurant to pay its rent, payroll, and other bills.

Meanwhile, the more efficient operators, the ones who don’t waste money on daily indoor sod installation, hunker down and survive.

Prior to the Fed’s overreaching into markets, everyone knew how to handle recessions. Think about the hard-working restaurant owner who puts on an apron and works alongside his staff.

He sets an example. His work ethic shows the staff that a little sacrifice now means keeping their jobs. It might mean taking market share from competitors who don’t survive the recession.

Throw that out the window. These days, at the first sign of trouble, the Fed ramps up its effort to soften the blow of recession. Interest rates of 6% are a distant memory. These days, anything over 0% seems excessive.

Are You Happy With 0%?

This won’t go on forever. My guess is you wouldn’t lend your hard-earned savings in exchange for a 0% return. You certainly wouldn’t lend it to a restauranteur who planned to use it for a turf flooring.

In our current “crisis system,” every bubble is bigger than the last. When it pops, the mess is also bigger.

The final bubble will make a mess so large it triggers a financial reset. What that means is the pattern of bubble, crisis, bubble, crisis continues until everyone goes along with it, assuming another bubble follows.

People get used to the pattern. The final bubble explodes, and there’s no more steam left in the system. It resets. The price of everything converts to a new value under the new money system. It happens overnight. At that point, it’s too late to prepare.

Today, your incentive is to not prepare. Preparing means spending less than you earn, putting aside the difference for tomorrow.

Meanwhile, the instant there’s a sign of trouble, the Fed and the government step in with a rescue plan. They have the power to pick survivors and set the terms.

Try to see the pattern. It’s right in front of you, if you care to look.

miércoles, junio 24, 2020



The Rivalry Between Iran’s Armed Services

The army vented its frustration this week over its losing competition against the IRGC.

By: Caroline D. Rose

A longstanding struggle between the services of Iran’s armed forces spilled into the open this week after the government’s official news agency published an interview with a senior army commander. Rear Adm. Habibollah Sayyari, the coordinating deputy of the Islamic Republic’s army, said that state media ignored his service in favor of the Islamic Revolutionary Guard Corps, and criticized the IRGC’s dominant position in the economy and politics. Sayyari said the IRGC’s involvement in politics violated national principles, and he praised the army for not engaging in self-promotion.

The interview was deleted within hours of publication, likely at the direction of the government, but for a moment, the world got a glimpse into Iran’s deep-rooted inter-service rivalry. The competition between the conventional army, known as the Artesh, and the IRGC has been a central feature of Iran’s military landscape since the 1979 revolution.

But unlike a lighthearted army-navy game or bureaucratic tussles over funding, this is a perilous fight over economic, political and ideological influence in which only one side can win. It is a battle over not only operational capabilities, but the direction of the country.      

Since the 1980s, the IRGC – considered the guardian of Shiite Islamism, whereas the Artesh has always had a secular-nationalist bent – has had the upper hand. The IRGC’s growing portfolio of responsibilities, its control over the formal and informal economies, and the favor of the political establishment have enabled it to transcend and upstage the Artesh.

Facing a global recession, the coronavirus pandemic and continued U.S. sanctions, the Iranian government will have to make budget cuts. Awareness of that fact has pushed the Artesh to intensify its fight to win funding and impose its ideological agenda.

But financial constraints and festering socio-political discontent against the government will ultimately stack the cards in the IRGC’s favor, enabling it eventually to absorb the duties and resources of Iran’s waning conventional army.

History of Bitter Rivalry

Cracks in the foundation of Iran’s armed forces have been evident since the Islamic Republic came into being in 1979. When Ayatollah Ruhollah Khomeini dethroned the shah, he faced a decision: dismantle the shah’s Imperial Guard completely, or reform it to fit within the revolution’s set of principles. Despite political and clerical pressure, Khomeini chose the latter option, wishing to retain the force’s expertise. The shah’s army was heavily purged, indoctrinated and renamed the Islamic Republic of Iran Army, commonly referred to as the Artesh.

Even with these changes, the government remained uncomfortable with the Artesh’s affiliation with the toppled regime, suspicious of potential loyalties to the shah and secular nationalism. Those suspicions were confirmed after the Nojeh coup plot, an attempt to overthrow the Islamic Republic in 1980, was found to have involved Artesh servicemen. Out of concern for his own safety, Khomeini was forced to put more trust in the militias that fought on the side of the revolution before becoming the IRGC.

The IRGC and the Artesh were enshrined in Iran’s 1979 constitution as parallel forces, but ambiguous wording enabled Supreme Leader Khomeini to empower the former and keep the latter on a tight leash. For example, Article 143 says the Artesh is responsible for guarding the “independence and territorial integrity” of Iran, while the IRGC defends “the revolution and its achievements.”

Those revolutionary “achievements” have come to carry greater meaning in post-revolutionary Iran, encompassing not only internal order but also control of a network of Shiite proxies across the Levant. While the Artesh protects Iranian territory in the event of a ground attack, the IRGC has emerged as a flexible tool for the advancement of the government’s domestic, intelligence and foreign priorities.

Because of this, the IRGC has been able to establish ground, naval, aerial, domestic security, disaster relief and even aerospace branches, which were initially presumed to be under the Artesh’s purview. The Artesh’s navy, air force and army all conduct routine annual maritime and ground patrols and exercises and project Iranian conventional military power.      

But as Iran is not a conventional power – it lacks modernized weaponry, strategic mobility, balanced defensive and offensive capabilities, and the ability to conduct cross-spectrum operations – the Artesh is largely obsolete, and it’s left to the IRGC to perform the heavy lifting of defending the country.

IRGC vessels have been the primary agents harassing U.S. 6th Fleet warships, assaulting foreign oil tankers and disrupting shipping through the Strait of Hormuz. The IRGC’s domestic paramilitary, the Basij, has been responsible for internal security (quelling protests and internal dissent) and natural disasters, and has even served as the key COVID-19 response team.

And as the heart of Iran’s core foreign policy mission, the “Shiite Crescent,” IRGC ground and air forces have been instrumental in sponsoring pro-Iran militias and strikes on Western troops in Iraq, Syria, Lebanon and the Palestinian territories, all in an effort to pave an avenue of influence into the Mediterranean.

Not only has the IRGC’s mission ballooned over time, but its budget has as well. The Artesh’s budget, meanwhile, has been incrementally downsized, even though it employs more personnel and is considered Iran’s conventional force. IRGC command has gained sway over the Iranian parliament, advisory bodies and the economy. IRGC members outnumber Artesh representatives among Iran’s political elite, with more advisers at the side of Supreme Leader Ayatollah Ali Khamenei and in the national parliament, the Majlis.

The IRGC even exercises some institutional control over the army itself: The Revolutionary Guards holds the reins of the Armed Forces General Headquarters, which acts as an intermediary between the supreme leader and Artesh command. As a result, the IRGC is the first to review Artesh planning, resources, logistics and operations.

And, importantly, the IRGC enjoys more independence from the state budget, with exclusive access to Iran’s foreign exchange reserve, ownership of roughly one-fifth of the market value of the Tehran Stock Exchange, a hand in the black market, and access to many of Iran’s oil and gas sector contracts. The IRGC’s financial semi-independence has proved helpful, as sanctions and a painful economic recession have quickly chipped away at Iran’s defense spending.

A Losing Battle

The clear disparity of power between Iran’s parallel services has bred resentment among the Artesh’s command about the service’s atrophying budget and influence. For decades, the Artesh has made a tradition of keeping its mouth shut, praising Islamist principles and Khamenei’s leadership, and taking a backseat to the IRGC.

Yet new opportunities for funding, such as the potential lifting of the U.N. arms embargo in October (the five-year embargo expires on Oct. 18 under the terms of the Iran nuclear deal, but it could be extended), as well as budget considerations due to sanctions have incentivized the Artesh to speak up. The potential strength of the Artesh comes not from within but from the tacit threat that it could galvanize nationalist sentiment among regime opponents.

The Artesh believes it can pressure the government by appealing to secular-nationalist factions in the Iranian population, many of which rallied against the government at the end of last year. But this is a risky gamble for an already diminished force to make.

Despite its efforts, the Artesh has not convinced the government of its worth. Limited by aging armaments (many are holdovers from the shah’s time), unserviceable machinery and a budget now less than half the IRGC’s, the Artesh has tried to keep its head above water. But the fact that the Artesh has become second class to the IRGC has led to substandard performance among its demoralized personnel.

Lower pay, fewer benefits and a lack of career mobility have affected the Artesh’s recruiting, enabling the IRGC to pick from among the most talented recruits. This has led to a string of mishaps among the Artesh’s branches, the most recent example being the May 11 friendly fire incident between two Artesh navy vessels, the support ship Konarak and the frigate Jamaran, which killed 19 and injured 15 of its own personnel.

The Artesh’s recent mistakes and pressure tactics won’t work to change minds within a government overwhelmingly favorable toward the Revolutionary Guards – especially after the election in February increased the number of pro-IRGC conservative hard-liners in the Majlis.

In fact, the Artesh’s waning relevance and tight budget, combined with growing socio-economic grievances among the public, will only push Tehran closer toward allowing the IRGC to absorb the Artesh’s functions and resources. Drawing from some of the Artesh’s resources, the IRGC’s funding for its Levantine operations and efforts to quell dissent at home will receive a boost.

Nevertheless, increasing U.S. sanctions, an internal economic crisis and rising opposition to Iranian influence in the region will continue to constrain Iran.


Chinese Diplomats Behaving Badly

At a time when China’s reputation is suffering and its relationship with the United States is in freefall, the country’s diplomats should be focused on differentiating China’s foreign policy from that of US President Donald Trump. Yet they are doing just the opposite.

Minxin Pei

pei63_WANG ZHAOAFP via Getty Images_chinaforeignministrywangyi

CLAREMONT, CALIFORNIA – Chinese diplomats have long had a reputation as well-trained, colorless, and cautious professionals who pursue their missions doggedly without attracting much unfavorable attention.

But a new crop of younger diplomats are ditching established diplomatic norms in favor of aggressively promoting China’s self-serving COVID-19 narrative. It is called “wolf warrior” diplomacy – and it is backfiring.

Shortly before the COVID-19 crisis erupted, Chinese Foreign Minister Wang Yi instructed the country’s diplomatic corps to adopt a more assertive approach to defending China’s interests and reputation abroad. The pandemic – the scale of which may have been far smaller were it not for local Wuhan authorities’ early mistakes – presented a perfect opportunity to translate this directive into action.

And that is precisely what Chinese diplomats have been doing. For example, in mid-March, the foreign ministry’s newly appointed deputy spokesman, Zhao Lijian, promoted a conspiracy theory alleging that the US military brought the novel coronavirus to Wuhan, the pandemic’s first epicenter.

Similarly, in early April, the Chinese ambassador to France posted a series of anonymous articles on his embassy’s website falsely claiming that the virus’s elderly victims were being left alone to die in the country. Later that month, after Australia joined the United States in calling for an international investigation into the pandemic’s origins, the Chinese envoy in Canberra quickly threatened boycotts and sanctions.

But, unlike the fictional special-operations agents after which they are named (from a popular Chinese action movie), China’s wolf-warrior diplomats have not been rewarded for their recklessly confrontational style. Far from burnishing China’s international image and placating those who blame the country for the pandemic, their actions have undermined China’s credibility and alienated the countries it should be wooing.

Why change tack in the first place? One reason is China’s current combination of historical insecurity, rooted in its so-called century of humiliation, and heady arrogance, fueled by its immense economic clout and geopolitical influence. So keen are China’s leaders to gain the respect they feel their country deserves that they have become highly sensitive to criticism and quick to threaten economic coercion when countries dare to defy them.

Another reason is the current regime’s emphasis on political loyalty. Under President Xi Jinping’s highly centralized leadership, Chinese diplomats are evaluated not on how well they perform their professional duties, but on how faithfully and vocally they toe the party line. This is exemplified by the appointment last year of Qi Yu, a propaganda apparatchik with no foreign-policy experience or credentials, as Party Secretary of the Ministry of Foreign Affairs – an important post traditionally held by an experienced diplomat.

If aggressively pushing the Communist Party of China’s preferred narrative is a matter of professional survival, diplomats will do it, even if they recognize that it is counterproductive (as many probably do). They certainly will not try to persuade their political masters to change course. Whereas diplomats risk paying a heavy price for conscientious dissent, they seem to suffer no consequences – from criticisms in official media to demotions or dismissals – for destructive loyalty.

When pushing the CPC-approved narrative produces negative results, it is, in Party parlance, an issue of tactics, not the “political line.” Punishing loyal diplomats for “tactical errors” would make them more reluctant to do the CPC’s dirty work in the future.

By removing any incentive for diplomats to temper their approach and offering a convenient excuse for setbacks, this logic entrenches bad policy. It does not help that China lacks a free press and political opposition to highlight the failures of the wolf-warrior approach. Unlike Western diplomats, those in China do not have to fear public ridicule or criticism. All that matters is what their bosses say – and their bosses want wolf warriors.

This is a mistake. At a time when China’s reputation is suffering and its relationship with the US is in freefall, the country’s diplomats should be focused on differentiating China’s foreign policy from that of US President Donald Trump.

It is Trump who recklessly promotes conspiracy theories and aggressively responds to any perceived slight with threats and sanctions. It is Trump who foolishly alienates friends and partners, rather than cultivating mutually beneficial relationships. And it is Trump whose belligerent insistence on his country’s superiority has eroded its international reputation and undermined its interests.

China’s leaders should know better.

Minxin Pei is Professor of Government at Claremont McKenna College and a non-resident senior fellow at the German Marshall Fund of the United States.