Think about this. Look at where 10-year US Treasury yields are, look at 10-year UK gilt yields for that matter. The world is crying out for AAA assets. The world’s investors want somewhere safe for their cash; European pension funds, Asian economies building reserves and commodity rich countries all need to preserve value. There is an overdemand for safe havens especially since in recent years other previously deemed safe assets such mortgage-backed securities and peripheral Euro Zone debt have proved to be toxic. The private sector has a large amount of cash stashed away but it doesn’t want to spend it for fear of what the future holds. One way to boost demand is for every company to pay their employees a lump sum bonus to help demand to recover. Obviously, shareholders are not about to let that happen so can governments replace this even with debt levels so high?
With demand for US Treasuries so high it’s certainly possible. But fiscal injections must be targeted in the right way. At the beginning of the year, Obama’s extension of the Bush tax cuts were badly targeted at the wrong section of society weighted in favour of the rich who haven’t had their spending dramatically constrained by the financial crisis. A brave fiscal expansion targeted at those who really need it will help bring back demand, raise confidence in the economy and in global economic leadership, something that has been particularly lacking of late. However, given the latest US debt ceiling brinkmanship, any hope of strong demand returning in the US seems to be a long way off.
Supply side economies such as Germany and Japan depend on foreign demand for their goods but given that this has dried up, domestic demand cannot provide sufficient support, therefore, it is imperative that the world’s largest economy finds its thirst once again.
Even though the US credit rating has taken a knock lately, US Treasuries are still safe and highly liquid. Can the world’s demand to preserve wealth help find US demand, otherwise, where are we heading? Japan style deflation? That’s the way the yield curves are heading.
P.S. Politicians are paid to make tough decisions. Merkel, Sarkozy it’s that time now! Combined with the brinkmanship of the US debt ceiling, the political world is only making both Wall Street and Main Street more uncertain and this will only lead to further economic deterioration.