Figure 9. The Italian DEBT/GDP ratio projected forward. Here the growth in the GDP was assumed 1.3% -- the 2011 rate -- and the starting DEBT/GDP ratio is assumed 120.5% -- the rate at the end of 2011. These results are for the recursion model: "The Recursive Problem -- II" presented subsequently. The line is at the paradoxical 7% value -- where rates are suggested to lead to "unsustaniable" run-away debt condition.
(2/8/2012)
As the discussion indicates, the recursive nature of the Debt issue depends strongly on the “weighted sovereign yield.” In the US, we have kept this number low, currently less than 2%. How did we do this? According to the Wall Street Journal [2/4/2012], the way we’ve done it is through the “Bernanke put.” Basically, the Fed has implemented QE I and QE II, which amounted to “printing money” to purchase Treasury bonds and notes to keep “US sovereign yields” low. Further, as currently appears, the Fed is considering a QE III to continue this process, as the focus is now on reducing the interest on “mortgage-based securities” in our depressed mortgage industry.
As Lahart’s article in the WSJ (above reference) points out, the “…risk is obvious: The Fed could easily lose control of the long end of the curve in the improving economy – especially if worries about inflation take hold.” (The worry about the ”long end” of the economy comes from the fact that the latest Fed emphasis has been on buying 30-year Treasuries, in an effort to “twist” the Treasury “spread” between 10- year and 30-year bonds.)
In the European sector, Germany has long been worried about inflation. They have prevented the ECB from providing any sort of European commitment to “back-up” the other European economies through providing additional funds from the ECB to these countries. The EU treaty prevents direct issue of “euro-bonds” to nations to facilitate their economies.
When Mario Draghi became head of the ECB last year there was considerable concern that he might favor such an extension of the ECB’s role. Draghi indicated that he’d support the Germans and not issue euro-bonds. The matter seemed settled.
Unfortunately, Draghi seems to have changed his mind because he implemented a new tool: 3-year loans to any Eurozone banks who wanted them at 1% yields (to the tune of 489 BN euros in the 1st quarter of 2012). Of course, the European banks gobbled this money up. Further, Draghi is now talking about another 750 BN euro extension of this program. Such “long-term refinancing operations” (LTROs) may become more common (?).
This latest maneuver by the ECB amounts to the ECB “printing money” in the same manner that our Fed is doing – and it’s very inflationary. It does appear to have prevented a possible “credit crisis,” although it’s unclear as for how long. Today the inflation rate in the Eurozone is 2.7%, significantly higher than the US, but if Bernanke continues to “print money” it seems inevitable that we’ll also have inflation, even as he continues to hold-down Treasury yields this way.
Things are getting more complex as each day goes by. The up-shot of all this, however, seems to be a potential significant increase in the GLOBAL inflation rate. Any thought that the US can avoid this seems to be unrealistic in light of Bernanke’s policy of keeping rates down through “printing money.” Clearly, the US and the Europeans are now doing this.
In the US, inflation has not taken off, yet, since it seems we are continuing to save rather than spend (?). There is clear evidence that something’s at work – grocery and gasoline costs seem to be increasing (February 2012). The down-side to “printing money,” however, is clearly inflation.
