E Economists Reveal Massive Market Forces In Bonds Before And After QE

The debate over Market Monetarism and long bond demand continues. The problem is that few economists, including market monetarists, address the issue of massive demand for long government bonds that I have written about more than once on TalkMarkets. Economists are technicians, and it is often difficult to get them to think outside their boxes.

But there are a few encouraging signs that economists are at least starting to think about massive bond demand and/or the roll of clearinghouses in the new normal system we face. And with the new LCR requirement for banks for short duration bonds and notes, studies, like one cited at the end of this article, from Gary Gorton and Tyler Muir, are now being done. The study by Gorton and Muir that shows some bond yields declining arises from the need for better and better collateral by BIS rule and requirement.*

David Beckworth (another Market Monetarist like Scott Sumner) appears to understand most if not all of the history behind the concept of massive market forces in the bond market. Mr Beckworth said this:

“This downward march of interest rates has occurred prior to and after QE programs and is therefore not the result of central bank tinkering. Rather, it is the result of far bigger global market forces. One interpretation of this movement (based on the expectation theory of interest rates) is that the market expects future short-term interest rates to be increasingly lower. As Tim Duy notes, the Fed is fighting against this force and is unlikely to win. Put differently, interest rates are being suppressed by market forces despite the Fed’s best efforts. The Fed will not be able to raise interest rates this year and maybe even next year”

And, Ari Blask describes what George Selgin, of the Cato blog, Alt-M, has said:

George Selgin discussed clearinghouses' role in the pre-Fed American financial system, which came to include providing liquidity during panics. After the failure of the Ohio Life and Trust Insurance Company in 1857 led to a system wide suspension of specie payments in New York, the recently formed New York Clearing House issued temporary loan certificates to member banks for use in settling transactions...

...Selgin closed by noting the advantages of the 19th century’s spontaneous and private clearinghouses relative to today’s government imposed and run versions. In addition to the Fed, Dodd-Frank’s mandated central clearinghouses for OTC derivatives will socialize risk and create moral hazard, removing an incentive for the private sector innovation that might actually improve payments and settlement in the derivatives market.

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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