Ferguson-Krugman Exchange, Who Is Right?

You may be aware of a disagreement between Paul Krugman and Niall Ferguson (not to be confused with Turd Ferguson) about what the rise in treasury yields actually means.

Krugman believes it is evidence of confidence about the future and normalcy in terms of market function.

Ferguson believes the market is pricing (what should be) the realization that the US is headed for big trouble as it is printing money, issuing debt and effectively monetizing some of that debt.

Dan Gross chimes in here with links galore if you want to get the whole story.

There are a lot of moving parts to this and for now all anyone can have is an opinion. We won’t know the answer for a while yet. Between the two camps (Gross calls them Krugmanites and Fergusonians) is probably where the true answer lies.

As far as confidence and normalcy the pure panic that existed does appear to have subsided. By this I mean confidence that the market can just function (not a directional call for where things are going). Hopefully people remember that there was rampant fear that markets would not function ever again, there were a couple of spasms in this regard of course but we have moved out of the panic stage. I’m not sure how the Fergusionians could argue otherwise as they could be right about the US being in big trouble but the market could easily function the way it should in the face of that outcome.

I suppose there could be a return to that sort of panic but the world is far more educated about things like counterparty risk, the magnitude and danger of the leverage employed and everything else. We can debate whether these things have been fixed or not but if everyone now knows much more than they did before March 2008 then I’m not sure panic in the context we are discussing is possible.

Krugman believes the rise in treasury rates is evidence that investors are willing to go for more return than a few basis points from treasuries, Gross notes how much Brazilian and Indian stock markets have rallied. Again this is a point that is hard to argue because again the US could erode (or implode?) as other markets do well. Money is flowing into other asset classes–not to say it won’t all correct aggressively one more time but it is tough to argue that money has not moved from US treasuries to other things.

As for the logic behind the Fergusonian camp I’m not sure how anyone can argue that the US has become a much more attractive investment destination in the last couple of years (to be clear I haven’t read anywhere that Krugman has said this). If the US is much less attractive than it was because of all the reasons that you can think of then rates would seem to have to go up a lot, although not necessarily to 1981 levels. I suppose this could be wrong but I don’t see how they do anything but go up.

There is an element to this of captive buyers. One way to look at this is that China has to buy US debt in order to protect its current investment. That is at least partially true and I would have to imagine that China getting out of its US investment would require both strategic and logistical planning and some sort of management of the consequence to them when the US can’t buy as much stuff from them. No matter your conclusion on this it is a very unhealthy relationship with bad consequences for both parties.

It should be obvious that I am not too concerned with trying to solve this debate as I am concerned for what this means for growing/protecting the portfolio. US treasuries are down a lot but still expensive so anything beyond short term (don’t even have any short term though) would be off the table. It seems to me that to think uncomfortably high price inflation (I am not in the hyperinflation camp) won’t happen is to believe that the Fed and Treasury will know exactly when to reverse everything which seems unlikely given how reactive they have been all along. Additionally it seems very unlikely that the Obama administration will err on the side of belt tightening.

As I read the Krugman/Ferguson debate they can each be correct on certain things but I am leaning toward the Fergusonian side of the debate because it is closer to what I have expected would happen (not to the same magnitude) and because I see very little need to “protect” against a happy outcome.

About Roger Nusbaum 169 Articles

Roger Nusbaum is an Arizona-based financial advisor who builds and manages client portfolios using a mix of individual stocks and ETFs. Roger writes a popular blog, which focuses on risk management, foreign stocks, exchange traded funds, options etc.

Roger has been recognized by many in the investment management industry for his expertise in portfolio management. Roger has been regularly interviewed by the financial press, trade journals, and television news shows. He has also had numerous technical articles published and has been quoted in a number of professional trade journals, newspapers, and consumer finance magazines. He appears frequently on CNBC Asia as a market commentator.

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