Five Misunderstandings About Government Debt
Comment of the Day

October 12 2012

Commentary by Eoin Treacy

Five Misunderstandings About Government Debt

Thanks to a subscriber for this interesting report by Thorsten Slok for Deutsche Bank. Here is a section:
1. By definition: Assets = liabilities. This means that saying that “there is too much debt in the world” is the same as saying “there are too many assets in the world”. But is "too many assets in the world" a problem that's holding back growth?

2. It is not the amount of debt outstanding that matters but the market's assessment whether the borrower can pay back the debt. Japan as an example.

3. The transmission channel from high debt to growth is via high interest rates. If US long-term interest rates remain unaffected by government debt levels then US government debt levels may never be a problem.

4. Causality tests show that growth explains future debt. Debt does not explain future growth.

5. Growth is not always driven by credit. In many countries, for example Germany, growth is driven by exports and not by debt accumulation.

Eoin Treacy's view 10-year TIPS yields have been below zero for a year and continue to trend lower. At close to -1% this represents a deleterious effect on savings. So while in a dividend discount valuation model every asset does represent a liability that is cold comfort for an unleveraged investor who is seeing their spending power chipped away every year. Let's not forget that compound interest also works in reverse! It is therefore, little wonder that gold has been remonetised in the eyes of investors since it is no one's liability.

In my opinion, the total return on US Treasuries is one of the best ways to monitor the sovereign bond trend because it depicts how the largest participants in that market regard it. Since it is one of the most consistent trends anywhere, the upside can continue to be given the benefit of the doubt until it becomes inconsistent. When that occurs, we will be able to say with a high degree of confidence that this bubble has burst. What would this look like? The Index will need to break its progression of higher reaction lows and sustain a move below the 200-day MA. Until that occurs, the arguments for why bond yields can continue to compress will remain credible.

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