From the comments

It seems like market forecasts of low real yields 30 years into the future support TGS. How long does it take for long-run money neutrality to win out? If the yield curve showed low yields 100 years out, would that dissuade those looking for a monetary solution?

That is from fmb.  Here are the real yield rates.


It seems like market forecasts of low real yields 30 years into the future support TGS

Or investor stupidity and willful blindness/indifference to inflation risk.

They're indifferent to inflation risk because there is no credible inflation risk. In my experience, the inflation hawks simply refuse to understand the concept of velocity or look at any evidence contradictory to impending inflationary doom.

Or skeptical that all this new money will somehow never actually be spent, or that the entitlements problem can be solved without debasing the crap out of the currency.

This Matt's exact point about velocity... if the money isn't spent, there's no impact of the policy whatsoever and thus no impact, good or bad, with no impact on currency value or anything else, see Adam Smith about money locked in a chest, etc. If it is spent, then the policy is successful. So it's basically a win or no-lose scenario.

Btw, since fiat currency has no base it can't be debased. The analogous thing that can happen, however, is that the central bank can cause the relative supply and demand for the currency to deviate from prior market expectations. Since the central bank has allowed the dollar to be valued far above its long-term price level, the supply of money relative to demand has shrunk far below past market expectations, which has caused past contracts to become overvalued (debt owed is more burdensome and more valuable in real terms than was expected at contract signing). There are also real negative effects from allowing inflation close to 0 because wages are sticky downwards.

Historically, treasury yields have a pretty poor track record at predicating significant movements, upwards or downwards, of coming price inflation.

I'm not sure why you brought up the treasury, but according to macroeconomic orthodoxy, the fed determines core inflation. So I don't know why the treasury doesn't just ask the fed what inflation will be if it wants to know.

"since fiat currency has no base it can’t be debased"

Huh? Maybe semantically, but it's base is all goods and services, or previous dollars, against which it has lost a huge chunk of value, even over the last decade.

The issue to me is that the argument assumes the market's yields over the next 30 years must accurately predict the real yields for the next 30 years.

The issue with this is that investors do not really buy 30-year bonds with a time horizon of 30 years. A more straight-forward explanation is that the flight to safety is creating a bubble in both gold and Treasuries. For gold, investors have completely discounted the possibility that the gold price may crash. For Treasuries, 30-years have such insane prices because investors no longer care about interest rate risk if they hold to maturity.

The reason these low yields have happened do not have to do with TGS or real growth rates. They have everything to do with a flight to safety from a possible depression. Once the Fed becomes more credible in meeting its inflation target long-term, then interest rate risk becomes more credible and Treasury and stock yields will come into more alignment.

You completely misunderstand what a financial bubble is. Bubbles require widespread participation. Participation rates in the gold "bubble" range somewhere around 1-2%.

Gold is going up because a lot of smart money is predicting the collapse of the financial system and the complete remonetization of gold. That bet looks pretty good given the history of fiat money systems and our current fiscal and monetary trajectory, along with metrics like employment %, food stamp usage, levels of satisfaction with the political system, etc.

Treasuries are a bubble -- almost everyone owns a lot of them, directly or indirectly, via bond funds, pensions and the like. They are obviously mispriced given the terrible negative real interest rates on the short and medium end, and the hideous long-term fiscal outlook.

Asset prices = forecasts + risk adjustment. Hard to say what this means without more structure.

The 30 year yield is not a forecast of what short term interest rates will be approximately 30 years in the future. There are several theories of term structure. One model of term structure eliminates arbitrage opportunities. Another model builds the term structure up from the instantaneous rate through risk premia. Then there's the theory of liquidity preference.

As Matt said, the investors who buy long tenor debt have long investment horizons and are thus less price sensitive. He didnt say, but he implies that they have interest rate hedges (swaps) in place to mitigate interest rate risk. Their portfolios have a high duration, but they are likely interest rate neutral positions if they are well managed. Some of their portfolio is close to maturity, and as interest rates rise, they are reinvesting at higher yields. Since they are held to maturity, theyre not worried about bond prices, but rather the yield or coupon.

With a barbell strategy, investors will hold long bonds for yield and short bonds for reinvestment. Other highly leveraged investors might be borrowing short and lending long, picking up lots of pennies.

Other investors (China) are simply not price sensitive. Their investment strategy is based on maintaining their export promotion policies.

Hmmmm, so it's getting increasingly difficult to find a place to put money for a high return, a la TGS.

Though that does make me wonder whether the marginal propensity to save is getting higher and whether that could be a factor. (I mean globally and over the long run; I know savings rates are up here in the U.S. since the housing collapse).

Real ten year yields were between 1 and 2% in the 1960's and negative for much of the 1970's but high in the 1980's, 1990's. and the 1930's.

Yes TallDave, it’ is getting increasingly difficult to find a place to put money for a high return, that's why many folks are looking to buy silver and gold bullion in these markets because of the super low yields and increasing inflation.

A couple of follow-ups / responses:

1. Yes, there are many factors that make "market forecasts" less than perfect, perhaps I should have called them "naive" forecasts. However, I don't see anyone asserting that these factors are sufficient to undermine my main thrust.

Tyler pointed to one data source, but this one attempts to address at least some of the criticisms in the comments and may be at least a little better:

2. That said, according to Tyler's data the 20 year forward 10 year real yield is over 1.6% (approximated simply as (30 * .95 - 20 * .62) / 10). Combine that with Joan's graph and maybe the market's naive forecast is for a return to something resembling normalcy in the 2030s.

3. It's still possible to put all of that aside and engage the actual question, perhaps starting "Even though I disagree, I'll stipulate to your premises for the sake of argument..." In this case, stipulate that, after all adjustments, the market is pointing to very low real yields very far into the future. How low and how far does that need to be to dissuade you from a monetary solution?

Pardon me, what did you say the "correct" interest rate is supposed to be?

Yes, the forward rates are a much better predictor of future spot rates, but remember that the forecast error increases at an increasing rate with time. There are millions of intervening factors between now and then that will affect real yields.

But I was already dissuaded from a monetary solution before this post.

The funny thing about the propensity to save increasing is that saving makes much less sense when investment returns are this low. Savings becomes a direct trade off between future consumption and present consumption, to which you should at best be indifferent.

However, much of the current "saving" is probably repaying debt, which is a different matter.

Say one doesn't believe in TGS and expects growth to be stronger over the next 30 years than TGS predicts. Where does this optimist invest her money? Let's even imagine that this optimist is named China. Does China buy shares in Apple or IBM? That's pretty risky to predict where those particular stocks will be 30 years from now, even for an optimist. Does our optimist therefore buy a broad portfolio of US stocks? Well, keep in mind that our optimist named China has so much money that a broad portfolio of US stocks won't absorb all of her investment money. She could perhaps buy a bunch of US companies outright -- but she has experienced political opposition when she has tried that in the past. So, reluctantly, she puts money into 30 year US treasuries, where else? Perhaps she could buy short term bonds yielding less and roll them over with the expectation that in say 5 years 30 year yields will have risen enough to make that strategy more profitable. But who says she isn't doing this also? Where else do you suggest this optimist invest her money? Empty cities in the desert? Done.

My point is that even if the wisdom of crowds believes the economy and with it long bond yields will eventually return to normal that still doesn't give it any better long-term investment options in the present. Present market conditions influence every market, even presumably long term ones.

The point of monetary stimulus is not to end TGS (money can't do that) but rather to end high unemployment (money can help do that.)

Yes, but you often suggest that the hope/expectation is that less-tight money will lead to higher real GDP growth, too (notwithstanding your "Even if I'm wrong, I'm right" post).

If this is plausible, then I think we would also expect that a sufficiently long-run (i.e. long enough for long-run money neutrality to kick in) estimate of real yields to be higher, too.

So, observing that they're not very high might not dissuade you, but it might lead you to revise downward your estimate of the benefit.

FWIW, I'm in your camp more than any other.

Unemployed people don't produce GDP, so I suppose that's how money would increase it.

Note how wrong Bill Gross was. He claimed that the end of QE2 would be an important day in history, that nobody would buy treasuries after the Fed stopped buying them, that China had already bailed the scene. He was as wrong as he could have been. Quantitative easing caused yields both short and long to RISE the end of it caused them to FALL.

QE raises rates, it doesn't lower them. Why do I understand that point better than the Federal Reserve does? I'm just some idiot that knows little about economics but knows how to use a spreadsheet.

Yields on treasury debt in the US are being determined by a flight to quality and higher liquidity premia. I think they are only weakly related, at the moment, to investor perceptions of future economic growth. This may not be generally true, but it markets are weird right now.

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