Here is the (slightly edited) text of a letter I sent to editors of The Wall Street Journal a few weeks ago:
John Cochrane, in “Treasury Needs a Better Long Game” (Opinion, Wall Street Journal, 3/4/13) has finally spoken the truth one dare not utter: we are on the verge of experiencing a doomsday scenario for the US bond markets, the so-called “death spiral” when deficit-spending spooks the bond markets, which forces the price of Treasury obligations down, which in turn increases the deficits, which force Treasury obligations further down, and so on. A “China Syndrome” in financial markets, where everything melts down and burns its way to the bottom – the destruction of America’s economy, maybe the world’s.
Prof. Cochrane had already laid the foundation for this scenario, in ”Running On Empty” (Books section, Wall Street Journal, 3/2/13), in which he made the case for the likelihood of that scenario, observing that our cumulative response to the financial crisis of 2008 (or thereabouts) has been for the government to guaranty still more bank debt and then (having thus merely enhanced the incentives for risky behavior) to impose mountains of new regulations that are supposed to compel the bankers to stop engaging in risky behavior – as though such regulations might have even the slightest chance of actually accomplishing that goal. (Prof. Cochrane went on to spell out the obvious cure that should have been undertaken, but still has not, which is that we need to increase the capitalization of the banks, not the regulation of them, while we try to see about the business of restoring economic growth and overall fiscal sanity.) Andy Kessler, in any earlier piece, “When Interest Rates Rise, Watch Out” (2/22/13), had also sounded the alarm on the financial terror that lies ahead and that would be realized via the bond markets.
Can something be done, to dodge this approaching asteroid before it can inflict upon us the equivalent of a nuclear or electromagnetic-wave attack? Yes, and Prof. Cochrane has spelled it out: a once-in-a-lifetime opportunity for the US Treasury to issue long-term Treasury bonds (with fixed interest rates that are somewhat higher than the rates on our currently outstanding short-term Treasuries), in exchange for all of the outstanding short-term Treasuries (which have very low floating interest rates), a swap that would not require Treasury to sell any bonds and that could increase our annual interest costs by an amount that is pretty substantial (though quite a bit less than even the short-term costs of the various Obama “stimulus” programs) but would buy us a lot of time to get our fiscal house in order and would cost us chicken feed in comparison to what the swap would save us over the time it would take us to achieve fiscal order. Will something be done? Prof. Cochrane has not spelled it out, but it is not difficult to read between his lines: NO, because the last thing the President (or for that matter, the Fed Chairman) wants to do, before the 2014 elections, is anything that might inflict pain on the voters, even if the pain is only temporary and even if it is far less than the pain that awaits the voters after 2014 if nothing is done to tackle this financial crisis-in-the-making.
I do not think the professor is crying wolf.