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I've surmised from years of reading the economic press that there's really only one bad thing that can happen in a capitalist economy: bondholders not getting p

I've surmised from years of reading the economic press that there's really only one bad thing that can happen in a capitalist economy: bondholders not getting paid. Heck, lots of commentators argue that war is good for the economy, a natural disaster is good for the economy, the broken window fallacy is a mainstay of Keynesian economics. However, bondholders not getting paid is something that should be prevented at all costs! The federal reserve is doing $40 billion a month of bond buying with electronically printed money (quantitative easing) so the bond holders get paid! "I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody." - James Carville

xal 10y ago
Planet Money did a great episode on Argentina, which decided at some point to default on its debt. http://www.npr.org/sections/money/2016/03/11/470136949/episode-689-a-hedge-fund-a-country-and-a-big-sailboat http://www.npr.org/sections/money/2016/03/11/470136949/episo...
- alecco 10y ago
  Argentina didn't decide. It couldn't pay the interests anymore. It was a snowball of crazy high interest rates in a foreign currency. You can't pay your debt if it's much higher than GDP growth even with a surplus. And Argentina had neither growth nor surplus, thanks to the idiotic IMF economic plans with a currency pegged to the US dollar. A better point might be, why were they lent money in the first place?!?
  - Mindcraft 10y ago
    And to a de-facto government.
  - lambertsimnel 10y ago
    Debt to GDP ratios can also be described in terms of how long it takes to produce GDP equal to the debt. Owing 100% of GDP is owing one year's product. Whether that's a significant dividing line depends on rates of interest and growth.
grondilu 10y ago
It might be just true. Destroying value is not such a big deal since after all value can always be created. But when bonds default people start losing trust in fiduciary instruments. And trust is much more difficult to build than pure value.
- daodedickinson 10y ago
  I'd say wars since Vietnam have eroded quite a bit of trust.
- adevine 10y ago
  Agreed, but I find it funny/dangerous how bond markets can get into risky positions and then demand to be bailed out because they basically argue that bonds shouldn't be risky. Fannie/Freddie bonds before the housing crash were a perfect example of this. All the information marketing the bonds came with specific warnings that they were not backed by the US government and didn't carry any "explicit or implied" government guarantee. Of course, this turned out to be bunk, and the bond markets knew it, which is why Fannie and Freddie were able to borrow money at lower rates than everyone else. When push came to shove, everyone knew Fannie and Freddie were too big to fail and the government would have to bail them out. I wouldn't be surprised if history repeats itself.
- pjc50 10y ago
  > Destroying value is not such a big deal since after all value can always be created. ?! I'm not sure what you mean by that, but value is rather hard to create. Certainly the value in real estate and physical goods. Stock value and services are a bit more ephemeral. But the reason Keyensian hole-digging makes sense is that labour is a wasting good - you can't store the output of people who would otherwise be unemployed, and having people unemployed does long term damage to productivity.
  - justincormack 10y ago
    Bonds are not net value, just an asset and an equal liability. Default is just a redistribution.
phkahler 10y ago
When a company fails the bond holders get paid first. Bonds are also the rich man's way of getting paid by governments. Lending money to finance war has always been a nice way to trap governments.
- jacques_chester 10y ago
  > Bonds are also the rich man's way of getting paid by governments. Unless the government, which has the power to break the agreement, breaks the agreement. The history of finance is well-woven with the thread of sovereign defaults.
  - TheSpiceIsLife 10y ago
    When this happens is it true that if a person had invested in private or publicly listed companies their money would have been safer? I'm just thinking that by the time a state defaults on bonds the "rich man" may be facing a bundle of problems. How much would diversification help in those circumstances?
    - bwilliams18 10y ago
      If your investments are all inside the country That defaults on its debt then yeah your fucked anyway, but if you're investing in a country's debt and you have little other exposure to said country, then their defaulting on the debt is the only thing that's fucking you. Argentinas default is the best example of this problem.
    - jacques_chester 10y ago
      > When this happens is it true that if a person had invested in private or publicly listed companies their money would have been safer? For a while during the 07-09 financial crisis, Coca-Cola bonds were priced by the market as less risky than Treasury bonds.
    - marcosdumay 10y ago
      They may be much safer, or they may be completely gone in any random afternoon. I guess, strictly speaking, that makes them safer.
nradov 10y ago
That's not really how it works. Bondholders don't get paid all the time. This is priced in and isn't a problem for a capitalist economy unless the actual rate of defaults significantly exceeds the expected rate of defaults as predicted by bond ratings.
- pmorici 10y ago
  Massively fraudulent credit ratings on mortgage bonds was one of the things if not the thing that precipitated the 2008 housing/economic crisis. Your comment reads like you think bond ratings are mostly accurate but recent history tells us they can't really be trusted.
  - nradov 10y ago
    Yes, massive fraud is one factor that can cause bond defaults to significantly exceed those predicted by credit ratings. Other reasons can include disruptive technology, natural disasters, armed conflict, and other "black swan" events.
    - ninguem2 10y ago
      What does "priced in" actually mean? A low probability event should be priced in, with the appropriate small but non-zero coefficient. If you get hit by a "black swan event" couldn't you say that your model failed to account for it?
      - azernik 10y ago
        It just so happens that people, when making predictions, are not very good at accounting for ("pricing on") those kinds of events.
        paganel 10y ago
        After which they blame the "bad model" and immediately pass on to constructing newer, presumably better models. The fact that maybe, just maybe, trying to model such a thing as a modern-day economic system is futile never crossed these people's minds.
xenadu02 10y ago
nit: quantitative easing was ended in October 2014. The Fed is not currently buying bonds and is doing a combination of selling off some bonds and letting others mature.
crdoconnor 10y ago
>broken window fallacy is a mainstay of Keynesian economics That's a crass (although depressingly common) straw man of one of Keynes' views. He mentioned that paying people to dig a hole/fill it up was one way - though emphatically not the most efficient way you could escape from a liquidity trap.
- Gibbon1 10y ago
  There was his observation that if building ships full of war stuff and sending them across the Atlantic for the U-Boats to sink was enough to shake off the great depression the US certainly didn't need to wait ten years for the Germans to declare war. If one looks at the composition of debt 1920-1950 what happened during WWII is the US government essentially took all of the commercial and consumer debt onto it's own books.
- imtringued 10y ago
  The reason why digging holes was suggested is if it wasn't a useless economic activity it wouldn't be politically acceptable. If the government employed workers produced anything of value they would compete with private companies. "It is curious how common sense, wriggling for an escape from absurd conclusions, has been apt to reach a preference for wholly ‘wasteful’ forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest; whilst the form of digging holes in the ground known as gold-mining, which not only adds nothing whatever to the real wealth of the world but involves the disutility of labour, is the most acceptable of all solutions." - Keynes
pjc50 10y ago
Most of the bondholders are pension funds and (re)insurers, which makes not getting paid have knock-on consequences for the rest of the economy.
kilroy123 10y ago
That's why I think a war with the US and China would never happen. Too much debt wouldn't be paid and it isn't actually profitable.
- muninn_ 10y ago
  Well, they say that the economy has never gotten in the way of a war. I wouldn't completely rule it out. Most likely there would be some sort of skirmish, but not a full war. But do recall that people said the same thing before World War I. All you need is some yahoo to kill the wrong person .
Gibbon1 10y ago
> the broken window fallacy is a mainstay of Keynesian economics No that is actually not true. You'll find the broken window theory espoused by dingbat modern economists[1] and business people[2] but not hoary old Keynesians and NeoKeynesians. Keynesians believe somethings different which is that if you have a demand and production shortfall due to excess debt and fear (dread zero bound), then the government can help by creating demand. AKA borrow money to pay for labor and materials and use that to build useful stuff. Experience from WWII in the US shows that it'll work even if the stuff is not very useful. [1] Because modern economics isn't an applied science practitioners are allowed to believe what they want about the real economy. [2] Leaned about the broken window theory at the country club bar.
paganel 10y ago
> there's really only one bad thing that can happen in a capitalist economy: bondholders not getting paid. Maybe I over-read it at the time, but I got the same feeling after reading a history of the 1500s Mediterranean countries (Braudel's "The Mediterranean and the Mediterranean World in the Age of Philip II"), more exactly that the a very great injustice had been made to the bankers of the time (mostly the Genoese and Fugger family) for not getting their money back from the King of Spain, to which they had lent a lot of money (it's like they had gotten a big haircut on present-day Government bonds). There's an interesting discussion about that at this link: http://history.stackexchange.com/questions/4432/what-were-the-consequences-of-the-bankruptcies-of-the-spanish-empire?answertab=active#tab-top http://history.stackexchange.com/questions/4432/what-were-th...
megablast 10y ago
A questions, is the broken window a fallacy if it forces you to spend money when instead you were just going to put it into the bank, and there is already enough money in the banks.
- hilop 10y ago
  It's not. That's the original Keynesian analysis of the liquidity trap. Dollars have no inherent stored value, so putting them to use can improve economic productivity, even if the reason they start moving is silly. Breaking windows is a stupid way to crate liquidity though. Better to do some debt-financed spending without destroying anything. For example, the USA's CCC and TVA, that started ending the Great Depression.
  - nikatwork 10y ago
    Is that an argument in favor of China's relentless infrastructure spending?
  - astrostl 10y ago
    Unless we're talking about physical cash under a mattress, "stored" dollars in banking are put to use through loans and investments.
qj4714 10y ago
It's deflation, the fear is deflation...
secfirstmd 10y ago
People of Ireland here... Can confirm.
ikeboy 10y ago
https://www.bloomberg.com/view/articles/2016-07-18/bond-trading-and-bank-memoirs https://www.bloomberg.com/view/articles/2016-07-18/bond-trad... >My rough definition of a financial crisis is that it's when someone borrows money from someone else, and can't pay it back, and it is politically and socially unacceptable not to pay it back.
panarky 10y ago
> The federal reserve is doing $40 billion a month of bond buying with electronically printed money (quantitative easing) so the bond holders get paid! Nope. The US Federal Reserve did three rounds of QE, and round three ended in October, 2014. This is not an ongoing program. https://en.wikipedia.org/wiki/Quantitative_easing#US_QE1.2C_QE2.2C_and_QE3 https://en.wikipedia.org/wiki/Quantitative_easing#US_QE1.2C_...
code_sardaukar 10y ago
While I don't agree with everything you said, you are right that modern economics puts a lot of emphasis on the bond market. Their reasoning is that the bond market is like a giant, distributed bank. Bondholders borrow short-term, and invest long-term, thus providing liquidity for businesses that need to make long term investment. The problem is, we have no idea what the actual economics of liquidity provision is. The standard Diamond–Dybvig model is used to justify bailing out the banks (and also the "shadow" banks, i.e. the bond market) when things go bad. But if the Diamond–Dybvig model is correct, then liquidity provision is a mechanical process that could be done just as well by the government, and the bond market is just a way to get the free market to do this at exorbitant cost. We need better theories to understand liquidity. I think the best work in this area is by Holmstrom and Tirole. Holmstrom's nobel price should help raise the profile of this work.

xal 10y ago

Planet Money did a great episode on Argentina, which decided at some point to default on its debt. http://www.npr.org/sections/money/2016/03/11/470136949/episode-689-a-hedge-fund-a-country-and-a-big-sailboat http://www.npr.org/sections/money/2016/03/11/470136949/episo...

alecco 10y ago
Argentina didn't decide. It couldn't pay the interests anymore. It was a snowball of crazy high interest rates in a foreign currency. You can't pay your debt if it's much higher than GDP growth even with a surplus. And Argentina had neither growth nor surplus, thanks to the idiotic IMF economic plans with a currency pegged to the US dollar. A better point might be, why were they lent money in the first place?!?
- Mindcraft 10y ago
  And to a de-facto government.
- lambertsimnel 10y ago
  Debt to GDP ratios can also be described in terms of how long it takes to produce GDP equal to the debt. Owing 100% of GDP is owing one year's product. Whether that's a significant dividing line depends on rates of interest and growth.

grondilu 10y ago

It might be just true. Destroying value is not such a big deal since after all value can always be created. But when bonds default people start losing trust in fiduciary instruments. And trust is much more difficult to build than pure value.

daodedickinson 10y ago
I'd say wars since Vietnam have eroded quite a bit of trust.
adevine 10y ago
Agreed, but I find it funny/dangerous how bond markets can get into risky positions and then demand to be bailed out because they basically argue that bonds shouldn't be risky. Fannie/Freddie bonds before the housing crash were a perfect example of this. All the information marketing the bonds came with specific warnings that they were not backed by the US government and didn't carry any "explicit or implied" government guarantee. Of course, this turned out to be bunk, and the bond markets knew it, which is why Fannie and Freddie were able to borrow money at lower rates than everyone else. When push came to shove, everyone knew Fannie and Freddie were too big to fail and the government would have to bail them out. I wouldn't be surprised if history repeats itself.
pjc50 10y ago
> Destroying value is not such a big deal since after all value can always be created. ?! I'm not sure what you mean by that, but value is rather hard to create. Certainly the value in real estate and physical goods. Stock value and services are a bit more ephemeral. But the reason Keyensian hole-digging makes sense is that labour is a wasting good - you can't store the output of people who would otherwise be unemployed, and having people unemployed does long term damage to productivity.
- justincormack 10y ago
  Bonds are not net value, just an asset and an equal liability. Default is just a redistribution.

phkahler 10y ago

When a company fails the bond holders get paid first. Bonds are also the rich man's way of getting paid by governments. Lending money to finance war has always been a nice way to trap governments.

jacques_chester 10y ago
> Bonds are also the rich man's way of getting paid by governments. Unless the government, which has the power to break the agreement, breaks the agreement. The history of finance is well-woven with the thread of sovereign defaults.
- TheSpiceIsLife 10y ago
  When this happens is it true that if a person had invested in private or publicly listed companies their money would have been safer? I'm just thinking that by the time a state defaults on bonds the "rich man" may be facing a bundle of problems. How much would diversification help in those circumstances?
  - bwilliams18 10y ago
    If your investments are all inside the country That defaults on its debt then yeah your fucked anyway, but if you're investing in a country's debt and you have little other exposure to said country, then their defaulting on the debt is the only thing that's fucking you. Argentinas default is the best example of this problem.
  - jacques_chester 10y ago
    > When this happens is it true that if a person had invested in private or publicly listed companies their money would have been safer? For a while during the 07-09 financial crisis, Coca-Cola bonds were priced by the market as less risky than Treasury bonds.
  - marcosdumay 10y ago
    They may be much safer, or they may be completely gone in any random afternoon. I guess, strictly speaking, that makes them safer.

nradov 10y ago

That's not really how it works. Bondholders don't get paid all the time. This is priced in and isn't a problem for a capitalist economy unless the actual rate of defaults significantly exceeds the expected rate of defaults as predicted by bond ratings.

pmorici 10y ago
Massively fraudulent credit ratings on mortgage bonds was one of the things if not the thing that precipitated the 2008 housing/economic crisis. Your comment reads like you think bond ratings are mostly accurate but recent history tells us they can't really be trusted.
- nradov 10y ago
  Yes, massive fraud is one factor that can cause bond defaults to significantly exceed those predicted by credit ratings. Other reasons can include disruptive technology, natural disasters, armed conflict, and other "black swan" events.
  - ninguem2 10y ago
    What does "priced in" actually mean? A low probability event should be priced in, with the appropriate small but non-zero coefficient. If you get hit by a "black swan event" couldn't you say that your model failed to account for it?
    - azernik 10y ago
      It just so happens that people, when making predictions, are not very good at accounting for ("pricing on") those kinds of events.
      - paganel 10y ago
        After which they blame the "bad model" and immediately pass on to constructing newer, presumably better models. The fact that maybe, just maybe, trying to model such a thing as a modern-day economic system is futile never crossed these people's minds.

xenadu02 10y ago

nit: quantitative easing was ended in October 2014. The Fed is not currently buying bonds and is doing a combination of selling off some bonds and letting others mature.

crdoconnor 10y ago

>broken window fallacy is a mainstay of Keynesian economics That's a crass (although depressingly common) straw man of one of Keynes' views. He mentioned that paying people to dig a hole/fill it up was one way - though emphatically not the most efficient way you could escape from a liquidity trap.

Gibbon1 10y ago
There was his observation that if building ships full of war stuff and sending them across the Atlantic for the U-Boats to sink was enough to shake off the great depression the US certainly didn't need to wait ten years for the Germans to declare war. If one looks at the composition of debt 1920-1950 what happened during WWII is the US government essentially took all of the commercial and consumer debt onto it's own books.
imtringued 10y ago
The reason why digging holes was suggested is if it wasn't a useless economic activity it wouldn't be politically acceptable. If the government employed workers produced anything of value they would compete with private companies. "It is curious how common sense, wriggling for an escape from absurd conclusions, has been apt to reach a preference for wholly ‘wasteful’ forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest; whilst the form of digging holes in the ground known as gold-mining, which not only adds nothing whatever to the real wealth of the world but involves the disutility of labour, is the most acceptable of all solutions." - Keynes

pjc50 10y ago

Most of the bondholders are pension funds and (re)insurers, which makes not getting paid have knock-on consequences for the rest of the economy.

kilroy123 10y ago

That's why I think a war with the US and China would never happen. Too much debt wouldn't be paid and it isn't actually profitable.

muninn_ 10y ago
Well, they say that the economy has never gotten in the way of a war. I wouldn't completely rule it out. Most likely there would be some sort of skirmish, but not a full war. But do recall that people said the same thing before World War I. All you need is some yahoo to kill the wrong person .

Gibbon1 10y ago

> the broken window fallacy is a mainstay of Keynesian economics No that is actually not true. You'll find the broken window theory espoused by dingbat modern economists[1] and business people[2] but not hoary old Keynesians and NeoKeynesians. Keynesians believe somethings different which is that if you have a demand and production shortfall due to excess debt and fear (dread zero bound), then the government can help by creating demand. AKA borrow money to pay for labor and materials and use that to build useful stuff. Experience from WWII in the US shows that it'll work even if the stuff is not very useful. [1] Because modern economics isn't an applied science practitioners are allowed to believe what they want about the real economy. [2] Leaned about the broken window theory at the country club bar.

paganel 10y ago

> there's really only one bad thing that can happen in a capitalist economy: bondholders not getting paid. Maybe I over-read it at the time, but I got the same feeling after reading a history of the 1500s Mediterranean countries (Braudel's "The Mediterranean and the Mediterranean World in the Age of Philip II"), more exactly that the a very great injustice had been made to the bankers of the time (mostly the Genoese and Fugger family) for not getting their money back from the King of Spain, to which they had lent a lot of money (it's like they had gotten a big haircut on present-day Government bonds). There's an interesting discussion about that at this link: http://history.stackexchange.com/questions/4432/what-were-the-consequences-of-the-bankruptcies-of-the-spanish-empire?answertab=active#tab-top http://history.stackexchange.com/questions/4432/what-were-th...

megablast 10y ago

A questions, is the broken window a fallacy if it forces you to spend money when instead you were just going to put it into the bank, and there is already enough money in the banks.

hilop 10y ago
It's not. That's the original Keynesian analysis of the liquidity trap. Dollars have no inherent stored value, so putting them to use can improve economic productivity, even if the reason they start moving is silly. Breaking windows is a stupid way to crate liquidity though. Better to do some debt-financed spending without destroying anything. For example, the USA's CCC and TVA, that started ending the Great Depression.
- nikatwork 10y ago
  Is that an argument in favor of China's relentless infrastructure spending?
- astrostl 10y ago
  Unless we're talking about physical cash under a mattress, "stored" dollars in banking are put to use through loans and investments.

qj4714 10y ago

It's deflation, the fear is deflation...

secfirstmd 10y ago

People of Ireland here... Can confirm.

ikeboy 10y ago

https://www.bloomberg.com/view/articles/2016-07-18/bond-trading-and-bank-memoirs https://www.bloomberg.com/view/articles/2016-07-18/bond-trad... >My rough definition of a financial crisis is that it's when someone borrows money from someone else, and can't pay it back, and it is politically and socially unacceptable not to pay it back.

panarky 10y ago

> The federal reserve is doing $40 billion a month of bond buying with electronically printed money (quantitative easing) so the bond holders get paid! Nope. The US Federal Reserve did three rounds of QE, and round three ended in October, 2014. This is not an ongoing program. https://en.wikipedia.org/wiki/Quantitative_easing#US_QE1.2C_QE2.2C_and_QE3 https://en.wikipedia.org/wiki/Quantitative_easing#US_QE1.2C_...

code_sardaukar 10y ago

While I don't agree with everything you said, you are right that modern economics puts a lot of emphasis on the bond market. Their reasoning is that the bond market is like a giant, distributed bank. Bondholders borrow short-term, and invest long-term, thus providing liquidity for businesses that need to make long term investment. The problem is, we have no idea what the actual economics of liquidity provision is. The standard Diamond–Dybvig model is used to justify bailing out the banks (and also the "shadow" banks, i.e. the bond market) when things go bad. But if the Diamond–Dybvig model is correct, then liquidity provision is a mechanical process that could be done just as well by the government, and the bond market is just a way to get the free market to do this at exorbitant cost. We need better theories to understand liquidity. I think the best work in this area is by Holmstrom and Tirole. Holmstrom's nobel price should help raise the profile of this work.