With the unemployment rate at 8 percent
plus and after having the government put trillions of dollars into the economy in
the form of stimulus, recovery and shovel read jobs, is high inflation next? Mohamed
El-Erian, Pimco’s CEO believes that the Fed wants just that. Pimco is a large bonding company, Mr. El-Erian’s
company could benefit from people wanting to buy bonds, but his suggestions are
ominous. The US has issued so many
bonds in the effort to buoy up the economy by keeping interest rates low, rescuing “too big to fail” corporations, paying
for so many expanding programs, and to pay for additional debt that the US
government is taking on.
The bond market includes bonds from
corporations, cities, states, and counties. US Bonds
have always been the safety net for investors seeking no risk. Bonds have been known and a desired vehicle to
safeguard one’s money, especially during inflation or during periods of high
interest rates. But with so many US Bonds in the market, almost to the point of
flooding, would the bond market demand curve really move, or would just the quantity
and price move along the same demand curve?
Will the Federal Reserve be able to balance inflation and encourage
growth? I think that we are heading into uncharted
waters with this one.
5 comments:
Alexa: -30 for a spelling mistake, a spelling/grammatical/usage error, and a further grammatical error.
My biggest issue is I'm not sure how this is related to what we do in ECON 6200? There are classes called something like macro for managers, but this isn't one.
It would also be nice if all of you learned to put the link in the text of the body of your post, instead of appending some HTML to the end.
There's a lot of issues with this post, so let's try to learn from them :)
First, Pimco is not a bonding company. A bonding company sells insurance in the form of bonds for single uses, like bail bonding or construction bonding. Pimco is a financial services company that buys and sells bonds.
Issuing bonds does not bouy the economy. Government spending helps bouy the economy, and may continue to do so when it is financed by borrowing money through selling bonds.
Next, how would you get people to buy more bonds: by lowering the rate they pay, or raising it? Clearly it is the latter. So, Alexa, be careful when you say things like issuing bonds is going to lower the interest rate. The reason these occurred together is because of other circumstances, not because there is a causal mechanism doing what you propose.
Bonds are not a useful way to conserve your wealth during periods of inflation or high interest rates. Inflation erodes the value of future cash flows you'll receive from a bond. Interest rates are inversely related to bond prices, so higher interest rates will lead to destruction of your wealth.
Lastly, the question posed about a demand shift vs. a movement along demand feels like it was appended hastily to the end. The former is caused by an action on the part of buyers, while the latter is caused by an action on the part of suppliers. The answer to your question is whether the action in question will amount to buying or selling more bonds. It would be a better post if you had answered the question for the reader.
So, Alexa, all in all, this is a very poorly thought out post. Learn from this experience. This is the sort of thing that someone who hires an MBA does not want to be paying for.
I find the facts stated about bonds "flooding" the market a very interesting idea. I do not follow bond markets, and do not know the saturation levels. I would assume that as interest rates fall (and remain low) that the quantity of bonds demanded would drop. The reason the Fed is keeping interest rates low is to encourage people to invest in the market instead of in government bonds. In addition, the loss of the U.S.'s AAA credit rating would most likely shift the demand curve to the left, decreasing even further the number of government bonds that people are buying.
In addition to my previous comment, I don't think that bonds actually offer that much of a safety net during inflationary periods. When a bond is purchased (usually at par of $1,000) it pays interest over the life of the bond. At maturity the investor receives the $1,000 back. No appreciation is included. A "safe" investment during inflation might include something like gold that goes up in value along with inflation.
Hey folks ... I've modified my grading system from last year.
Remember, the grading on spelling, grammar and so on, is very severe on this blog.
But ... Alexa is the first one I did this semester, and I took off too many points. It should be -18 and not -30.
That's right: 6 points per mistake for each of you.
Zach: I see both comments, but you already did one for credit so I'll just give you 50/50 here.
"Saturation level" is not a term that is used or has meaning in this context.
Interest rates don't just fall. They fall because of some action. Since prices of bonds and their interest rates are inversely related, falling interest rates must mean higher prices. Prices can be pushed up two ways: either by shifting demand to the right or supply to the left. Given this explanation, your "I would assume ..." thought needs to be rethought.
As to the loss of AAA credit rating, that is relatively minor when compared to the issues discussed in the post.
And you are probably right about bonds not being that safe of an investment. Rather than being inherently safer during episodes of inflation, bonds tend to end up looking like a smart investment. The reason for this is that inflation can play havoc with stock valuations. This encourages people to shift out of stocks and into bonds, pushing up their price. So, the safety of bonds during inflation is more of a result than a cause.
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