So central banks can drive the demand for sovereign bonds to any level necessary while central governments are creating supply at whatever level their policies generate.
Pretty much. The Fed uses the secondary market (contracted players “must” buy bonds directly from Treasury) to set interest rates. Its purchases always balance to zero since it shares a balance sheet with Treasury. The Fed is the nation’s (Congress) clearing bank and has unlimited spending authority. It uses that authority to drive the overnight rate (cost of money to its banks) upward when it desires.
The natural rate is zero for fiat currency. The supply is the deficit spending of Congress that creates excess reserves in the system. Those reserves are already “paid for” by the Constitutional authority given to Congress to create the US Dollar, so Treasury bonds are a following event from money creation and not “funding” for the monopoly issuer of the currency.
Their intended purpose was to defend the gold reserve and allow Congress to anticipate tax revenue when spending. The bond offerings changed the convertibility to gold of reserves for a specified time to maturity, after which they are converted back to reserves with a small dividend to entice investors to give up liquidity. Sans a gold reserve to defend they are mostly welfare for investors but they do offer a secure place to park money which keeps investors away from mischief.
But with price having totally replaced yield to become the only source of demand in that market, wouldn’t that eventually result in crowding out all other bonds, the prices of which would not be guaranteed?
That is possible with the current anti-deficit fervor in politics, should anyone actually act on it and come close to balancing the US budget which is just another way of saying “100% tax rate” that leaves nothing in the economy to fund savings/store value or net retire private debt. The only source of reserves required to purchase Treasury bonds is Congress deficit spending, while other bond markets can utilize money from private sector debt, which is normally many times that of our national debt.
The only seven times we have come close to balanced budgets for any length of time have resulted in almost immediate recessions or depressions as private sector defaults increased. Most private-sector bonds are secured via taxpayer or utility money, so are slower to respond, but can be affected in time as well. The relationship between federal deficits and the economy can be seen in this graph of sectoral balances.
Some economists point to Clinton’s surplus budgets as the root cause of the meltdown in ’08, as no bonds were issued by Treasury to meet the demand for secure parking for the excess dollar reserves of the dotcom bubble or compensate for demand leakage caused by trade deficits. US mortgages were the next best thing until Wall St started running with scissors and the Fed failed to anticipate the problems that created. The Fed creates reserves to allow interbank transfers for bank loans and credit cards. Those reserves are liabilities to its member banks and require public money creation to be retired as borrowers make payments on principle.
The borrower’s contract balances those reserve liabilities as an asset, so no “net” money is created on the bank spreadsheets, but that depends upon the borrower’s credibility and the availability of public money in excess of taxation. A lack of deficit spending to compensate for wealth/savings and the increased trade deficit simply made the banking system anemic and overly dependent upon private sector credit. The crash was held off for a while with Bush’s deficit spending but was entirely predictable.
