The Axis of Incoherence (Cochrane, Romney, and Boehner)

Since the meltdown the yields on US 10 year Treasuries (GT10) Moody's Aaa and Moody's Baa indexes have all been falling .  However what I find interesting is that both Baa-GT10 and Aaa-GT10 are now approaching their pre-meltdown highs.  Rising corporate risk premiums to treasuries could be due to the threat of another corporate melt-down - but then we would expect to see Aaa and Baa rising which they are not.  Alternately, increasing corporate risk premium to treasuries could be a sign of increasing liquidity demand for treasuries.  There may not be risk of a meltdown in the US right now but there is a lot of uncertainty in the world and the US Treasury is the safe haven.  This drives its yield down relative to riskier assets. 

So why does it matter that sovereign bond prices keep rising - and rising relative to the prices of riskier assets?  Because it is more evidence of the safe asset shortage story that  Ricardo Caballero, the Market Monetarist gang, and David Andolfatto have been telling us.  Brad DeLong is on board and  Joe Weisenthal seems to be joining the chorus as well.  It is just simple supply and demand.  If the relative price of safe assets (sovereigns and money) is rising then the relative price of other goods and services must be falling.  Since nominal prices tend to be sticky and since you cannot reallocate labor to producing safe assets - that leads to excess demand for safe assets and excess supply of other goods and services.  Excess supply of goods and services means unemployment and low capacity utilization ie recession.  I am not sure I buy that this is the only cause for the current recession but it is clear that there is huge (and potentially excess) demand for safe assets.

Cochrane, Boehner, and Romney on the other hand are arguing that the key to growth is lowering the national debt...which would reduce the supply of safe assets - and push their yield potentially below zero.  Cochrane is a smart guy, I assume he knows better.  Romney may know better ..certainly some of his economics team understands this.  But it is probably not politically wise for him to suggest we should be increasing the national debt - especially when you are trying to impress your Tea Party base.  Boehner I am sure has no idea.  Nor does he care.

Late note:   as if on cue.  Today someone pointed out to me that German 2yr debt is yielding 0%.