Thursday, September 5, 2019

Vox explains the yield curve, 'the chart that predicts recessions'

Ever since I wrote The tax bill and the U.S. economy in 2018 and beyond at the end of 2017, I've been watching the yield curve invert.  In all five entries, I noted that an inverted yield curve predicts recessions.  However, I didn't explain how and why that works.  Vox does in The chart that predicts recessions.

A chart called the "yield curve" has predicted every US recession over the last 50 years. Now it might be predicting another one.
Economic experts are starting to warn that a US recession is becoming more likely because of something called the "yield curve." So what's the yield curve? What does it show? And why is it bad if it "inverts?" We visualized the yield curve over the past four decades, to show why it's so good at predicting recessions, and what it actually means when the curve changes.
Along with the article that inspired the video, that's the best explanation of both how and why the yield curve inverts, using both expectations of economic performance and supply and demand.  The only thing missing is how an inverted yield curve works to dry up credit, as there is less incentive for long-term lending.  This is how an effect can contribute to the cause, creating something of a self-fulfilling prophesy.

Finally, I'm going to repeat what I quoted the last time I wrote about the inverted yield curve.
"I've been bearish and on recession watch since December 2017 and still stand behind the prediction I made in Ten years ago, we were partying like it was 1929. Are we about to do it again?...'I'm moving my recession call to between July and December 2019.'"  If that happens, it will be closer to December than July, which is only a month away, but I will not revise my forecast until October at the earliest.  I'm even more confident that a recession is coming, even if it takes a bit longer than I expect.


  1. I have never had a feel for the bond market. Even though I love to geek out about financial news, there's a mental blind spot in my intuition when it comes to grokking bonds. Stock markets, yeah, I can instinctively understand their nuances. Things like derivatives, options and especially the many money-based scandals cooked up by sociopaths such as manipulating LIBOR (and every other market) are relatively easy to imagine. But the concept of "yields" does not come naturally to me. I had an online friend from a couple of econoblogs we followed who had a great grasp on that whole "price of money" thing, but I could never match his acumen. My short-sightedness, no matter how much I try to pound it into my head.

    When I think about bonds, it brings me to the realm of "the quantum physics of money." Can money, unlike matter, be made to disappear? I contemplate this particularly in regard to the Bank of Japan's buying up of so much of the Japanese government's public debt. (And to a certain extent, the U.S. Federal Reserve's.) I've seen allusions on financial blogs that the BOJ has hoovered so much Japanese government debt during its QE mania that there wasn't enough for conventional market-based traders to work with. If a central bank buys a 10-year bond, puts it on its balance sheet and just sits on it for a decade, does the debt represented by that bond go "poof"? Non-existence? The central bank gave "real" money (which it created out of thin air) to the government or a corporation/private person who owned the bond. Ditto for when the U.S. Fed paid for all those shonky real estate-backed bonds after the 2008 financial panic. If the CB holds them until the term of the bond extinguishes, can it just say "That debt is no longer there"?

    Sure, there might be an accounting deficit on the central bank's accounting books, but if there is no audit of those books, and no legal entity has the power to charge them with fraud or insolvency, does it matter? That's why I question whether so much of the economic worry about deficits is based on nothing (except insofar as TPTB want to make us worry about it.) If debt is buried deeply enough, does "nothing matter" as JHK says? Maybe it's just me having a mistaken understanding of how stuff works.

    1. Bonds are just government debt, so I think of them as loans. Since I have something of a real estate background (my mom and middle sister are or were real estate agents, my baby sister was an appraiser, and the whole family has invested in real estate at one time or other), it's an easy way to think about it, as the nation's mortgages or credit cards.

    2. But there's so much more than just the government debt (although that's a huge amount, way more than corporate debt. It's also less likely to default, unless it's Argentina. /snerk/) Corporate debt, especially shonky stuff with "B" ratings or less, is a problem. Doubly so when it's debt that has been issued for share buybacks that reward "investors" ("speculators" is the word that I prefer) and inflate executive salaries that are based on company stock prices.

      One of the reasons that right-wingers are so aggravated about the U.S. Federal Reserve is because of the way the Fed paid banksters with "real" money for the crap-filled mortgage-backed securities they deceptively flogged off to yield-chasing pension funds and other suckers. The "shitty deals" that your U.S. Senator Carl Levin excoriated Gold-in Sacks (sic) about. That's one of the few areas where I find common ground with people on the reich, although most of them don't extend their political analysis into the economic realm. Economist Steve Keen (an Aussie! Oi-oi-oi!) has written extensively about that as it pertains to the real estate sector worldwide.

      There's a world of private debt for enterprises such as shale oil companies that will never be paid back. JHK is correct when he mentions that (instead of moaning about transsexuals). What happens when those loans go bad? Banks will have to book a loss, and as overextended as they are with the fractional reserve lending on their balance sheets, they could become insolvent. But will the Fed, which is not the government but just the front organisation for its constituent banks, bail them out again with "real" money (made up from thin air) in exchange for unpayable loans? And then sit on those bad loans until they go away? How much crap like that can go on before the rest of the world says "Your American dollars are backed by a massive pile of shitty deals"?

      Maybe it can go on forever. Who's gonna call bullshit? I remember having a conversation on this topic with a guy who worked as a debt market analyst for the local arm of Credit Suisse as we were in a van headed for a group hike on some desert mountains south of here back in 2015. He was surprised to hear an American ranting about the potential for debt defaults. Four years later, it hasn't blown up. So maybe I'm wrong. Money is an imaginary substance, not bound to Newtonian Laws of Physics like the natural universe. The game might go on forever, as long as the mass of humans don't lose faith in it. Money is the world's new religion. If enough people believe in their false god of Mammon, it has power...

    3. That's a long and thoughtful comment that deserves more than I can give it, at least in today's response. Sorry. I will address a point I missed in the first comment about money being destroyed. Well, that depends. The money lent out is still out there circulating, as it was spent and the people it was spent on either still have it or spent it themselves, so others have it. In that regard, you may lose the money, but it still exists, so it wasn't destroyed. This is even more true now that money consists of bits and bytes more than paper and metal. Those can be destroyed or lose value, but even Roman coins and Confederate bills have some value, if only as collectors items, long after the governments that backed them have disappeared; they're just not currency any more.

      As for your last point, I tell my students the urban legend that Einstein is supposed to have said that the most powerful force in the universe is compound interest. That's because it can do something that other forces cannot — expand a finite amount to infinity. I also tell them that if Einstein ever said that, he meant it ironically. What Einstein really said was "Only two things are infinite, the universe and human stupidity, and I'm not sure about the former."