The way the global government bond market is acting, it looks as if the highly controversial Modern Monetary Theory is about to be put to the test. In essence, the theory suggests that countries with their own central banks need not worry about budget deficits and spending to spur economic growth because those central banks could just buy whatever debt the government issues.
What makes MMT relevant now is that despite continuing jitters over the global financial system and another plunge in equities on Wednesday, government bonds from the U.S. to Germany, and from Italy to Australia, tumbled, sending their long-term yields soaring and causing yield curves to widen. This is hardly the reaction that would be expected in a “risk off” environment when the safest assets such as government debt should be in demand. Some might argue that the bond market is just discounting the possibility of runway inflation once the economy recovers because of all the fiscal stimulus programs — including ones that may total close to $2 trillion in the U.S. alone — that will need to be financed with debt. But so-called breakeven rates on bonds have held steady, or even declined, suggesting traders see no inflation on the horizon. That leaves worries about who will buy all the debt that will be issued. It’s hard to know how much is coming, but “Bond King” Jeffrey Gundlach said Tuesday in a webcast that the U.S. budget deficit may triple to $3 trillion. That’s a scary thought for bond traders in a country whose debt has already ballooned to $23.4 trillion from less than $10 trillion before the 2008-2009 financial crisis.