John Cochrane writes:
Inflation Should Be Feared: We are not having inflation because foreigners are still buying prodigious amounts of our unbacked government debts, out of fear that their governments are worse. If that stops, watch out. The inflation some are hoping for will then come with a vengeance…
Let's look at how much U.S. government debt foreigners have been buying since the start of the financial crisis. Total net purchases of U.S. assets are about 3.5% of potential GDP a year--about $500 billion/year.
Of that, it looks as though on net about 2/3 are purchases of U.S. government debt and government-guaranteed debt. Call it $350 billion/year. Current foreign holdings of U.S. government and government-guaranteed debt look to be about $6 trillion. $350 billion/$6 trillion means that foreigners are adding to their holdings of U.S. government and government guaranteed debt at a pace of about 5.8%/year. With world nominal GDP outside the United States growing at about 6%/year, that means that foreigners are… buying about as much U.S. Treasury, Agency, and other goverenment-guaranteed debt as they should in order to keep their portfolio shares constant.
It does not look as if it is the case that the US government is running out of its foreign-based debt capacity.
Could foreigners all of a sudden decided that there governments are not worse than the US government, decide to dump US government bonds and buy their own country bonds, send the dollar down, and have that falling dollar set off a upwards surge of import prices that then set off an inflationary spiral here at home? Yes. Is this a high probability scenario? I confess that I do not see how: imports are a relatively small fraction of total US spending, foreign governments are at least as feckless as our own and are subject to political risks that we are not, and nobody--literally nobody, not even the people Cochrane talks to directly--is willing to bet any money on Cochrane's favored scenario.
So from whence comes his confidence that an upward outburst of inflation is the big risk that must be guarded again? For he is confident, in spite of not just a lack of evidence but strongly disconfirming evidence in asset prices:
It’s not happening yet; interest rates are low now, but so were mortgage-backed security rates and Greek government debt rates just a few years ago. And it need not happen, if we put our fiscal house in order first. But if it happens, it will happen with little warning, the Fed will again be powerless to stop it, and it will bring stagnation rather than prosperity.
My view, as I have said before, is that Cochrane started 2008 several mutually inconsistent wrong views of how the economy worked, and has not yet performed the proper Bayesian updating of marking his beliefs to market.