But Dad…The Bond Market Said I Could!

June 9th, 2011 at 5:26 pm

The bond market is like the proverbial mama in the old adage, “If mama’s not happy, then nobody’s happy.”

Ever since the Clinton years, when the bond vigilantes—investors who would demand crippling high returns if we failed to obey them—allegedly ruled, more policy than you’d like to think is deeply influenced by warnings of how the bond markets will react.

The thing is, nobody really knows how they’ll react.  So they become a Rorschach Test wherein you can see, and argue for, whatever it is you want.  I half expect my 11 year old to warn me that that the bond market won’t be pleased if she doesn’t get to go to that pricey horse-riding camp this summer.

Take, for example, this quote from yesterday’s CQ (subscription req’d):

“Mark Warner, D-Va., expressed concern that a bipartisan, bicameral group of lawmakers led by Vice President Joseph R. Biden Jr. might not be able to agree on enough deficit reduction to give the bond market confidence that the nation is getting its debt under control.”

Well, you sure can’t see that by looking at the yields.  Such fears should lead those buying new bonds to insist on protection against interest-rate risk (when rates go up, the value of the bonds you’re holding go down) but you don’t see that at all.

Source: Bloomberg, 10 yr T-bills

So you say, “well, the market is mistakenly discounting such fears.”  But this doesn’t make sense.  If the market is too inefficient to recognize that it needs appeasement, how will you know when it’s appeased?

And why appeal to market mind reading, anyway?  Occam’s razor and all that…at first blush, low interest rates on American Treasuries are reflecting weak growth, low inflation outlook (i.e., core inflation, leaving out energy/food prices), Fed zero-rate policy, and flight to safety from the debt situation in some European countries where, btw, you can very clearly see rational investors demanding high yields from deeply troubled economies.

What about the threatened downgrade by Moody’s and S&P?  You’re forgiven if your faith in the rating agencies to get this right is shaken by their role in inflating the housing bubble, and thus far, their announcements haven’t had much apparent impact.

Now, were we to actually default on our debt (by failing to raise the debt ceiling), a lot of very bad things would happen.  I’ve asked bond market investors why we don’t see obvious signs of that anxiety in the market, and they’ve basically answered, “we assume you DC guys will eventually take care of it.”

I think and hope they’re right.  If not, we are likely to see the bond market go nuts and I’ll be the first one to comment on the interest rate impact of terrible policy mistakes.   Until then, I don’t want to hear any talk about fancy horse riding camps.

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19 comments in reply to "But Dad…The Bond Market Said I Could!"

  1. Fed Up says:

    “Well, you sure can’t see that by looking at the yields. Such fears should lead those buying new bonds to insist on protection against interest-rate risk (when rates go up, the value of the bonds you’re holding go down) but you don’t see that at all.”

    Is this why? And from:

    http://www.calculatedriskblog.com/2009/12/fed-chairman-never-learn.html

    Now comes Fed Chairman Bernanke today on the deficit. From Ryan Grim at Huffington Post:

    “Well, Senator, I was about to address entitlements,” Bernanke replied [to Senator Bennett]. “I think you can’t tackle the problem in the medium term without doing something about getting entitlements under control and reducing the costs, particularly of health care.”

    Bernanke reminded Congress that it has the power to repeal Social Security and Medicare.

    “It’s only mandatory until Congress says it’s not mandatory. And we have no option but to address those costs at some point or else we will have an unsustainable situation,” said Bernanke.

    “Willie Sutton robbed banks because that’s where the money is, as he put it,” Bernanke said. “The money in this case is in entitlements.”

    This is why debt should stop being issued.

    Why do you seem to believe that the solution to too much debt is more debt?

    What are your economic assumptions that all new medium of exchange should be the demand deposits from debt?


    • Sandwichman says:

      “Willie Sutton robbed banks because that’s where the money is, as he put it,” Bernanke said. “The money in this case is in entitlements.”

      No, Willie Sutton robbed banks because he was not a player in the military-industrial complex. Had he access to the defense budget, the banks would have gladly done the robbing for him.


    • DrJim says:

      “Why do you seem to believe that the solution to too much debt is more debt?”

      Because the debt you ran up to give tax breaks to your rich buddies didn’t accomplish anything economically useful and is the reason we are nearly bankrupt, but the debt we want to run up to build tunnels, repair disintegrating bridges, and create jobs for unemployed people will more than pay for itself. Businesses take on debt when they can earn more on their investments than the cost to service the debt. So should governments.


      • Fed Up says:

        “Because the debt you ran up to give tax breaks to your rich buddies didn’t accomplish anything economically useful and is the reason we are nearly bankrupt, but the debt we want to run up to build tunnels, repair disintegrating bridges, and create jobs for unemployed people will more than pay for itself.”

        I didn’t do either (notice in both cases you said debt, gov’t I think). I believe the various levels of gov’t should have balanced budgets. I’m not convinced they will pay for themselves. Is there a jobs problem or a retirement problem?


      • Fed Up says:

        “Businesses take on debt when they can earn more on their investments than the cost to service the debt. So should governments.”

        I believe that assumes supply constraints. What if Qsupplied is greater than or near Qdemanded in most markets? Businesses probabaly won’t issue equity (stock) to expand, issue debt (future demand brought to the present) to expand, and may not even use retained earnings (present spending in the present) to expand. Microsoft is a good example.



          • Fed Up says:

            And here is my answer to that.

            “In the discussion of Richard Koo, I’m seeing a number of people asserting (a) debt can’t be the solution to debt (b) inflation can’t possibly be helpful. I guess that’s the problem with blogging: even if you explain your position clearly, after a few months people enter the discussion without knowing about or having forgotten the earlier discussion.”

            No, I read and remember. You have not listened to others and me.

            “Households borrowed too much; now you want the government to borrow even more?”

            It is more like savings of the rich = dissavings of the gov’t (preferably with debt) plus the dissavings of the lower and middle class (preferably with debt)

            When the rich couldn’t get the lower and middle class further into debt and some tried to default, the rich got the gov’t to go further into debt for them. The rich are accumulating retirement and won’t retire, while the lower and middle class are losing retirement (that is what the debt is all about, losing retirement).

            “one person’s liability is another person’s asset.”

            Actually, meaningless.

            “It follows that the level of debt matters only if the distribution of net worth matters, if highly indebted players face different constraints from players with low debt.”

            If the economy is getting high debt levels and very little to no wage inflation and price inflation, is one of the major economic entities experiencing negative real earnings growth (the lower and middle class)? Have they been tricked into debt to prevent price deflation because of poor assumptions about wages and prices (from the 1970’s)?

            “And this means that all debt isn’t created equal – which is why borrowing by some actors now can help cure problems created by excess borrowing by other actors in the past.”

            And, “For the Sams to do this, of course, the Janets must be prepared to dissave, to run down their assets. What would give them an incentive to do this? The answer is a fall in interest rates. So the normal way the economy would cope with the balance sheet problems of the Sams is through a period of low rates.

            But – you probably guessed where I’m going – what if even a zero rate isn’t low enough; that is, low enough to induce enough dissaving on the part of the Janets to match the savings of the Sams? Then we have a problem.”

            Here is where wealth/income inequality factors in. The spoiled and rich, which have excessive real earnings growth, don’t need to borrow to spend. They have all they need. They and most businesses also won’t invest because most industries already have enough capacity and investing more will only lead to lower prices and a lower stock price. So, they don’t invest in new capacity. For various reasons, they don’t retire and spend down what they have either. You need to add a bank or something bank-like to your scenario. IMO, the zero overnight interest rate should be telling people that the economy has gone from mostly real supply constrained to real demand constrained. This is actually something to be strived for. It also would violate almost all economists’ assumptions that real aggregate demand is unlimited or real aggregate supply can never reach real aggregate demand.

            This brings me to the medium of exchange question. What are the economic assumptions behind almost all economists’ belief that all new medium of exchange has to be the demand deposits from debt (meaning it has to borrowed into existence with an interest rate attached, repayment terms attached, and brings something from the future to the present).

            “The bottom line, then, is that the plausible-sounding argument that debt can’t cure debt is just wrong.”

            Nope. You don’t understand medium of exchange and/or have poor economic assumptions.

            “On the contrary, it can – and the alternative is a prolonged period of economic weakness that actually makes the debt problem harder to resolve.”

            What if real aggregate demand grows slower than real aggregate supply, there is already enough supply, and that is actually what should be happening? Will you need more retirees? You are actually making the case that NOT all new medium of exchange should be the demand deposits from debt.


    • Jeff H says:

      “Why do you seem to believe that the solution to too much debt is more debt?”

      Who said, other than you and all the Rs, that debt was the problem. IT JOBS!!!

      ‘The FDR administration soon increased funds to FERA, and added additional programs to get people back to work and revitalize the American economy. Hopkins and the Brain Trust were criticized for excessive spending by conservative members of Congress, who claimed that the economy would sort itself out in the long run. To which Hopkins replied, “People don’t eat in the long run, they eat every day.”‘

      http://www.u-s-history.com/pages/h1610.html


      • Fed Up says:

        “Who said, other than you and all the Rs, that debt was the problem. IT JOBS!!!”

        I believe the R’s are saying gov’t debt is the problem but aren’t too worried about private debt.

        Is there a jobs problem or a retirement problem, and is there any link between debt and retirement?

        And, “… who claimed that the economy would sort itself out in the long run.”

        Not if the medium of exchange market is not correct or not unless supply is destroyed somewhere.


        • Jeff H says:

          “I believe the R’s are saying gov’t debt is the problem but aren’t too worried about private debt.”

          Yes, the Rs, and you in your comment.

          My point was that it’s not a debt problem, it’s a jobs problem. It is a private problem because of the job problem.

          People with private debt and no job can not pay their private debt nor buy (DEMAND) anything.

          Creating jobs will go a long way to fix the debt problem, both public and private, but if the tax rates aren’t fixed (something a lot closer to 90s rates) no amount of jobs will fix the public debt.


          • Fed Up says:

            Jeff H’s post said: ““I believe the R’s are saying gov’t debt is the problem but aren’t too worried about private debt.”

            Yes, the Rs, and you in your comment.”

            I am worried about debt whether private or gov’t. Which R’s are worried about private debt? A little off topic, but in the UK (if I’m remembering correctly) they are actually counting on more private debt to offset austerity. I believe that is what the R’s are counting on here in the USA too.

            And, “My point was that it’s not a debt problem, it’s a jobs problem. It is a private problem because of the job problem.

            People with private debt and no job can not pay their private debt nor buy (DEMAND) anything.”

            IMO, it is a medium of exchange problem. If productivity growth (and other things) lowers the amount of labor needed, there is mostly enough supply, and no new industry comes along, are more retirees needed?

            People with no private debt and no job can demand goods and services if they are retired.


  2. Fed Up says:

    “Ever since the Clinton years, when the bond vigilantes—investors who would demand crippling high returns if we failed to obey them—allegedly ruled, more policy than you’d like to think is deeply influenced by warnings of how the bond markets will react.”

    Well… if you stopped the idea that all new medium of exchange has to be demand deposits from debt (meaning it has to be borrowed into existence), you could worry a lot less about the bond markets’ interest rates.

    The other idea that needs to end is that as long as more debt does not produce price inflation (or more likely wage inflation) then there is nothing to worry about. That means there can be a scenario of too much debt.


  3. some guy says:

    Is it too cynical to suggest that a small bloc of free market True Believers would actively seek default so as to force increasing privatization of govt services and assets while further reducing social welfare expenditures?


    • Jeff H says:

      Not cynical at all. They Rs have essential said that, and are now doing it in state after state where they won majorities.


  4. some guy says:

    On second thought, “suggest” should read “wonder”.


  5. Altoid says:

    I remember when Louis Rukeyser used to talk about the “bond ghouls.” They used to come out and raise interest rates whenever the stock-market party threatened to get going.

    Ghouls, vigilantes, disembodied “bond markets,” “confidence fairies,” and round and round we go.

    They seem to be infinitely conjurable, whatever they’re called.

    But how often has anyone actually tripped over one?


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