Six Essential Questions About The Deficit, Wall Street and Washington
What you see below was published today at Niemanwatchdog.org.
Six essential questions about the deficit, Wall Street and Washington
ASK THIS | August 12, 2010
Fiscal expert Stan Collender points out that the bond market is not demanding deficit reduction -- in fact, quite the opposite. So where is the Washington establishment's obsession with the deficit coming from? Whose interests does it serve?
By Stan Collender
1. For almost two decades we’ve been told that when you’re looking for signs of what Wall Street wants Washington to do about the federal budget, the bond market is the place to watch. What’s the bond market saying today?
The bond market is being as unequivocal today as it was when Bob Rubin used what it was saying in 1993 to convince Bill Clinton that he had to push to reduce the deficit. The only difference is that, instead of demanding deficit reduction, the bond market today is exhibiting no worries about the deficit or federal borrowing at all In fact it’s indicating that Washington should do more to stimulate the economy.
Although there are also a number of technical reasons why the demand for federal debt is strong and interest rates have remained low, the bond market’s interest in Treasury securities has been high no matter what the maturity. This demonstrates that, contrary to what deficit hawks and demagogues have been insisting, there is little or no concern on Wall Street about the government’s borrowing, either short- or long-term.
2. Why are Congress and the White House ignoring the bond market now after feeling the need to follow it so closely before?
In 1993, the bond market was threatening higher interest rates if the deficit wasn’t reduced, something elected officials could ignore at their own political peril. By contrast, the only threat the bond market can make now is to lower interest rates further, and that isn’t as fearsome to politicians.
In addition, the bond market in 1993 had a former bond trader -- Bob Rubin -- as a high-level advisor to the president and, therefore, in a position to communicate and validate what it was saying to Washington.
Most important, however, what the bond market is saying today is different from what deficit hawks and GOP critics of the Obama White House want to hear. As a result, the echo chamber that amplified and repeated the bond market’s message almost two decades ago doesn’t exist today.
3. What makes 2010 so different from 1993 for the bond market when it comes to the deficit?
It’s simple: The economic situation today is the opposite of what existed at the start of the Clinton administration. In 1993, the bond market was worried about excess demand and soaring inflation, which would have eroded the value of bonds. Having the federal government spend less and tax more -- that is, do things that would reduce the deficit -- meant that the economy would cool rather than overheat, and therefore that the demand for goods, services, and workers would be reduced. This would keep inflation in check and allow federal bonds to maintain their value.
The big concern today is about deflation and slow growth rather than inflation and overheating. With unemployment high and capacity utilization low, the bond market not only isn’t worried about the excessive economic growth, it actually would welcome the additional activity that would be generated by higher spending and lower taxes.
4. So if Wall Street isn’t demanding that the deficit be reduced, who is?
In the current environment, the federal deficit is more of a political issue than an economic problem. It’s not surprising, therefore, that those demanding that the Obama White House and Democratic Congress reduce the deficit even in the face of the bond market’s insistence that it’s not needed are those who want to score political points by doing so. Look at the inflammatory language being used on this issue by the administration’s opponents and it’s easy to understand how much of what is being said is demagoguery rather than substantive policy analysis.
The White House has paid a great deal of lip service to the concept of deficit reduction and symbolically has done a number of things to demonstrate its concern. This has included a one-day deficit reduction “summit” at the White House and the creation of a presidentially-appointed deficit reduction commission.
But this too is far more about politics than about economics. Much of what the White House has done was intended to satisfy the demands of the so-called “Blue Dog” Democrats in the House who have made deficit reduction a major priority. The Blue Dogs are a significant coalition in the House and without their support much of the Obama agenda -- especially health care -- would never have been adopted. (There are even some reports that the White House agreed to support deficit reduction in return for votes for health care.)
Many of the Blue Dogs are from fiscally conservative districts and are facing serious reelection challenges from Republicans who have made the deficits that have occurred during the Obama administration into a significant issue.
In addition, although some deficit hawks have moderated their language to say that deficit reduction is needed over the long-term rather than immediately, they have continued to demand that a deficit reduction plan be proposed now. That's because deficit hawk groups are largely one-issue special interests, and pushing deficit reduction is what they do even when, as has been the case the past few years, a bigger rather than smaller deficit is economically justified.
5. Why do these groups and individuals insist that the deficit needs to be reduced? What’s in it for them?
More often than not, the federal budget deficit is a surrogate for something else rather than a standalone concern. Agitating about deficit reduction gives Republicans a reason to talk about their pet issue -- tax increases -- and to blame Democrats for them. Over the past two years the rising deficit has also been used by Republicans as a symbol of excessive government spending and involvement in people’s lives. Even though deficits have generally been higher when Republicans were in the White House and in control of Congress, complaining about the nominal record highs that have occurred the past two years under a Democratic administration, House, and Senate has given the GOP the opportunity to place the blame elsewhere.
6. How is it possible that the politics and economics of the deficit are so different?
The answer is: Ignorance. Polls, surveys, and other research demonstrate conclusively that the public exhibits little understanding about the federal budget, the budget deficit, and the impact of the deficit on the economy as a whole. This makes the situation ripe for the misleading statements, campaign slogans, and demagoguery that are typical of today’s U.S. budget politics. The average voter also has dramatically conflicting views about budget issues, which allows the public debate to disintegrate into emotional slugfests that have little to do with reality.
The current situation is a prime example. With unemployment high, economic growth slow, interest rates low, and the bond market and Federal Reserve all signaling that more needs to be done to change the outlook, deficit reduction would actually be harmful -- a repeat of Herbert Hoover-like policies that would prolong the slow recovery. Nevertheless, concern about the deficit has been growing over the past few years and in some polls rivals terrorism as an issue in people’s minds.
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Number 7
How about a number 7 describing how the large deficits arose? The only reason Republicans can demagogue this issue is because the public is woefully ill-informed on what caused the deficits. Therefore, the Republicans can get away with blaming Democratic 'spending' for debt they created. The current deficits are caused primarily by revenue shortages due to the recession and Bush tax cuts as well as two wars, TARP, and the Medicare D giveaway. Only the stimulus can be blamed on Obama and that was a reasonable response to the terrible economy (and 40% tax cuts that Republicans support).
We can judge the Republicans honesty on this issue based on what they have done, what they are doing, and what they plan to do.
-They added huge amounts of debt in each of the last Republican administrations. The total debt increased by about $5 trilion during Bush's 8 years and at least that much of future debt is due to his policies. They made no effort to get health care costs under control (they actually made them worse), they got rid of paygo, and they started 2 wars without paying for them.
-Currently Republicans want to make the Bush tax cuts permanent adding $3.7 trillion to the debt over 10 years. This dwarfs any spending cuts they have proposed.
-They have in general totally avoided spelling out any plan to balance the budget and refused to identify any specific large cuts they would implement. THe one exception is Paul Ryan's road map and that will actually increase the deficit while giving the rich a huge tax break. The only spending cuts are achieved by unspecified cuts in the general budget and creating massive income insecurity by privatizing and underfunding SS and Medicare.
http://www.cbpp.org/cms/index.cfm?fa=view&id=3036
Here is a good summary of the current state of the budget and the effect of the Obama's policies on the debt. http://www.cbo.gov/ftpdocs/100xx/doc10014/Chapter1.5.1.shtml
2010 versus 1993
It's remarkable to see recent bond price moves being described as taking place in a normal market explicitly comparable to 1993's -- without one word about the Fed's buying a trillion dollars of securities to push their price up and interest rates down. Nor one word about the immense international flight into the dollar and T-bonds -- pushing their price up -- driven by troubles elsewhere. Which, unless the world really ends, will be temporary, and certainly has nothing at all to do with the US deficit.
Regarding Q#3 "What makes 2010 so different from 1993 for the bond market" these differences are too minor to deserve a mention?
(As remarkable as this notion is, I've seen it in so many places recently that it does seem like it might be the theme of the week on whatever is the successor to Journolist.)
Speaking of which, do we apply the same logic to conclude that the simultaneous surge in the exchange rate value of the dollar, reversing its decade-long decline, is the market now demanding bigger trade deficits?
Bond Prices and the Deficit
"In the current environment, the federal deficit is more of a political issue than an economic problem. It’s not surprising, therefore, that those demanding that the Obama White House and Democratic Congress reduce the deficit even in the face of the bond market’s insistence that it’s not needed are those who want to score political points by doing so".
I'm one of those who think that the deficit is too high. And this is not because of a hidden agenda to keep tax rates low. Taxes need to rise and spending needs to be reduced, too. We can discuss timing, but we need to make firm commitments now. Regardless of what the markets say in the short term, the public debt is not going to disappear. Eventually, rates will go up and the interest charge on the public debt will explode as we need to rollover our short term Treasury debt.
Mr. Collender seems to have an excessive trust in the markets with respect to this particular issue. It is interesting that one's trust or distrust of markets tends to change depending on the political issue involved. The fact is that interest rates on Treasury's are not necessarily a reflection of the market's long-term expectations. The market is controlled by short-term thinkers, who, even though they may feel the rate on, say, 10 Treasury's is a good investment now, have absolutely no intention of holding those bills to maturity. They are merely waiting for a convenient time to bail.
With respect to one's trust in markets, one need only think back 5-10 years. The markets then were telling us that housing prices were not too high and this excessive trust in markets by policymakers led to a disastrous financial crisis. The lesson here is that one needs to look well beyond the short term markets for wisdom on what to do with respect to fiscal policy rather than merely follow those markets. We need more wise men (and women) whose vision extends a bit further over the horizon and fewer chart following technocrats making these vital decisions. This wisdom comes through suffering, and it doesn't appear Mr. Collender has suffered enough yet.
Well said, indeed! Hear hear!
Well said, indeed! Hear hear!
Serious
Anyone that is not in favor of letting the Bush tax cuts expire is not serious about cutting the deficits.
That is how we know Republicans are just using the issue to fire up their base and oppose any public spending and Democrats are too once again too cowardly to do what is right because they are afraid Republicans will attack them for raising taxes. They don't seem to realize that Republicans attack them no matter what they do.
The real issue is when to cut the deficit and how. Number one we need to lower health care costs. We spend about $3000 per capital per year than other countries with better health care. That adds up to $1 trillion per year in potential savings. We also can cut defense spending considerably without sacrificing our safety. Taxes are at historically low levels we can raise them especially if we simplify the tax code, cut loopholes, and add brackets to increase taxes on the very wealthy that are paying lower rates than the merely wealthy.
If we shift spending from nonproductive uses ( health insurance companies, military, and tax cuts for the wealthy) to productive uses with higher multipliers (infrastructure, education, alternative energy) we can cut the budget now and position the country for future economic growth. Of course the corporate control of our government makes this impossible.
Repubs and Dems
Anyone that is not in favor of letting the Bush tax cuts expire is not serious about cutting the deficits. That is how we know Republicans are just using the issue to...
The Democrats are planning to make 85% of the tax cuts permanent.
So what does this tell us about them?
Agreed
As I said in my second paragraph, they are too cowardly. They routinely put political calculation above sensible policy. This is very frustrating because, almost without exception, their political calculations are wrong. More often than not enacting sensible policy would also be politically popular (at least with voters, not with campaign contributors).
That said, they did reinstitute paygo, create the catfood (deficit) commission to cut Social Security benefits, make some feeble attempts to rein in health care costs, and are raising taxes on the wealthy, all with Republican opposition. So they are more serious than Republicans, an admittedly low bar.
Your first question shows a
Your first question shows a simplistic understanding of the bond market and its participants. Many bond market participants, ie, central banks, are not traditional investors. They aren't buying 10yrs at these levels because they are great investments. They have policy goals for their currency vs. the dollar etc.
You may be aware that the Fed is expanding its balance sheet and purchasing Treasuries?
I think you need to do better than interest rates are low = no long term concern about the deficit. It's just silly to say that Wall Street has no long term concerns over US government finances.
The Fed is buying the
The Fed is buying the treasuries. So what? If the Fed can buy all of the new treasuries without increasing inflation then the Govt has free money to spend, and it should spend that money improving the economy. Balancing the budget right now would be a disaster which would lead to a situation akin to what Ireland currently faces (it isn't pretty). I say issue new treasuries, let the Fed buy them, use the proceeds to stimulate the economy. When inflation ticks up the Fed has then necessary tools to cool the economy. But right now only a deficit can provide the ammo to stimulate the economy because the Fed is out of interest rate cut bullets.