Trying To Have It Both Ways On What The Bond Market Is Saying About The Deficit
My column from this morning's Roll Call asks two very troubling questions:
1. Why are some people refusing to hear what the bond market is saying?
2. How is it possible that so many of those who insist the bond market should be ignored now were saying just the opposite before?
Having It Both Ways on the Bond Market’s Message
Sept. 7, 2010
My Aug. 3 column about the former “bond market vigilantes” now being obvious federal budget deficit cheerleaders generated a great deal of attention and lots of pro and con comments.
The biggest complaint by far was that the bond market will someday change its mind, think that the economy warrants lower rather than higher federal deficits and start to push up interest rates in anticipation of that not happening. We should deal with that, the complainers said, by beginning to reduce the deficit immediately.
The best way to demonstrate the absurdity of this position is to ask what the complainers would be recommending if the mirror image of this situation existed. What would they say, for example, if the bond market were signaling that deficit reductions were called for as unequivocally as it is now demanding more stimulative policies?
Would the same people who responded that we should ignore what Wall Street is saying and start to reduce the deficit in the face of low economic growth be just as adamant that, if the bond market were back in a vigilante mode, we should begin to adopt policies that increase federal spending, reduce taxes and raise Washington’s borrowing because, after all, at some point it will change its mind?
Of course they wouldn’t.
If it was important to hear what the bond market vigilantes were saying in the 1990s — and it was — it’s just as vital to listen to what the bond market deficit cheerleaders are saying today.
There’s no doubt that the bond market will turn on a dime — or in this case on a few hundred billion dollars — when economic growth is projected to be at the levels where traders are worried about federal budget policies leading to shortages of raw materials, goods and labor and, therefore, inflation. That’s what markets almost always do when they get and understand new information: They change.
But the likelihood that Wall Street will be concerned about an overheating economy at some point down the line doesn’t detract from the message that it is unambiguously sending now: Given unemployment and capacity utilization (among other measurements), slow growth and deflation rather than excessive growth and inflation are the primary concerns.
Because of that, federal deficits and additional stimulus are not feared or fearsome. Not only is there no reason to begin to reduce the deficit now, the bond market is saying there are strong reasons to do just the opposite.
Some of those who disagreed with the Aug. 3 column said that given the usual lag between when a change in the economy occurs, the change is recognized by policymakers and the legislative process is able to deal with the new information, budget policies have to be adjusted before the bond market calls a new play. (Forgive me, but after all, football season is under way.)
But that ignores the role of the Federal Reserve, which has the ability to change monetary policy long before Congress and the White House usually are able to revise existing fiscal policies and well in advance of when deficit reductions take effect. And because in this case the Fed would be raising interest rates to deal with a perceived threat of overheating the economy, its ability to move decisively and by whatever amounts are needed would be far greater than its current options, which are limited.
The question asked at the end of the Aug. 3 column — Why aren’t the bond market deficit cheerleaders being heard or followed by policymakers? — continues to be the most interesting, but in light of some of the responses that I received, it needs to be asked differently: Why is it seemingly so easy to dismiss what the bond market is saying today when what it said before was taken as gospel and as if it was handed down from on high?
Some of the reasons I offered a month ago continue to be realistic and very plausible. The lower interests that the bond market is using to send its message today simply aren’t as potent a threat as the higher rates that it was imposing almost 20 years ago. As a result, the politics of lower interest rates just isn’t the same and the imperative for dealing with them quickly is very different.
In addition, given the financial services sector’s overall low approval ratings and the fact that Federal Reserve Chairman Ben Bernanke is much less willing to comment forcefully on fiscal policy issues than Alan Greenspan was, it may simply be easier for legislators today to give short shrift to what the bond market is saying.
But given how easy it is to demonstrate that those who refuse to listen to what the bond market is saying are trying to have it both ways — it’s important to listen to Wall Street when it says deficit reductions are necessary, but it can be ignored when it says the opposite — it’s hard not to conclude that the primary reason the bond market doesn’t have the influence it had before is that it is saying something very different from what many want to hear. Because of that, they have to reinterpret what the market is saying so that even though the message being sent actually is completely different, it somehow means the same thing.
Having it Both Ways
This reminds me of a quote cited by Mr. Collender's colleague Bruce Bartlett several years back (2002):
"'It is a standard tactic to take someone's proposal, misstate it, and then disagree with it. It's very effective.
I've used it myself.' So said Senator Edward Kennedy, Massachusetts Democrat, at the National Press Club recently".
So, all your critics want to have it both ways? Not this one. Not to be too redundant, but the point was that the market in Treasury's, particularly today, says a lot more than traders' expectations about inflation. What the market most definitely does not say is that bond traders want more federal deficits. And, an equally fundamental point is that our government policy makers need to think a bit further ahead than bond traders. With respect to our federal finances, I don't think those responsible should pick up the morning news to find out from a vigilante (or a cheerleader) what they should do.
As a case in point, let's re-wind and re-phrase this argument for the situation just a few years ago:
"There’s no doubt that the housing market will turn on a dime — or in this case on a few hundred billion dollars — when housing is projected to be at the levels where mortgage backed securities traders and home owners are worried about federal policies leading to an over-abundance of housing and, therefore, housing deflation. That’s what markets almost always do when they get and understand new information: They change.
But the likelihood that Wall Street and homeowners will be concerned about a deflating housing market at some point down the line doesn’t detract from the message that it is unambiguously sending now: Given the continuing demand for housing and the healthy appetite for mortgage backed securities (among other measurements), insufficient housing growth and supply of mortgage backed securities rather than excessive growth and over supply are the primary concerns".
And, as testimony to Mr. Collender's long-range thinking, he adds, "some of the reasons I offered a month ago continue to be realistic and very plausible". Imagine---"some of the reasons...a month ago"!
Peter Orszag--a Cheerleader?
Oh, and by the way, Peter Orszag seems to have joined the ranks of cheerleader in his first NYT editorial. Here's the rah rah line:
"A benign bond market, however, is a luxury we won’t enjoy forever if we fail to tackle our long-term fiscal problem. What’s more, losing the confidence of the bond market could prove painful, since it is widely known that our fiscal trajectory is unsustainable and market sentiment may therefore shift quickly and unpredictably. In any case, as the economy recovers, the dominant problem will move from depressed demand to excessive budget deficits".
Serious question: How do you
Serious question: How do you get from "the bond market is not worried about current deficits" to "the bond market wants bigger deficits"?
Suppose the current state of the economy were optimal, from the point of view of bondowners. Wouldn't that lead to high prices for bonds, just as we see now? So what makes you think the bond market is "cheerleading" for a more expansionary policy, rather than the continuation of the policy we have now?
Personally, I think 9.6% unemployment is a disgrace and a disaster, and we need to take big steps to increase AD. But imputing this belief to the bond markets seems a bit like wishful thinking, to me.
Demanding More
Good question. He actually wrote that they are DEMANDING more stimulatory policies.
Amusing
I'm terribly amused how thoroughly Vivian managed to miss Stan's point.
The point is NOT that markets can't turn on a dime. They can. The point is that you have to acknowledge that it can change in a way you disagree with. You have to acknowledge that it's possible that bond markets may decide that deficits are less of an issue than the demand gap.
Right now, you've just got one unfalsifiable solution. Treasuries trading high? Cut deficits! Treasuries trading low? Cut deficits! Economy collapses? Cut deficits! Martians invade? Cut deficits! Housecats finally rebel against their monkey overlords? HOLY HELL, CUT THE DEFICITS!!
You're fitting your analysis to match your preferred solution, and it's profoundly intellectually dishonest. That's Stan's point, and he's completely right.
Greater QE Needed
Whether we need more fiscal stimulus or not, it probably won't happen for political reasons.
That leaves the Fed. The Fed should engage in $100 billion a month of QE, and keep it up until we see positive results.
Scott Sumner has been advocating this.
Play it again Sam
And as many times as you want and you will still be wrong.
And this is to your contention that you claim the bond market wants bigger deficit spending on top of what we already have.
Try looking at it from the perspective from the person/group whatever who is buying the bonds that you think you are speaking for.
Can we agree that people buy bonds to actually make money ? The people buying the bonds right now are the ones driving down interest rates ( can you also admit that the fed buys treasuries ? )
Ok so now people who buy bonds have their own self interests at heart. They want to make money or at least preserve it. Some buy to hold till maturity. Some especially on the shorter end of the curve buy because they dont know where to put their money so they basically let the govt hold it for next to nothing on the shorter end of the curve because of the uncertainty everywhere else inside the US and outside the US.
Then you also have people buying on the intermediate to long end of the curve for yield or to profit from price moves and also following momentum also knowing that there are crosswinds right now in the US and outside of the US that prevent the economy from recovering to any great extent. ( just look at where rates were and how much they came down after the Greece thing started blowing up )
Now why the heck would this crowd be demanding greater deficits ( higher than the ones we are already have ) to stimulate the economy knowing that they will get clobbered on their bond holdings ?
Your logic doesnt make sense. As a bond investor I would like some reflation to get higher yields on cash that I have on the sidelines ( and no doubt there is a lot of money that would like higher yields ) but the people who are buying bonds today who are the actual ones responsible for the lower yields arent telling you or anyone else they want the govt to spend even money and run higher deficits than they already are. They are saying right now today sept 8th that they dont see a strong recovery and they are willing to accept todays yields as an investment for whatever their own reason.
But they certainly arent saying " gee I hope the govt borrows even more money jeopardizing my investment "
You'd have a much better argument trying to say the stock market would like to see more stimulus
"Clobbered"
Now why would they get clobbered? Core inflation is so low that it's likely to switch to Japanese-style deflation fairly soon. So they aren't going to get clobbered that way. Interest rates are likely to remain low, too, so the market price of their low- (or no-)interest bonds won't go down much, either.
No, the only way they would get "clobbered" is if the economy continued declining to the point where they could no longer be sure that their bonds would be honored, or the currency they're denominated it declines enough in value that it wipes out the value of the bond. That isn't in the cards, really, but it's certainly possible, especially the latter. Better to have short-term deficits than face the prospect of default.
You're falling into the same trap that Vivian has. If this isn't a situation where bond traders would like to see more spending, then what WOULD be? Are you fitting your judgment to a pre-determined end (lower deficits!) at the cost of all else, or are you willing to grant that other considerations may trump whinging about deficits?
(After all, you clearly don't know the whole story. If you did, you wouldn't have ended with that lame little "for whatever their own reason.")
You and Vivian both have to accept the possibility that you could be wrong. If you're just constructing tautologies, you're not only being intellectually dishonest, you're doing yourself a disservice.
Demosthenes
#1 You have no idea if we are heading to japan style inflation soon. No offense but you are talking out of your rear end. It's far from certain and there is also a strong possibility that we could just be heading to low to moderate growth. The truth of the matter is no one is certain right now so I'll take comfort in knowing you dont know for sure.
#2 I fully understand the need for deficit spending in recessions.No offense but you certainly dont understand how to read someones post because I clearly was writing about Stan's contention that the bond market is calling for increased deficits above what we already have. He's trying to say the bond market wants the govt to ramp up spending even more in order to get the economy to grow at a faster rate.
Thats's just a load of BS because like I mentioned before people who are buying bonds care only about their own investment. If they were buying intermediate to longer term bonds and the economy started growing stronger than what they are thinking right now then that would mean interest rates going higher and their bond prices taking a hit. Maybe you dont understand the correlation between existing bonds and rising interest rates and price volatility thus explaining your naive thought that bondholders would only get clobbered if the govt couldnt pay on the bonds. It's just not true for people not planning to hold till maturity
# 3 I'll tell you the people who would love to see more govt spending above and beyond what we are already doing right now. The people who would be shorting treasuries or shorting things like tlt or buying things like tbt because the odds would be more in their favor of making money in that scenario than that of people who are locked in low paying bonds bought today
#4 You think I clearly dont know the whole story because I wrote "They are saying right now today sept 8th that they dont see a strong recovery and they are willing to accept todays yields as an investment for whatever their own reason." ?
I wrote that because I didnt want to speak on behalf of every person who is buying bonds today. But the fact that I manage their money for a living and speak to these people every day I think qualifies me to understand exactly what I'm talking about.
Once again you'd be on much better footing trying to argue the stock market wants even higher stimulative measures