by Gary North: My
Response to New York Times Op Ed Columnist David Brooks: 'Liberal Democrats'
to think that if there was reincarnation, I wanted to come back
as the president or the pope or as a .400 baseball hitter. But now
I would like to come back as the bond market. You can intimidate
everybody." ~ James Carville
In the American
West, an unofficial assembly of private citizens known as vigilantes
would gather together to exact vengeance against some suspected
evil-doer who had the backing of the local politicians and who could
not be prosecuted. If they had a symbol, it was a noose.
There has been
a strange fascination with them over the years. They have been ideal
candidates for Western movies, from The
Ox-Bow Incident to Hang
'Em High. Called lynch mobs in other contexts, they have
often been seen as necessary evils.
I never agreed
with the phrase "bond vigilantes." There is nothing illegal about
investors staging a boycott against government bonds because they
do not trust either the government or the central bank. The bond
investor who says "no" at some price (interest rate) is exercising
his legal right as a property owner. He is saying, "I don't trust
the government at this low rate of interest. There should be an
inflation premium built into this rate."
In recent months
in Europe, another factor reared its head: the risk premium. For
the first time since 1950, investors contemplated the possibility
that West European governments might default on their debts. Governments
had long promoted the convenient fiction that sovereign debts are
always honored by politicians.
So, the phrase
"bond vigilantes" probably had its origin in a spin-room of the
federal government. Bond investors who demand higher rates are regarded
as traitors by politicians. They have broken faith with the full
faith and credit of the United States. They say: "A little faith,
yes, but not as much as before."
The bond investor
is far closer to a juror than he is to a vigilante. The juror assesses
the credibility of testimony by the Treasury. Maybe he votes to
release the prisoner. Maybe he votes for a felony manslaughter conviction.
At some point,
the jury may even convict for murder conviction. "Guilty as charged,
CLINTON MEETS THE BOND MARKET
In late 1992,
after his election but before his inauguration, he outlined his
economic program to a group of advisors. It was the usual Great
Society stuff. Bob Woodward described this meeting in his book,
"The Agenda." In the room was economist Alan Blinder, soon to be
part of Clinton's Council of Economic Advisors, and later to become
Vice Chairman of the Board of Governors of the Federal Reserve.
to Clinton's agenda, Blinder said this. Falling interest rates on
Treasury bonds could offset a decline of economic growth due to
a reduction in federal spending. (This is standard Keynesian nonsense,
as if a reduction of federal spending will not be offset by increases
in private spending.) Blinder had doubts that rates would fall.
Why? Because, he said, "after ten years of fiscal shenanigans, the
bond market will not likely respond."
reaction has become part of the Clinton legacy, only a few notches
below "I did not have sex with that woman, Miss Lewinsky."
the president-elect's end of the table, Clinton's face turned red
with anger and disbelief. "You mean to tell me that the success
of the program and my re-election hinges on the Federal Reserve
and a bunch of [expletive deleted] bond traders?" he responded in
a half whisper.
his end of the table. Not a dissent.
it seemed to Blinder, perceived at this moment how much of his
fate was passing into the hands of the unelected Greenspan and
the bond market.
right. The bond traders decided not to buy bonds at low rates. From
October 1993 to November 1994 10-year yields climbed from 5.2% to
just over 8.0%. Investors were worried about federal spending. With
guidance from Treasury Secretary Robert "Goldman Sachs" Rubin, the
Clinton Administration and Congress made an effort to reduce the
deficit. Ten-year yields dropped to approximately 4% by November
1998. Clinton ran surpluses in the last three fiscal years
the first time since fiscal year 1969.
surpluses are mythical. They relied on Social Security payments.
You can read about
the myth here. But, compared with his predecessors, he ran a
tight ship. The bond market forced his hand.
WAS THEN. THIS IS NOW.
recent Wall Street Journal article brings us up to date
about the power of bond traders.
No longer can
investors' bond-selling campaigns pressure officials into politically
unpopular tax increases or spending cuts, measures that both Clinton
and his predecessor, George H.W. Bush, were forced to adopt to improve
the fiscal balance and support bond prices.
What has changed?
The Federal Reserve System's policies. Its decision-makers have
decided to accommodate whatever deficits that Congress and the President
agree to. "The central bank's giant purchases in the Treasury market
and near-zero interest rates have supported bond prices and marginalized
private-activist bond investors."
(rates) are trading at historic lows. But I have argued for two
years that these low rates are not the result of FED monetary inflation.
Monetary inflation tends to raise long-term rates, because bond
investors demand a higher rate of return to compensate them for
rising prices, i.e., falling real income.
What is holding
rates down is fear. Borrowers fear to borrow; bankers fear to lend.
Instead, bankers turn the money over to the FED as excess reserves,
for which they are paid essentially nothing. The article admits
this, but attributes this to fear in the eurozone. But this decline
in rates began three years ago.
is partly due to the "flight to safety" that Treasurys have enjoyed
as investors escape exposure to the euro-zone debt crisis, but it
is also because of the Fed's yield-suppressing actions, which are
aimed at encouraging investors to take risks and bolster the economic
recovery, and are made possible by a benign inflation environment.
explaining is "the benign inflation environment." The answer is
rising excess reserves, which have offset the increase in the FED's
Ahrens, head of U.S. interest-rate strategy at UBS Securities LLC,
in Stamford, Conn., said until risk appetites rekindle and disinflation
fears dissipate, the bond vigilante is likely to be "as scarce as
the Abominable Snowman."
So, the FED
is trapped. On the one hand, if the U.S. economy remains in the
pits, fear will win. Bankers will not lend the money they are legally
allowed to lend. The money will not get into the economy. This means
that Keynesian pump-priming in the form of $1.3 trillion federal
deficits will not work their magic. Stagnation will become permanent,
unless there is a recession and things get worse.
On the other
hand, if the skies clear, and businessmen start singing "happy days
are here again," bankers will lend. The FED's monetary base, which
went from $900 billion in late 2007 to $3 trillion today will work
its black magic. Prices will double or worse. That is hyperinflation.
But it has not happened yet.
although critics have said the Fed has distorted the normal functioning
of the Treasury bond markets by crowding out private investors,
inflation the biggest threat to bonds' fixed value over time
and a big worry for fixed-income investors has remained muted
and given the central bank wiggle room.
Open Market Committee (FOMC), which decides monetary policy, remains
in a deflationary mindset. It has ever since July 2011, as
this chart reveals.
So, it is clear
that the cause of today's low rates is not monetary inflation. It
is fear. Investors think the safest place for their money is in
U.S. Treasury debt. There are so many of these investors that the
Treasury can borrow money almost for free for 90 days. It can borrow
long term for very little.
This puts Bernanke
in the catbird seat. Consumer price inflation continues in the 2%
per year range. This is low enough so that inflation hawks and bond
traders are mute. At the same time, economic growth is in the 2%
range. It is high enough so that most Keynesians are not demanding
another round of monetary base expansion.
want a larger federal deficit, not more fiat money. Keynesian theory
identifies the major economic responsibility of government as fiscal
policy: taxing and spending. They become advocates of fiat money
expansion whenever rising Treasury rates threaten the deficit. That
is not the case today.
Ron Paul on his case, but not for long. Paul will retire in January
2013. If he is elected President, this will be a nightmare for Bernanke.
It will be a nightmare for the Establishment in general. Council
on Foreign Relations Team B would not replace Council on Foreign
Relations Team A for the first time since 1928. Unthinkable! So,
the Establishment is hoping that Paul will drop out.
bides his time. He is not being attacked by the mainstream media.
He can operate in the shadows, coming out to give his trademarked,
footnote-laden speeches that describe what has happened recently,
which everyone knows, and list hypothetical FED policies as fallback
positions if the current do-nothing policy fails.
This is an
ideal period for Bernanke. He can sit on the sidelines. No one except
Ron Paul is calling for his scalp, such as it is. He is in Goldilocks
country: not too inflationary, not too recessionary, just right.
Millions of workers remain unemployed, but this can be blamed on
"tight" fiscal policy. That's not Bernanke's department. That's
for Congress to resolve.
tires of nagging Congress to get its fiscal house in order. He knows
that this is not going to happen. So, he can play the Stern uncle.
February 9, 2011, he lectured the House Budget Committee.
put the budget on a sustainable trajectory, policy actions
either reductions in spending, increases in revenues, or some combination
of the two will have to be taken to eventually close these
primary budget gaps.
the unsustainable trajectories of deficits and debt that the CBO
outlines cannot actually happen, because creditors would never
be willing to lend to a government with debt, relative to national
income, that is rising without limit. One way or the other, fiscal
adjustments sufficient to stabilize the federal budget must occur
at some point. The question is whether these adjustments will
take place through a careful and deliberative process that weighs
priorities and gives people adequate time to adjust to changes
in government programs or tax policies, or whether the needed
fiscal adjustments will come as a rapid and painful response to
a looming or actual fiscal crisis. Acting now to develop a credible
program to reduce future deficits would not only enhance economic
growth and stability in the long run, but could also yield substantial
near-term benefits in terms of lower long-term interest rates
and increased consumer and business confidence.
Then he could
go back to his office and think: "That ought to hold them for another
later, when a fight over raising the debt ceiling broke out, he
dutifully came down on the side of the ceiling-busters.
to raise the debt limit would require the federal government to
delay or renege on payments for obligations already entered into.
In particular, even a short suspension of payments on principal
or interest on the Treasury's debt obligations could cause severe
disruptions in financial markets and the payments system, induce
ratings downgrades of U.S. government debt, create fundamental doubts
about the creditworthiness of the United States, and damage the
special role of the dollar and Treasury securities in global markets
in the longer term. Interest rates would likely rise, slowing the
recovery and, perversely, worsening the deficit problem by increasing
required interest payments on the debt for what might well be a
So, he covers
both cheeks of his backside. He plays stern uncle when he lectures
Congress on deficits in general, and then plays lenient uncle when
push comes to shove over the deficit specifically.
The FED is
in wait-and-see mode. As long as Congress lets Bernanke alone, he
can sit tight. Like a gambler playing for the house and sitting
with a pile of chips, with a chip-making machine in the back room,
Bernanke can afford to bide his time. He can play for small stakes,
steadily building his pile.
He is like
any other bureaucrat. As long as he can evade criticism, he is content.
Unlike all other bureaucrats in Washington, his agency gets to set
its own budget. The FED keeps whatever money it needs to run its
operations. At the beginning of each calendar year, it pays the
Treasury whatever it has left over after expenses. This
year, it paid $76.9 billion retroactively for 2011.
The name of
the bureaucratic game is survival. Bernanke is a survivor. He is
not going to rock the boat. He is determined not to get blamed if
the boat capsizes. He will take action inflation if
the necessity arises. Then bond rates will rise. Then the bond traders
will reassert themselves. But, for now, he has hanged them high.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2012 Gary North
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