Bond Market Shrugs Amid Huge Deficits
With the U.S. budget gap reaching a mind-bending level, why are Treasury yields lower than when the government ran a surplus more than a decade ago?
Tea Party stalwarts are angry at the U.S. government’s rising tide of red ink. Print and broadcast media are full of dire warnings about the debt and the deficit. Some Wall Street analysts’ worry that the government’s spending will topple the nation’s triple-A credit rating, bringing the economy to its knees. Even economists who support the Bush and Obama Administrations’ dramatic fiscal actions to prevent the Great Recession from morphing into a Great Depression agree that the federal budget deficit and mounting government debt is unsustainable over the long haul.
But the agreement stops there. The raw, vicious, partisan politics splintering the country from Washington, D.C., to Washington State makes any move toward a solution, let alone a rational dialogue, seemingly impossible.
This is one of those times when conventional wisdom looks to be right: Thanks to a broken-down political system, the debt and the deficit are only going to get worse and worse until America sinks into a Greece-like crisis.
But here’s the puzzle: If the federal government’s fiscal position is so financially parlous, its need for debt financing so insatiable, and our political system so bankrupt, then why is the interest rate on U.S. government bonds lower than at the beginning of the 2000s, when the government ran a budget surplus and was paying down its debt? For example, the yield on the benchmark 10-year U.S. Treasury bond is currently around 3.8%. Last year, the yield averaged 3.3%. The budget deficit in the latest Economic Report of the President is projected to be -$1.5 trillion in 2010. Last year, the White House Council of Economic Advisers pegged it at -$1.4 trillion. Yet from 1998 through 2001, when the U.S. government was in a budget surplus for the first time in three decades, the 10-year Treasury bond yield ranged between 5% and 6%.
What is the message in government bond yields? That the conventional fiscal pessimism could be wrong, deeply wrong.
Valid Price Signals?
Of course, we know that the market—the collective judgment of millions of investors worldwide risking money and reputation daily—isn’t always right. (The late, lamented real estate bubble will attest to that.) Still, the market is a wondrous competitive “system of telecommunications,” in Friedrich Hayek’s apt metaphor. The price signal should be taken seriously.
It’s also doubtful that the world’s hard-nosed bond market vigilantes, the metaphor for the role of fixed-income investors to guard against fiscal and central bank profligacy, have suddenly gone squishy. The memorable words of James Carville, President Clinton’s campaign manager, still ring true. “I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a.400 baseball hitter,” he said. “But now I want to come back as the bond market. You can intimidate everyone.”
Bond-trader calmness partly reflects the reality that much of the bluster and wailing about the deficit is simply nonsense. “No doubt, there is plenty to worry about. There always is!” writes James W. Paulson, chief investment officer for Wells Capital Management, in his latest economic and investment newsletter. But his advice for dealing with the nation’s obsession with the next disaster in the making is to “ignore the rabble.”
