The Bond Vigilantes Drop the Ball

     And their failure is greatly perturbing Ronald McKinnon. He harks to the good old days when upon the proposal of Hillary's health care bill, 10 year U.S. Treasury bonds surged dramatically hitting 8% in 1994. This lead to the summary drop of HillaryCare and in 1996 the decimation of the Aid to Families with Dependent Children Act-to be replaced by the spartan and very ineffective Temporary Aid to Needy Families (TANF). According to McKinnon it is those bond vigilantes who deserve the credit for putting so many needy families into desperation.

    Yet somehow today they are not working their magic.

    "In contrast, after the passage of ObamaCare in March 2010, long-term bond rates remained virtually unchanged at around 3%. This was despite great doubt about the law's revenue-raising provisions, and the financial press bemoaning open-ended Medicare deficits and the mandated huge expansion in the number of unfunded Medicaid recipients. Even with great financial disorder in the stock and commodity markets since late July 2011, today's 10-year Treasury bond rate has plunged below 2%. The bond market vigilantes have disappeared."

    "Without the vigilantes in 2011, the federal government faces no immediate market discipline for balancing its runaway fiscal deficits. Indeed, after President Obama finally received congressional approval to raise the debt ceiling on Aug. 2, followed by Standard & Poor's downgrade of Treasury bonds from AAA to AA+ on Aug. 5, the interest rate on 10-year Treasurys declined even further."

     http://online.wsj.com/article/SB10001424053111904332804576538363789127084.html?mod=WSJ_Opinion_LEADTop

   
     It has also perturbed Alan Greenspan.

     "Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from $5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences."

    If the feared consequences of an action don't materialize that is proof of how dangerous that action is, more so than if they did lead to them. Or something like that. You'll have to excuse me, I'm trying to keep up. If you say that eating cheese leads to hives and someone ignores you, eats the cheese and develops no hives that's even more dangerous for them to eat the cheese than if they did develop the hives. Got it?

     http://krugman.blogs.nytimes.com/2010/06/19/the-facts-have-a-well-known-keynesian-bias/

     http://prospect.org/csnc/blogs/tapped_archive?month=06&year=2010&base_name=greenspan_is_back_baby


     McKinnon does have an explanation for the disappearance of the bond vigilantes. According to him:

     Two conditions are necessary for the vigilantes to thrive:

     (1) Treasury bonds should be mainly held within the private sector by individuals or financial institutions that are yield-sensitive—i.e., they worry about possible future inflation and a possible credit crunch should the government's fiscal deficits get too large. Because private investors can choose other assets, both physical and financial, they will switch out of Treasurys if U.S. public finances deteriorate and the probability of future inflation increases.

    (2) Private holders of Treasurys must also be persuaded that any fall in short-term interest rates is temporary—i.e., that the Fed has not committed itself to keeping short-term interest rates near zero indefinitely. Long rates today are the mean of expected short rates into the future plus a liquidity premium.

    So this is among other things a shot at Bernanke as he has indicated that the low short-term interest rates are not temporary-they are definitely going to last at least till 2013, in reality I presume much longer if the economy doesn't turn around.

   McKinnon is also decrying that by buying bons the government is distorting the market with the famous complaint that it is "crowding out the market." Part of the trouble is folks like him never understand that sometimes there really is no market to "crowd out." Obviously the government wouldn't have to buy bonds if the private sector bought a sufficient amount.
 
    So I'm sure glad the bond vigilantes could thrive during the Clinton years and heartily lament that they are no longer thriving. I mean can you imagine how bad things would be today if they didn't thrive during the 90s? We would have already had health care for 16 years-which itself would significantly brought down costs and the deficit-and needy families would still have some meaningful support from Aid to Families with Dependent Children. Now the program is very limited as TANF and after 5 years you are banned for life. Yeah we have a lot to thank the bond vigilantes for. Wow we could be so much worse off.