David Wessel asks why the U.S. bond market isn't pricing any of the high interest rate scenarios that we economists think are possible five or so years from now:
WSJ.com - Capital: Market Calm Belies Fiscal-Policy Dangers: April 27, 2006; Page A2: The U.S. government has promised health and retirement benefits in the future that exceed receipts projected from today's tax code. President George W. Bush pronounces current federal spending trends "unsustainable." The U.S. economy is more dependent on the savings of foreigners each year. Wise observers of differing political persuasions warn this cannot persist indefinitely.
Yet there is no hint that politicians in Washington are moving toward corrective policies.... They defer solving problems that lurk in the future until confronted with a crisis. So where is the bond market when you need it? Why aren't foreign investors fleeing the dollar? What happened to those market vigilantes who push up interest rates on Treasury bonds or yank down the dollar if procrastinating politicians head toward profligacy?
Fear of the bond market, after all, clubbed President Clinton into abandoning campaign promises for a middle-class tax cut and tackling the deficit instead. As Clinton political guru James Carville famously put it: "I used to think if there was reincarnation, I wanted to come back as the president or the Pope or a .400 baseball hitter...but now I want to come back as the bond market. You can intimidate everybody."
Puzzled by the market's complacency, former Congressional Budget Office Director Douglas Holtz-Eakin offers an amendment: "I want to come back as the bond market's shrink."... [S]omething other than the fiscal outlook is driving markets. That frustrates deficit Cassandras.... "Long-term interest rates are principally determined by expectations about what the Fed will do over the next year or so, rather than how much Treasury debt we expect to be trading five or 10 years from now at a set of interest rates that we can only dimly forecast," says Peter Fisher....
The Bush administration certainly isn't worrying. It takes comfort that the market won't validate claims of fiscal doomsayers.... Former Treasury Secretary Robert Rubin, now at Citigroup Inc., is still convinced that the day of reckoning is coming and shares a colleague's intriguing hypothesis to explain the market's apparent lack of concern: "A lot of investors believe in 'just-in-time politics' -- that the political system isn't going to be unwise enough to allow all these untoward things to happen, so it will respond just in time." Financial markets can focus on other things only because they assume Congress and the White House will steer away from the fiscal rocks before it is too late....
But the facts remain: The U.S. government has made benefit promises it cannot afford to keep and the U.S. economy cannot expect to borrow ever-greater sums from abroad forever. And the fixes, when they come, won't work quickly: The president can't send in the National Guard to fix Social Security or Medicare. Waiting to act until financial markets lose faith in just-in-time politics is somewhere between foolish and irresponsible.