Bond Madness: Things are looking bleak for the economy; Goldman Sachs (no link) is predicting that 2nd quarter GDP growth will be revised down to 1.1%, and it’s downhill from here. Yet from late 2009 until just the other day, all the Very Serious People were mainly concerned about the possibility of surging interest rates. Why?
I was looking back at some of my own notes about what happened last fall. At the time, there was serious consideration among the Obama people of pushing for some kind of second stimulus; what its chances might have been is hard to say. But the point is that they backed off. Why? My understanding is that they bought into the big scare of the time, which was that there was a “carry trade bubble” in the bond market, and terrible things would happen when it burst. No, this never made sense. Anyone who looked at recent Japanese history should have realized that with a depressed economy, low rates could and did last a very long time. And some of the scenarios being proposed were just plain bizarre: the bond bubble will burst, and this will plunge us into recession, and the Fed will have to buy up government debt, and this will mean inflation too. Really.
And then the whole story shifted: suddenly it wasn’t the carry trade, it was sovereign debt risks, we’re all Greece.
And now there’s a new one: you see, low interest rates will cause deflation. Really (near the end).
And though the story shifts, the moral is always the same: the little people have to suffer.
Appeasing the Bond Gods: Late last year the conventional wisdom on economic policy took a hard right turn. Even though the world’s major economies had barely begun to recover, even though unemployment remained disastrously high across much of America and Europe, creating jobs was no longer on the agenda. Instead, we were told, governments had to turn all their attention to reducing budget deficits. Skeptics pointed out that slashing spending in a depressed economy does little to improve long-run budget prospects, and may actually make them worse by depressing economic growth. But the apostles of austerity — sometimes referred to as “austerians” — brushed aside all attempts to do the math. Never mind the numbers, they declared: immediate spending cuts were needed to ward off the “bond vigilantes,” investors who would pull the plug on spendthrift governments, driving up their borrowing costs and precipitating a crisis. Look at Greece, they said.
The skeptics countered that Greece is a special case, trapped by its use of the euro, which condemns it to years of deflation and stagnation whatever it does. The interest rates paid by major nations with their own currencies — not just the United States, but also Britain and Japan — showed no sign that the bond vigilantes were about to attack, or even that they existed.
Just you wait, said the austerians: the bond vigilantes may be invisible, but they must be feared all the same.
This was a strange argument even a few months ago, when the U.S. government could borrow for 10 years at less than 4 percent interest. We were being told that it was necessary to give up on job creation, to inflict suffering on millions of workers, in order to satisfy demands that investors were not, in fact, actually making, but which austerians claimed they would make in the future.
But the argument has become even stranger recently, as it has become clear that investors aren’t worried about deficits; they’re worried about stagnation and deflation. And they’ve been signaling that concern by driving interest rates on the debt of major economies lower, not higher. On Thursday, the rate on 10-year U.S. bonds was only 2.58 percent.
So how do austerians deal with the reality of interest rates that are plunging, not soaring? The latest fashion is to declare that there’s a bubble in the bond market: investors aren’t really concerned about economic weakness; they’re just getting carried away. It’s hard to convey the sheer audacity of this argument: first we were told that we must ignore economic fundamentals and instead obey the dictates of financial markets; now we’re being told to ignore what those markets are actually saying because they’re confused....
It seems almost superfluous, given all that, to mention the final insult: many of the most vocal austerians are, of course, hypocrites. Notice, in particular, how suddenly Republicans lost interest in the budget deficit when they were challenged about the cost of retaining tax cuts for the wealthy. But that won’t stop them from continuing to pose as deficit hawks whenever anyone proposes doing something to help the unemployed.
So here’s the question I find myself asking: What will it take to break the hold of this cruel cult on the minds of the policy elite? When, if ever, will we get back to the job of rebuilding the economy?