Tuesday, June 1, 2010

Published Letter by your humble correspondant

LETTERS [Published in The Wall Street Journal] JUNE 1, 2010 [page A18]

The Bond Market Vigilantes Could Do Us Some Good Article

Comments [The article follows]

Nowhere in Mr. Blinder's article does he mention the concept of growth. His only methods of reining in cripplingly high interest rates are: spend more, export more (by currency devaluation) or spend less. All these together will not solve the problem. As is well known, but for political reasons not exercised in practice, you can't cut your way to prosperity. So what's left? What is the answer? Growth. Only by getting an economy bigger can it pay down debt, create jobs and finance social justice. A simple concept, but one resisted by liberals who don't at the core believe in the only path to that growth: successful businesses. Successful, growing businesses are the only way for an economy to grow. That growth can only come from activities anathema to liberals: lower taxes, reduce regulations, and downsize government. Add that to your arsenal, Mr. Blinder.

Theodore M. Wight

[The article]: Thursday, May 20, [The Wall Street Journal]


Remember the bond market vigilantes, that frightening band of financial marauders who once roamed the earth like a fearsome herd of Tyrannosaurus rex? They were so scary that in February 1993, as President Bill Clinton struggled to reduce the federal budget deficit, James Carville quipped that he wanted to be reincarnated as the bond market so he could intimidate everybody.

Well, they're baaack! Not in the United States, though. Here, the Treasury Department continues to borrow brobdingnagian sums of money at extremely low interest rates—about 3.5% for 10-year Treasurys and under 1% for two-years lately—even though everybody knows that the federal budget deficit is on an unsustainable path toward the stratosphere. (Could it be that not everybody knows?)

But the bond market vigilantes have landed in force in Europe. Their beachhead, of course, is Greece, which all but invited them in with—how shall we put it?—a certain lack of fiscal probity. The ensuing roller-coaster ride of ups and downs that have roiled stock, bond and currency markets around the world is apparently not over. As you read this, the markets may be either sinking or soaring on the latest news out of Europe.

Greece recently signed up for an International Monetary Fund program—the sort of treatment once reserved for supplicant developing countries. It also now has the European Central Bank (ECB) buying its bonds, access to the European Union's new €60 billion bailout fund, and potential access to bond guarantees via a €440 billion "special purpose vehicle" that euro-zone countries promise to cobble together if necessary. But all this has only partly calmed the Aegean waters.

Here's the problem: Bond market vigilantes can be a force for good or ill, often both at the same time. The bond market is certainly powerful, as Mr. Carville saw—but it's not always wise and it's rarely subtle. Once the vigilantes get riled up about, say, budget deficits, they can turn into an electronic mob that circles the globe faster than Hermes. Unfortunately, the basic economic message about deficit spending today requires some subtlety: Most countries need fiscal stimulus today but a large dose of deficit reduction in the long run.

To fight the 2008-2009 recession, many countries deliberately increased their spending and/or reduced taxes, thereby swelling their budget deficits. That was the right thing to do under the circumstances, because private spending was drying up and unemployment was on the rise. (Ask the oracle: John Maynard Keynes.) Or, more correctly, it was the right thing to do as long as the higher spending and lower taxes were temporary—as was typically, but not always, the case.

The trick was to promulgate major short-run fiscal stimulus programs without spooking investors about the long-run fiscal outlook. And it worked—for a while. But now the bond market vigilantes have been awakened and are spoiling for a fight. I worry that they may force many European (and other) countries into premature fiscal contractions.

Sadly, it is already too late for Greece, where sizable tax hikes and expenditure cuts are coming to a land where gross domestic product has already declined for five consecutive quarters. It is hard to imagine how Greece can avoid a nasty slump. If we look for historical examples of countries that have lived through major fiscal retrenchments without recessions, we find three principal ways out. But two of these options—easing monetary policy and depreciating the currency to boost exports—are unavailable to euro-using Greece.

The third way is to ignite a bond market rally by convincing traders that you've got religion on fiscal responsibility—which is what happened here during the Clinton years. (Full disclosure: I was part of President Clinton's original economic team.) Could the Greeks have accomplished that by themselves? It looked unlikely without intervention from Mount Olympus, which is why the EU rode to the rescue.

The more important question now is whether the rest of Europe is under a similar threat. Greece accounts for less than 2% of European GDP, so a sharp recession there—if it's only there—should have only minor demand spillovers to other countries. But with most of the other 98% of Europe growing very slowly, large fiscal contractions are not exactly what the macroeconomic doctor ordered. (Ask the oracles: Herbert Hoover or former Prime Minister Ryutaro Hashimoto, the "Herbert Hoover of Japan.") The ECB seems unlikely to help by cutting interest rates further. But the value of the euro has fallen, which should give exports a boost.

From a long-run perspective, the bond market vigilantes have it right. Greece, Europe, the U.S. and other countries must take serious steps to get their budget deficits under better control. And the long-run budget problems of many nations are too large to be solved exclusively on either the tax side or the expenditure side.

The U.S. is a case in point. Under continuation of current policies, our budget deficit and national debt would soar to impossible heights. (Ask the oracle: the Congressional Budget Office.) The amount of deficit reduction needed to stop this incipient explosion is so large that no serious person should believe we can do it without both spending cuts and higher taxes.

But not yet, please. And therein lies the difficult-but-essential subtlety.

St. Augustine urged the Lord to make him chaste, but not yet. Now budget and finance ministers around the world, including our own Peter Orszag and Tim Geithner, must make an analogous plea to the bond market vigilantes—and back up their words with deeds. The problem is that the vigilantes are an impatient lot and Greece has set their clocks ticking faster.

What needs to be done varies enormously by country. Here in the U.S. Social Security reform, once considered the third rail of American politics, is now the low-hanging fruit of deficit reduction. Fixing Social Security's finances is easy, technically. And the timing is perfect because promising deficit reduction now but delivering it later is exactly the right thing to do. After all, no one wants to raise payroll taxes now or reduce retirement benefits without giving people many years of advance notice.

When the Greenspan Commission "fixed" Social Security's finances (for a while) in 1983, it delayed much of the pain for decades. Its proposals not only passed Congress in a flash but have raised barely a whimper of objection since.

Pulling off something like that today might be a good way for the U.S. to steer a middle course between the Scylla of the bond market's wrath and the Charybdis of premature belt tightening that damages the recovery. Hey, Odysseus managed it.

Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve Board.

Further comment.  It is clear that the Democratic Deficit will never ebb.  The Party cannot get elected without the financial support of one of the main causes of the deficit(s): labor unions.  They buy the Democrats' elections in exhange for cushy jobs, with high pay, early retirement, and guaranteed work.  The Democratic Congress will never step out of its fat jobs, the rest of the country who get badly hurt by the selfishness of the union bosses need to elect Republicans, Tea Partiers, Libertarians.  Anything but Democrats looking out for their own interests ahead of those of the American Citizen.  We need to weed out all --  all politicians, bureaucrats and "activists" who are against the success and growth of businesses.


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