There was a time when it was feared by everyone. The most powerful people in the world were forced to concede to its every whim, the tiniest of moves. Any hint of dismay would set off an immediate chain reaction through the loftiest corridors of government.
Don’t fight the Fed? No. Never mess with the vigilantes.
The Ragin’ Cajun James Carville summed it up best when he conceded, “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”
Carville seemed like he would know. As a close advisor to President Clinton, he felt from the very beginning of Clinton’s two terms how it was going to be. Even before being sworn in, the fact that bond yields were modestly rising after the election in November ’92 already had the incoming transition team’s full attention.
In order to defeat “read my lips” Bush, the previous President who had once been thought unbeatable in the immediate aftermath of the Gulf War, since the conflict’s end he had been saddled with a weak economic recovery which for many Americans bore little resemblance to one. It was that fact which gave Rajin’ Carville the inspiration for “it’s the economy, stupid.”
Thus, Clinton had promised to do something. But what? The usual Keynes stuff, meaning spending and perhaps a tax cut or two. Why not? Bush had promised no new taxes only for his lips to renege. Clinton’s was a winning position.
And the campaign pledge immediately ran afoul of the vigilantes.
Who were these menaces? Holders of US Treasuries and other forms of government debts. The term bond vigilante is widely credited to Wall Street’s Ed Yardeni. He had said of this group in the 1980s, “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”
They had become so legendary, should any fiscal promise step out of their preferences they’d roil whatever market forcing concession. No government could risk losing control of interest rates which such selling threatened. This from the Los Angeles Times circa November 21, 1992, lays out the conventional wisdom:
“The U.S. government’s huge debt--nearly $4 trillion--and the resulting clout of bond investors here and abroad means that the seat of economic power, once firmly rooted in Washington, will to a greater degree than ever also reside in New York, London, Frankfurt and Tokyo.”
When push came to shove, breaking a campaign promise merely made the next campaign somewhat harder to conduct (just ask Bush 41). Getting on the wrong side of the bond vigilantes ended it well before it would ever begin, or so it was believed.
Such was Clinton’s early calculation. Any “stimulus” promises were quickly set aside in favor of managing the deficit. Don’t forget, 1992 was scarcely a decade removed from the Great Inflation. While prosperity boomed in between, no one was quite sure how that happened or if stagflation might come roaring back at any moment.
A sudden lurch in rates might signal the dreaded return, sparking fears they might have to drag Paul Volcker back to DC (if only to prove once and for all he had no clue what he was doing). Clinton gave in to the vigilantes, focused on government spending and the deficit, then enjoyed two terms in office during some of the most unparalleled prosperity in our country’s and even in all human history.
How did that happen? To this day, Economists still can’t really say.
Rather, ignorance had been substituted for understanding when interpreting the behavior of interest rates. Those, on the whole, remained relatively stable and intermediate throughout the Clinton nineties because of the real forces for good in the economy.
Vigilantism was therefore a form of mysticism, praying to the God of Bonds and sacrificing government programs unto the altar of Stable Interest Rates just hoping by divine fortune to stay out of repeating the seventies.
Curiously, ever since, oh, early 2009, market policing has gone missing. Vigilantes have been much talked about, of course, and for every good reason. First, during the opening stage of the Global Monetary Crisis of 2008, George Bush (the other) experimented with helicopters. No one but a bond guy even remembers because it was that ineffective.
After that bump in the fiscal deficit, new President Barack Obama went an order of magnitude bigger with the ARRA bill whose only small positive was that for a few more years it gave the word stimulus a bad name. There was deflation around so he hadn’t time or patience for inflation-fighting in the Treasury market. Deficits didn’t matter, Krugman hollered.
What this did was set a precedent, exposing a serious rupture vigilantism exposing how it had gone suddenly missing. Deficits got bigger and extended farther into the future and…nothing. No inflation. No skyrocketing interest rates. On the contrary, rates went lower as seemingly everyone bought USTs no matter their price or credit fundamentals.
This was explained via the other half of nineties dogma: Greenspan-ism as transformed into Japan-ism. They call it quantitative easing (QE) when it is neither of those. So, everyone simply assumed Prodigious Vigilantes had been outclassed by the even-greater power of the Almighty Fed.
Its bond buying, they all said, was the reason why rates could remain low – even though every last bit of scholarship, most of it conducted at the Federal Reserve itself, showed demand for USTs was unquenchable with or without the QEs. One need only look at a chart of Treasury yields and those programs to appreciate how visible this lack of correlation.
Deficits kept surging, rates fell more and more even as QEs flipped to QTs and back again. Uncle Sam’s overreaction (in every way) to the coronavirus just added to the monstrous pile.
Because it did, and because consumer prices finally did what the “stimulus” critics have been warning about for over a decade (which only proves they haven’t been warning about the actual problem), it was none other than Ed Yardeni who last fall said bond superheroes were right then about to mount their effective comeback.
Suddenly and after about $27 trillion more in debts than what Clinton started with (Bloomberg; September 27, 2022):
“In a note titled ‘The Bond Vigilantes: They’re Baaaack!’ Ed Yardeni said the huge amount of monetary and fiscal stimulus released during the pandemic has unleashed forces that haven’t been seen for decades, forcing central banks to respond with the massive policy tightening seen this year.”
For all that “tightening” and the consumer prices we’ve faced, right from the moment that view was published bond yields are only fractionally higher. Even now as those have jumped in recent days, they are but a tiny move which confounds every last part of the above quotation.
In the face of continued Treasury demand, there have been more than 500 bps of rate hikes out of the Fed. Quantitative Tightening (like QE, it is neither of those) has just about reached $700 billion USTs alone. You’d think that in the face of everything, UST yields would be double their current level. Yet, the majority of the Treasury curve has only been raised approximately 300 bps from their ultimate, record lows set in 2020.
Uncle Sam, for his part, can’t get enough of this. Why should he? The vigilantes are AWOL and Congress is his co-conspirator. There don’t seem to be any constraints.
Thus, when Janet Yellen’s Treasury Department released its estimates for borrowing in the latest quarter, though shrieks of fiscal insanity could be heard from a lot of places there hasn’t been catastrophe. And that’s despite the fact Treasury missed by more than a quarter trillion.
No joke. Back in May, the forecast borrowing need was around $725 billion, already an ungodly sum. Three months later, the requirement was revised to $1.007 trillion. And that’s just Q3. A three-month period suspiciously free of pandemics and pandemic politics.
How does anyone even in government get it that wrong in such a short period of time?
Recession, silly. The same one which has upended the yield curve, keeping these rates well below all comparisons in the face of all these headwinds.
The largest contribution to the $274 billion increase in deficit funding plans was the $148 billion less cash the government began the current quarter with. Outlays are running higher, sure, but receipts are way behind and falling further. Individual tax withholdings are down and claimed refunds way up.
Corporate taxes not coming. Excise dues shrinking. The feds are having an enormously difficult time funding their gargantuan indiscretions.
Count me among the vigilantes, too, even if only theoretical. I’m no bond bull and have no taste whatsoever for the complete absence of any borrowing constraints (and we do have to include the voting public here). I simply ask people to consider why this must be.
What is the difference between 1992 and 2022 now 2023?
To put it quite simply, a booming economy.
Three decades ago, we could see it unfolding and didn’t want to risk, in the absence of explanation, upsetting the apple cart. Economics became pure superstition. No one has been able to bring it back into the light, and few seem interested in doing so. How else could a guy like Greenspan end up with people seriously calling him the “Maestro.”
Nowadays, still no explanation for the economy and because it hasn’t boomed legitimately in so long, we can scarcely recognize the deficiency – unless you’re aware of the fundamentals behind yields. The perverse outcome pervades finance like economy, to where governments are handed over the keys to the “lockbox” without any pushback from anywhere.
If bond vigilantism was anything real, it would have been out in force in 2009 to strike against deflation, too, not just inflation which hasn’t been a problem since 1982. But vigilantism wasn’t real; it wasn’t even an ideal. It was, for a time, a bogeyman. A substitution.
When Fitch downgraded US government debt this week, it did so in large part because of the deterioration in current finances including weak receipts. The ratings agency also cited a lack of governance. Both as future risks, too.
Governments are just doing what they would always do. We don’t condone it, in fact condemn it. The bigger problem is Economics being swapped for economics.
