The story is that the bond market forced President Bill Clinton to change his budget plans. Bob Rubin, director of the newly created National Economic Council, supposedly convinced Clinton that those who buy and sell Treasury securities on Wall Street would force interest rates much higher and hurt the economy if he didn't do something about the deficit and federal borrowing.
[IMGCAP(1)]The anonymous traders were dubbed "bond market vigilantes" (a phrase coined by economist Ed Yardeni a decade or so earlier) because they were more than willing to use the weapon at their disposal — higher interest rates — to force fiscal policy in their preferred direction.
It's clear that the bond market is now giving at least as strong a signal about its desired fiscal policy as it did in the early 1990s. But instead of demanding reductions in the deficit and government borrowing and threatening higher interest rates if those don't happen, today's vigilantes are unmistakably saying just the opposite. They want Washington to do more to stimulate the economy, and they welcome the deficit and debt it will take to do it.
In other words, the former bond market vigilantes have now become the biggest supporters of federal deficits and borrowing. I'll follow in Yardeni's footsteps and call them bond market deficit cheerleaders.
It's almost impossible not to notice how unambiguously the bond market deficit cheerleaders are making their policy preferences known. In spite of the repeated prognostications made by multiple commentators that interest rates will (rather than could) rise in response to the large deficits because of bond market disgust, traders have voted with their dollars. The auctions of Treasury securities that were needed to finance borrowing have almost all demonstrated a strong demand for federal debt over the past year, no matter what the maturity. As a result, interest rates have remained low or fallen. This is especially the case with long-term rates, which would be the ones most affected by concerns about budget-related federal borrowing and inflation. The bond market deficit cheerleaders have shown little indication they're concerned.
There are some technical and non-fiscal-policy-related reasons for the high demand for Treasury securities. For example, it's become clear that banks are parking some of their excess reserves in Treasuries, rather than increasing lending during what they consider to be an uncertain economy. In the process, they are pushing interest rates lower.
The volatility in the stock market has also pushed some investors to allocate more of their funds to cash and cash-equivalents like Treasury securities. In addition, overseas demand for federal securities has been high because U.S. bonds are still considered the safest haven in the wake of concerns about the fiscal stability of Greece, Spain and other countries.
But all of this also proves the point about the former vigilantes becoming deficit cheerleaders. Banks and investors would look for other places to park their cash if federal bonds were considered dangerous or likely to become illiquid because of borrowing concerns. That's obviously not the case.
In just the past few weeks, another element that enhanced the bond market vigilantes' argument and credibility in the early days of the Clinton administration was shown not to exist today. Back then, Federal Reserve Chairman Alan Greenspan said at a much-publicized Congressional hearing that he wouldn't raise interest rates if Congress adopted its promised $500 billion deficit reduction plan. Now, however, Federal Reserve Chairman Ben Bernanke is saying just the opposite.
In testimony a few weeks ago, Bernanke indicated that he'll consider additional forms of monetary stimulus if economic growth is not at appropriate levels and Congress fails to take additional fiscal policy actions to make that happen — that is, if Congress doesn't enact spending increases and revenue decreases that add to the federal deficit and national debt.
In addition, James Bullard, the president of the Federal Reserve Bank of St. Louis and a current member of the Federal Open Market Committee, publicly proposed last week that the Fed consider additional monetary stimulative measures because current fiscal policy efforts haven't been enough. In other words, higher deficits and more government borrowing are acceptable.
The most interesting question about this situation is why the bond market deficit cheerleaders aren't being heard or followed by policymakers. Washington is being given permission by Wall Street to do more, but unlike the situation in the 1990s, federal budget politics has not moved in the direction the bond market is advocating.
Maybe that's because the fear of lower, rather than higher, interest rates isn't as great and, therefore, the punishment the bond market can impose is not as worrisome. Perhaps it's because the credibility of Wall Street and the Fed isn't as high as it was two decades ago. It's also possible that the deficit and debt are used more as political pawns than they were at the start of the Clinton administration, and that makes it easier to ignore the bond market when it deviates from what policymakers want to do for other purposes.
But regardless of the reason, the bond market deficit cheerleaders are making a statement that is every bit as forceful as the one made by the vigilantes a decade and a half ago. Not listening could be just as damaging.
Stan Collender is a partner at Qorvis Communications and founder of the blog Capital Gains and Games. He is also the author of "The Guide to the Federal Budget."