Bond Market Vigilantes Again Cheering Deficits

Posted October 15, 2012 at 3:42pm

I first used the phrase “deficit cheerleaders” in a column more than two years ago to describe what Wall Street bond traders were really telling Washington, D.C., about the budget.

It was August 2010, and I wrote that, contrary to what some in Washington were saying, the supposedly all-knowing and all-seeing traders formerly known as “bond market vigilantes” absolutely were not insisting that the federal government reduce its red ink and we had to stop saying that they were.

I also wrote that those who were using the bond market as an excuse for spending cuts and tax increases were misreading or — far more likely — misrepresenting the messages actually being sent by the bond traders. 

Based on both the low interest rates of the time and the direct statements they were making, it was clear two years ago that the vigilantes had turned into an increase-the-deficit cheering section. They were letting it be known that they not only wouldn’t criticize those who helped produce deficits but would be rooting for those who helped make them happen. 

In other words, no matter what they might have been saying to the Clinton administration and Congress in the 1990s, the bond market of 2010 actually wanted higher deficits, and the vigilantes had become deficit cheerleaders.

That was about 26 months ago. I mention it now because Wall Street’s deficit cheerleaders made it clear yet again last week that reducing the deficit in the current economic environment is not the right fiscal policy for the United States. 

Actually, the bond market has been saying this for quite some time, but it has been doing it with interest rates that have remained remarkably low despite a series of events that back in the 1990s probably would have driven them higher. This includes funds not flowing from stocks to bonds, the credit rating of the United States being downgraded by one of the major rating agencies because of the budget situation and a more than $2 trillion increase in the amount of federal debt.

In other words, there are ample reasons for bond market vigilantes to express unhappiness with the current budget situation and demanding that the deficit be reduced. 

The only problem is that they’re actually doing just the opposite.

In a series of interviews and research notes last week, representatives of three of Wall Street’s biggest names — Goldman Sachs Group Inc., BlackRock and Oppenheimer & Co. Inc. — indicated that the big deficit reduction that will start on Jan. 1 if the fiscal cliff goes into effect will do serious damage to the U.S. economy, stock prices and investors’ confidence, and they urged that it be avoided. 

In effect, the former bond market vigilantes were saying that the federal budget deficit today is not an economic plague of biblical proportions that will wipe out civilization as we know it. To the contrary, they’re saying the deficit needs to be much higher than it will be under current law.

To a certain extent Wall Street is just getting on the bandwagon that Federal Reserve Chairman Ben Bernanke started driving in February when he first used the phrase “fiscal cliff.” 

Bernanke was telling Congress that the tax increases and spending set to occur Jan. 1 and Jan. 2 will reduce economic growth far more than the other prime drivers of gross domestic product will be able to offset. He was using code to say that federal taxes should not be raised and spending should not be cut by as much (or at all) as will happen at the start of 2013. The mathematics of what he said or implied are inescapable: The budget deficit should be higher.

What’s curious about last week’s statements from Wall Street is that those making them somehow felt they needed to use the same hard-to-decipher code as
Bernanke and didn’t say directly that the fiscal 2013 budget deficit needs to be higher. 

Bernanke’s refusal to use plain language is somewhat understandable given the political dangers to him and the Fed if he speaks more directly about the need for higher budget deficits in an election year when the budget is a campaign issue. That makes the surrogate phrase “fiscal cliff” understandable, or at least somewhat excusable.

It’s less excusable for the deficit cheerleaders to be that indirect. 

Yes, Wall Street is still suffering low approval ratings and talking too openly about the need for higher deficits might hurt its credibility further with Main Street, where deficit reduction is favored by large margins. And, yes, Wall Street is still pushing for relief from many of the new laws and regulations put in place in response to the financial crisis. Doing anything to irk supposed or actual deficit hawks in the House and Senate might make that harder to do.

But regardless of the language they are using, at this point it’s nearly impossible not to see that Wall Street would welcome a plan that stops the fiscal cliff from going into effect or limits it in some way even though — or because — the federal deficit will be higher. There will likely be serious cheering if and when that deal is announced. 

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.”