The Bond War
Why Paul Krugman and Niall Ferguson are hammering each other about T-Bill interest rates.
It's fair to say that 10-year and 30-year Treasury bonds are not subjects that enthrall the American public the way, say, Kate Gosselin does. In the last six months, however, the state of those bonds has become the subject of feverish argument in the economic elite. The interest rate of the 10-year Treasury bond has spiked from 2.07 percent in December 2008, when the world was falling apart, to a recent high of 3.715 percent on June 1—a 79 percent increase. The 30-year bond has risen from 2.5 percent last December to about 4.5 percent today. Now factions led by economist Paul Krugman and historian Niall Ferguson are feuding bitterly about the import of these charts. In late April, Krugman and Ferguson squared off at a New York Review of Books/PEN panel, and they've continued with an op-ed war in the Financial Times and New York Times (Ferguson here and Krugman here).
In a nutshell, Ferguson and his allies believe that the rising bond yields prove that markets are worried about the inflation that will inevitably result from the fiscal policies of the Obama administration and the Fed. Given the large deficits and rising concerns about the viability of Social Security and Medicare, Ferguson writes, "It is hardly surprising, then, that the bond market is quailing. For only on Planet Econ-101 (the standard macroeconomics course drummed into every U.S. undergraduate) could such a tidal wave of debt issuance exert 'no upward pressure on interest rates.' " Ferguson's fears have been echoed by the planet's leading inflation-phobe German Chancellor Angela Merkel and by influential Stanford economist John Taylor. Turn on CNBC, and you're likely to hear talk about bond-market vigilantes, the mass of traders who sell bonds and push interest rates up in order to warn governments not to spend freely.
Krugman and his fellow travelers couldn't disagree more. Far from being a sign of failure and impending disaster, they say, the rising bond yields actually signal success and impending improvement. Government bonds were so low last December because the world's investors were totally freaked out about risk. They sold everything—U.S. stocks, emerging market government bonds, corporate bonds in Europe, Indian stocks—and parked their cash in the safest, most liquid investment around: U.S. government bonds. In the months since then, as the stimulus and bailouts have helped stabilize the economy, investors have started to relax. The indicators of market stress have improved. And so investors this spring began to sell the low-yielding bonds and start buying stocks and other assets again. Check out these six-month charts of the main stock market indices in Brazil and India. Clear-headed as always, Martin Wolf of the Financial Times notes: "The jump in bond rates is a desirable normalisation after a panic. Investors rushed into the dollar and government bonds. Now they are rushing out again. Welcome to the giddy world of financial markets." This line of argument makes sense, especially when you look at a very long-term chart of the 30-year bonds, which shows just how much of an aberration the December 2008 lows were. Does that chart look like a market that is worrying about the prospect of long-term inflation and high-interest rates in the future?
In evaluating the relative claims of the pessimists and the optimists, you also have to evaluate the messengers. And in this instance, the Fergusonians lack credibility. H.L. Mencken tagged the Puritans as people possessed of the "haunting fear that someone, somewhere, may be happy." Ferguson represents a strain of intellectual Toryism bedeviled by the haunting fear that someone, somewhere may be getting social insurance. (Fellow sufferers include Clive Crook, Andrew Sullivan, and George Will.) Their solution to the problem of large deficits always seems to be to cut entitlements and never to raise taxes.
As for the bond vigilantes, have you noticed that they seem to surface only when a Democrat is in the White House? Stanford's John Taylor didn't write many articles about the inflationary aspects of rapidly expanding deficits when the Bush administration and Congress were turning surpluses into huge deficits, massively increasing government spending, and creating a new Medicare prescription drug entitlement. He was working in the Bush Treasury Department. As Krugman notes, "But it's hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts."
Daniel Gross is the Moneybox columnist for Slate and the business columnist for Newsweek. You can e-mail him at email@example.com and follow him on Twitter. His latest book, Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation, has just been published in paperback.
Photograph of Paul Krugman by Mike Clarke/AFP/Getty Images.