Over the last week, I’ve been thinking a lot about the disconnect between the bond markets, and the people here in politics who are driving the bond market outcomes. After all, one answer to the question “Where are the bond market vigilantes?” is “they don’t really understand what’s going on.”
I don’t mean that they are not smart–they are. They’re deeply knowledgeable about the maths of default (a metric by which the United States is in basically OK shape, especially when you consider the most plausible alternatives–heavily indebted Japan, with its deficit even larger than ours; a European superstate that seems to be on the brink of a currency crisis; Chinese markets that are illiquid, less-than-transparent, and fairly tightly controlled by the government; and various small nations that don’t really have the asset base to absorb the amount of capital the world wants to stash somewhere “safe”).
But it is politics, not maths, which matters right now. In the immediate future, what matters is whether we’ll get it together and raise the debt ceiling; in the longer-term, what matters is whether we can cut some sort of deal over entitlements that puts the government on sound, sustainable fiscal footing.
And about that, Wall Street knows less than we here in Washington. I dialed into a sell-side conference call last week to hear what sort of high-level analysis the bond vigilantes were doing, and the answer seemed to be that they knew less than I did. I didn’t hear anything about the process that I couldn’t have read in the pages of the New York Times or the Wall Street Journal–or my own blog. Listening, I thought of the frustration I’ve often had with people in New York who blithely lay out political strategies for their favoured party that couldn’t possibly actually work, either because said New Yorkers don’t understand the institutional barriers, or because they don’t understand what is actually popular outside of Manhattan and Brooklyn. Even a misunderstanding of small technical questions–like the need for a CBO score, the vulnerability of bills to amendment, or the time it takes to whip votes–lead people outside of Washington to frequently underestimate the difficulties of doing the “obvious” thing.
On the flip side, it’s also clear to me that many people in Washington are living in a bubble where procedure and politics often shut out common sense. I know I’m losing valuable intelligence about what’s happening in the financial sector, because I’m simply not marinating in it every day. On that same call, I heard an analyst made a point about proposed 14th Amendment bypass of the debt limit, which was so obvious that I couldn’t believe I hadn’t thought of it: to wit, even if the Treasury simply went ahead and issued more debt, who was going to buy these instruments of dubious legality? And at what price? Yet all the DC people I’d seen writing about the “14th Amendment Solution” had focused on the legality of the move, or the political fallout; no one had thought about, like, finding customers for the debt.
Washington almost never really thinks about the customers for our debt. They’re useful bogeymen who can be deployed against policies you don’t like. You see liberals claiming that bondholders will be horrified if we cut Social Security benefits (they won’t, though they might be horrified if this becomes necessary because we don’t lift the debt ceiling–but that worry will be a fear that Congress is crazy, not a fear that this means we’re defaulting on our “obligations” to seniors) You see Republicans claim that they’ll be spooked by tax hikes (maybe if we were hiking them from 70% to 80%, but no, the bond market does not care whether top marginal rates are 35% or 45%.) But on questions where it’s actually important, we ignore the core problem of finding customers in favour of arguing about constitutional arcana. I had an email exchange with someone about the legitimacy of the 14th amendment route, to whom I pointed out that it didn’t seem very practical, and he replied “practicalities aside . . . ” Practicalities aside? Who cares whether it’s constitutional for the Treasury to issue bonds no one buys?
I submit that this disconnect is dangerous. Wall Street is giving us too much rope to hang ourselves because they don’t really understand the barriers to achieving fiscal sanity–and Washington is taking it, because they don’t really understand how Wall Street thinks, and what the bond traders will do when they finally decide that we’re likely to default.