The Bond News Bears Jude Wanniski October 25, 1993

It's suddenly the fashion on Wall Street to pontificate confidently on the coming inflation, which will, of course, be accompanied by a sagging bond market. The bond bears are everywhere, wire stories even including George Soros, who we all know is never wrong about such things! Jonathan Fuerbringer, the inept bond reporter of The New York Times, has been practically insisting that there will be an end to the marvelous bond market rally that brought yields as low as 5.78% ten days ago. The argument is that the economy is picking up speed, which everyone knows is inflationary, which is bad for the bond market, which everyone knows prefers a weak economy. The higher interest rates, in turn, are bad for the economy, which is why the stock market, which likes a strong economy, is weakening along with bonds. You follow that?

Then there is Robert J. Barro, a Harvard economist who normally has his wits about him, writing in this morning's Wall Street Journal about "The New Socialism" being foisted on the nation by Bill and Hillary, aided and abetted by Fed Chairman Alan Greenspan. That's right. Greenspan. By expertly managing monetary policy, Greenspan & Co. have brought about a stability in the financial markets that "makes it easier for the administration to enact an array of undesirable interventions into the economy." Barro compares Greenspan to the British colonel played by Alec Guinness in "The Bridge on the River Kwai," who helps his Japanese captors build a marvelous bridge, forgetting they are the enemy. Barro, a WSJ contributing editor, urges Greenspan to quit, thereby permitting the U.S. economy to blow sky high, and thus making life difficult for the socialist in the Oval Office.

Actually, Barro also notes that Clinton has supported Greenspan's commitment to monetary stability, and while this "helps to explain the low levels of inflation and short-term interest rates, the mystery is why this commitment extends beyond the tenure of the current Fed chairman and, hence, why the bond markets expect low inflation to continue over the next 10 to 30 years. I think, in fact, that there is no reasonable basis for this belief and that the bond market will fall precipitously when expectations of future inflation are raised."

Of course, bonds will fall if future expectations of inflation are raised, and that might happen if Mr. Greenspan quit, to blow up Mr. Clinton's bridge. Then again, if President Clinton supports Mr. Greenspan's commitment to monetary stability, shouldn't the bond market expect that he would name a person with similar views to the Fed chairmanship -- thereby making it easier for him and the First Lady to follow their socialist ways? And what of the other six Fed governors, who are known to share Mr. Greenspan's commitment to monetary stability? Should they also quit, so the President could replace them with people who are known to share his commitment to monetary stability? You see how silly it gets!

The fact is that Greenspan and Co. have thoroughly discredited the economic schools that invite inflationary monetary policies. Even if Milton Friedman himself were named chairman of the Fed, he couldn't breathe life back into the monetary aggregates or get more than one or two votes at an FOMC meeting. The Fed as an institution has rejected monetarism, and it will be at least 30 years before the Ms stage a comeback. Similarly, the Phillips Curve Korner of the Keynesian School has been just about beaten to death at the Fed. Professor James Tobin of Yale or Robert Solow of MIT can still find reporters, columnists and politicians willing to parrot their arguments that easy money will grease the wheels of commerce. They cannot, though, find anyone at the Fed to sing that tune.

The notion that the bond market likes a weak economy and abhors a strong one is a myth, completely without foundation. It rests on the observation that bonds were strong throughout the Great Depression, when the dollar was as good as gold and bonds were at 2%. Yet the dollar was as good as gold and bonds at 2% all during World War II, when the economy was stretched to its limit! The idea that creditors prefer their debtors to be unemployed is fatuous, but it is so thoroughly embedded in the Wall Street culture that it can be used by the bond bears to create a bandwagon effect, even if only for a few days. Bond traders believe it because they read about it in all the bond columns. The bond writers believe it because the bond traders tell them so.

If reporters or bond traders were ever to ask Greenspan, he would tell them a weak economy is not at all good for the bond market, which can only read into it the potential for inflation. Is inflation ever good for the bond market? That's another question, another way of asking if rising prices ever benefit creditors. In his 1954 "History of Economic Analysis," Joseph Schumpeter mulled this over in a discussion of indexation:

 ...the variations in the purchasing power of money brought up the question of "justice" as between creditors and debtors (or else, as far as the public is concerned, taxpayers). As always, "justice" was what benefited the interest with which each writer sympathized..."Squire" Western made the point that there are situations in which higher prices being the only alternative to widespread bankruptcy, a falling value of money might be deemed to be in the interest of the creditors.

This was essentially the argument I made to Fed Chairman Paul Volcker in February 1982, when I urged him to buy bonds in the open market, to arrest the steady slide in the price of gold, then at $310. "You want me to inflate?" he said. I said I merely wished him to stop deflating, since continued deflation would bring about a worldwide banking collapse as dollar debtors everywhere were unable to pay their creditors. The Friedmanites at the time argued that an easing of monetary policy would reignite inflationary expectations and cause a collapse of the bond market. When Volcker was forced by circumstance to ease, the bond market and the stock market boomed.

Are we at anything like this place now? With gold at roughly $370, it is $20 above the price we judge to be optimal -- a $350 benchmark that over the last several years appears to be the point at which "justice" for creditors and debtors is in equilibrium. At this point, an easier monetary policy at the Fed would not be welcomed by creditors as "the only alternative to widespread bankruptcy." Indeed, the bond market has weakened in the last ten days with this modest run-up in the gold price, which is perhaps built on speculation that the Fed is in no mood to offer resistance by leaning against the wind. I might even speculate $20 myself, merely on the strength of the bears, but not much more than that. Greenspan can pull the rug from under Papa Bear, Mama Bear and Baby Bear whenever he decides to lock in gold. There's nothing to stop him. He's got the board of governors on his side and the other three most powerful people in Washington: Bill, Hillary and Senate Minority Leader Bob Dole, who last week praised the President for supporting Greenspan.

The bears include all the bond writers, bond traders, and bond economists who predicted that the long bond could not possibly get below 6%. They are doing everything they can to persuade the creditors of the United States that bond yields can only go up. In my last conversation with Chairman Greenspan, I told him I thought he could eventually get the long bond to 3%, if he played his cards right, and he seemed perfectly comfortable with at least the theoretical possibility. The idea of refinancing the entire $4 trillion national debt at 3% interest rates is not an unappealing one. He might have to serve a third term, but that no longer seems out of the question, as he continues to hammer away at the Bridge on the River Kwai.

As for Barro's concern, he might even have it backwards. When Greenspan sat next to Hillary at the State of the Union, there was an uproar among conservatives that he was being co-opted by the Clintons, but I argued he was co-opting them. As long term interest rates "mysteriously" decline, it also becomes more difficult to persuade the American people that they need to socialize medicine, or anything else. Don't tell anybody, but this is Greenspan's hidden agenda -- to make capitalism work so well that political support for collectivism shrivels to a vanishing point. On the front page of Investor's Business Daily of October 18, "What Makes Greenspan Tick?" we get some of that flavor, as the newspaper explores the chairman's philosophical foundations. He was not a kid when, as recently as 1966, he wrote: "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation." His views today are, if anything, more refined. So go ahead, bears, have your fun. Greenspan will eat your porridge and lick the bowls.