Posts Tagged ‘tea party’

‘The market is rational and the government is dumb’

3 August 2011

The above quote is a favorite of former House Speaker Dick Armey (R-TX). He even used to write it on the blackboard on the first day of class when he was an economics professor. Armey has been out of government for years, but as a founding member of a Tea Party group, he’s been a big influence on that wing of the Republican Party. Not surprisingly, he seems pleased with the pounds of flesh they’ve extracted in the new Budget Control Act of 2011.

Armey and I have different ideas of “dumb.” He favors slashing government spending during our Little Depression and also favors a balanced budget amendment that would supposedly compel further slashing. I think those things are time-tested recipes (the times being 1932 and 1937) for worsening a depression. What do the markets think?

The stock market is on track for its eighth straight day of decline (as of 11:55 a.m., the S&P 500 is down 0.5%, and its biggest drop, 2.6%, was yesterday, when the Budget Control Act finally passed). 10-year Treasury bond prices have been rising, and T-bond interest rates falling, over the same span, now down to 2.57%. How to interpret those numbers?

Hard to do, because nobody (as far as I know) takes scientific polls of market participants to ask them why they did what they did. Armey would probably say, as some commentators have, that stocks have tanked because the $2.1 – 2.5 trillion in cuts over a decade aren’t enough. I would say, as have others, that the market is reacting to the dismal state of the economy and to the likelihood that, as basic macroeconomic theory tells us, the spending cuts will make it even more dismal.

What about bonds? The rosy view would be that T-bond prices have improved because the debt-ceiling vote means no default through 2012 and the spending cuts reduce the overall burden of debt. Armey and I might actually agree that the unrosy view is correct: T-bonds are in higher demand because of a worldwide “flight to safety,” as grim economic news causes people to move away from risky, cyclical assets like stocks and toward safe assets like T-bonds. Again, is the grimmer news the “failure” to slash spending more or the weakening economy?

I’m thinking Armey’s quote fits right now, except it’s the budget bloodletters who are dumb and the markets are rationally reacting by anticipating that they will cause further hemorrhaging of the economy.

P.S. At least one market participant agrees. From the Aug. 2 Financial Times:

‘Jim Reid, strategist at Deutsche Bank, . . . has warned the US could be approaching a “1937 moment” – when authorities removed post-Depression stimuli from still-fragile markets and triggered another recession. This risk, he says, has in fact only been magnified in the markets’ eyes by agreement on raising the US debt ceiling.’

(Hat tip: Brad DeLong)

Not shaken, not stirred

25 July 2011

So far, the Treasury bond market seems remarkably unconcerned about Washington politicians’ abject failure to reach an agreement on raising the debt ceiling. As of 3:20 pm Monday, after a weekend of dashed hopes for a bipartisan agreement for deficit reduction, the interest rate on 10-year T-bonds was 3.00%, up just 4 basis points from Friday’s close of 2.96%. I admit, I woke up expecting more of a negative reaction from the bond market. What gives?

From what I’ve read, there seem to be two factors at work here, of which the bond market is well aware:

(1) The debt ceiling drama has happened before, and those in the bond market expect Congress to raise the ceiling in time, just as they always have before (with the exception of 1979*). In all, Congress has raised the debt ceiling 74 times since 1962, including an average of once a year since 2001. Barry Ritholtz provides an excellent compendium of newsbites about past debt ceiling votes.

(2) Washington tends to go down to the wire on these deals, and this year “the wire” is Aug. 2, i.e., eight days away. Again, history suggests they’ll get a deal done this time, too.

* The 1979 episode has oddly disappeared down the memory hole, despite two months of hostage-taking over the current debt ceiling and despite the fact that the temporary default of 1979 — it lasted two weeks and was caused by a combination of Capitol Hill shenanigans and computer problems at the Treasury — caused Treasury interest rates to be an estimated 50 basis points higher for years, costing taxpayers billions in increased interest payments on the debt and slowing the economy. (Hat tips: Andrew Sullivan, Bruce Bartlett. The 50-basis-points estimate is from finance professors Terry Zivney & Dick Marcus.)

So is this summer’s repugnant, reckless, Republican posturing over this issue all that different from past obstruction by Democrats and Republicans over the necessary and obvious business of raising the debt limit so that the government can honor its commitments to creditors, employees, contractors, retirees, etc.? I haven’t seen anything this extreme since I started following politics, but then again that’s only been 30 years, and this time-wasting exercise that is the debt-ceiling vote has been around since 1917. (It probably served a purpose back then, as we were entering a world war.) If this time is different, the difference may be the simple fact that a great many Republicans (not just Michele Bachmann and the Tea Partiers but 53% of all Republicans, according to a Pew Research Center poll) think it will be no big deal if the debt limit is not raised by Aug. 2, or perhaps if it is not raised at all. Since President Obama clearly does and is unwilling to press for a clean vote to raise the debt limit with no strings attached, they’ve got him over a table.

shaken, not stirred