Following up on a previous matter, Karl Denninger  posted what is supposed to pass for a rebuttal to my recent post on government spending. To my eyes, as Jay Bookman so aptly put it, it looks like “the octopus trick, squirting black ink to cloud your retreat.” True enough. Anyway, done with that discussion.

Paul Krugman presents a chart in his new book, End This Depression Now, that just screamed at me for replication and a bit of enhancement, so here it is. Professor Krugman wrote about the ongoing cries of the bond vigilantes, who have been warning for about three years running that we were on the cusp of runaway inflation and skyrocketing interest rates any day now. I have documented this a bit myself over the past three years (in response to Bowyer and Laffer  here in July 2009, and again here last year), but Professor Krugman’s chart inspired me to revisit this topic.

Below is a chart of the US 10-year Treasury, including clearly marked points in time at which we heard from various vigilantes (including, regrettably, President Obama). The 10-year yield at the time of the comment is indicated.

Source: St. Louis Fed, Series DGS10. Markers placed on a best efforts basis.

In chronological order:

May 2009, The Wall Street Journal, The Bond Vigilantes. 3.67 10-year. Money shot:

It’s not going too far to say we are watching a showdown between Fed Chairman Ben Bernanke and bond investors, otherwise known as the financial markets. When in doubt, bet on the markets. [Ed. note: Assuming the Journal still believes an investor's best bet is "on the markets," what would be its advice now with a ~1.84 (May 8 close) 10-year?]

June 2009, Arthur Laffer in The Wall Street Journal, Get Ready for Inflation & Higher Interest Rates. 3.81 10-year. Money shot:

Reduced demand for money combined with rapid growth in money is a surefire recipe for inflation and higher interest rates. The higher interest rates themselves will also further reduce the demand for money, thereby exacerbating inflationary pressures. It’s a catch-22. It’s difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed’s actions because, frankly, we haven’t ever seen anything like this in the U.S.

July 2009, Jerry Bowyer, in National Review Online, We’re All Inflation Hawks Now. 3.63 10-year. Money shot:

But what happens when the [monetary] floodgates open? At some point the banks will have to release a river of liquidity. Consumers are demanding it, Congress is demanding it, and even President Obama is demanding it. (That last one may well be the clincher.)

November 2009, President Obama, Interview with Fox News. 3.33 10-year. Money shot:

“I think it is important, though, to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession.”

December 2009, Morgan Stanley Sees 5.5% Note as U.S. Faces Deficits. 3.69 10-year. Money shot:

The surge will push interest rates on 30-year fixed mortgages to 7.5 percent to 8 percent, almost the highest in a decade, Greenlaw said.

March 2010, Wall Street Journal (as a news story, not an editorial), Debt Fears Send Rates Up. 3.84 10-year. Money shot:

And some argue that the bond market has been too confident about these longer-term rates remaining low, at a time when the economy is slowly improving and the government is running huge budget deficits.

April 2011, Bond King Bill Gross, LA Times, Gross Boosts Bet That Treasury Bond Yields Will Surge. Even the best and brightest make mistakes. 3.52 10-year. Money shot:

As the U.S. Treasury gets set to issue another $66 billion in notes and bonds this week, Pimco bond guru Bill Gross has a message for potential buyers: Stay away.

August 2011, Standard & Poor’s downgrades the credit rating of the United States. ~2.50 10-year.

Now, there’s getting it wrong because you modeled it wrong, and getting it wrong because you’re a political operative first and economist or market pundit second. Both are on display above. The political operatives, who to this day are still making noise about Weimar in the United States tomorrow, simply refuse to acknowledge the mechanics of a liquidity trap. I know Gross, to his great credit,  has done some very public navel-gazing on this matter. Too bad the same can’t be said for the likes of Bowyer, Laffer, or the Journal.

@TBPInvictus

Category: Contrary Indicators, Data Analysis, Economy, Inflation, Markets, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

32 Responses to “MIA: Bond Vigilantes”

  1. XRayD says:

    I think one of the reasons why there are no more bond vigilantes of the past is all the excess cash sloshing around, which Ben continues to churn out for what only he hopes he understands – though to me it is nothing more than a bank rescue and reward operation.

    Twenty years ago the bond vigilantes were managing real money to deliver inflation adjusted returns for real clients often far into the future. Those days are gone in the casino like hedge-funded, derivative-drunk, credit default-swapped risk on/off markets – where hit, score, run is the rule of the game!

  2. machinehead says:

    A third way of getting it wrong is from a perception of asymmetric risk. U.S. long rates (basis 10-yr T-note) have never gone much below 2%. But they’ve been as high as 15%.

    Even if the U.S. ‘turns Japanese,’ the 10-yr yield could drop another 80 basis points or so … while the upside risk is 10 or 15 times that.

    The great bond bear market of 1946-1981 lasted 35 years, while the succeeding monster bond bull market has prevailed for 31 years since. No one knows the date of its final peak. But to make a stock market analogy, the bond bull market has a distinct 1999 feel these days.

  3. Mike in Nola says:

    They got me shakin’ in my boots. My almost all medium and long treasuries portfolio beat the S&P last year. And that’s when the S&P was doing well.

  4. flocktard says:

    Arthur Laffer is another one of those “economists” who cannot simply look at DATA and acknowledge what it is telling him, no different Messrs. Mankiw and Hubbard. He really fancies himself as the King of Economic Theory, no matter what.

  5. biscuits says:

    So, since the bond vigilantes are not too concerned about QE, I like the idea a People’s Bailout. Every adult citizen gets a monthly debit card, used first to pay off debt and then to spend within the local economy within a certain time period, none going to savings. Details would have to be worked out to prevent gaming. I think that would help demand and probably has a better chance of reducing unemployment than the fed buying mortgage backed securities from Bill Gross.

    Is Denninger still arguing about Obama’s birth certificate? Thats when he jumped the shark for me, before that I kept checking every once in awhile even after I had been banned from posting comments on his websight for calling Trump a teabagger (he thought the Donald was fo rizzle). The guy is hysterical.

  6. ConscienceofaConservative says:

    When the Federal Reserve can step in and buy any amount of Treasuries at any point in the curve to absorb supply the term bond vigilantes loses all meaning. At least that’s what QE and MMT teaches us.

  7. CSF says:

    The predictions of run-away treasury yields have been wrong so far. Prof. Krugman has said that low yields are the market’s way of signalling that they’re not worried about the debt, so go ahead and spend more.

    But wait a minute… are yields sending clear signals about what the market is thinking? Don’t they also tell us what the Fed is thinking (and doing)? My guess is both: real yields are negative because of fear and market distortion.

  8. holulu says:

    Would someone translate all of this in english, I got a big F for my econ 101.

    Are we or Are we not going to have high interest rates within the next (let’s say) 10 years? Thanks

  9. Mike in Nola says:

    holulu:

    Maybe within the next 10 years, but not soon.

  10. blackjaquekerouac says:

    I was as wrong as wrong could be HOWEVER! “I don’t think it’s as simple as a liquidity trap.” Simply put I had to do a revision post Fukushima and the Arab revolt…both which were MAJOR market negatives. Neither of these events were mentioned here…nor of the equity sell off that followed the reality of these two “new normals.” Indeed “how is a liquidity trap possible when we’re spending 200 billion a year on Afghanistan”?!!! The answer of course it is not. That’s because what “this” is is an incredibly innovative and creative way to finance a war…and all its attendant programs. And once this dawned on US equity markets “it was off to the races.” As commodity prices and high yield debt get reigned in the irony is of course people STILL ask “where is the growth going to come from”? And the answer is of course…

  11. Futuredome says:

    They aren’t spending 200 billion on Afganistan. It is now under 100 billion. Rates are low because of lack of clearing and slow nominal spending growth. Once the market clears, all interest rates will go up.

    This is why the NGDP crowd is doing the arm flapping cry about the FED on.

    U3 is similiar. Falling unemployment tells us that the market is closer to clearing. Nothing more or less. When U-3 is about 5.5 percent, wage inflation pressures start in earnest driving up rates.

  12. riodogg says:

    Invictus, very nice done I believe.

    I remember ole Ritholtz writing a comment about Bill Gross’ comment on staying away from longer treasuries to the effect “that is all I need to know about Treasuries.”

  13. patfla says:

    I thought “bond vigilante” meant “speculator”.

    War is Peace, Freedom is Slavery, and Ignorance is Strength.

    Speaking about language as it were, um, I assume Mr. Invictus that you’re using the expression “money shot” knowingly?

    Invictus: It’s just such a great phrase, isn’t it?

  14. GetReal1 says:

    Sorry Invictus, but Karl is making the point that no matter what rate Obummer is throwing money away at it’s still a heck of a lot more than what is being brought in. Spending money you don’t have to prop up the economy today just means that it will come out of the economy somehow down the line.

    Karl seems like the type of person who thinks about what can be done to make his children’s lives better (in the future), not what can we do today to make his life (or me, me, me) better. This is an admirable trait for people to have. It’s one you should respect him for.

  15. socaljoe says:

    Does that mean (the political operative) Dick Chaney was right… “deficits don’t matter”?

  16. jonas says:

    @machinehead The bond vigilantes have been wrong so consistently that it feels like they’re about to capitulate. Timing wise, is that the start or the end of the mania phase of a bubble?

    Invictus: A vigilante who has been wrong because of his ideology (Bowyer, Laffer, the Journal), i.e. that “money printing” and “debasing the currency” must cause runaway inflation and skyrocketing rates, cannot capitulate because doing so would be to acknowledge that all they know is wrong, and that ain’t gonna happen. It’s like the meme that’s just starting to blossom now that “austerity hasn’t failed ’cause it hasn’t even been tried.” Huh? But that’s the type of excuse-making one sees when one has gotten just about everything completely wrong.

  17. StatArb says:

    If Japan allows their debt/GDP to rise to 200% + …. where are we headed ?
    Has their inflation/deflation changed ?

    We are on that same path

  18. Moss says:

    The ideological based predictors can not accept the fact that the free market participants have all blown an incredible credit bubble and are still deleveraging. The black hole of bogus credit is not even measurable.
    The hope is that time will heal it.

    Supply side zealots simply can’t factor into their models the loss of demand and the destruction of collateral. So we still have a huge deflationary pull. Does anyone actually believe the bankster accounting of their assets?

  19. number2son says:

    Karl seems like the type of person who thinks about what can be done to make his children’s lives better (in the future), not what can we do today to make his life (or me, me, me) better. This is an admirable trait for people to have. It’s one you should respect him for.

    Well, that is an admirable quality. But that doesn’t make him any less wrong, nor does it make the motives of those who are correct in disagreeing with him any less worthy of respect.

  20. Invictus,

    w. ..”…It’s like the meme that’s just starting to blossom now that “austerity hasn’t failed ’cause it hasn’t even been tried.” Huh? But that’s the type of excuse-making one sees when one has gotten just about everything completely wrong…”

    you may appreciate Richard Dawkins’ works on ‘memetics’..intro..

    http://en.wikipedia.org/wiki/Viruses_of_the_Mind
    ~~

    personally, “meme” is much too soft, what the majority of ~these People are suffering from are “Mind Virii” ..~

  21. Lukey says:

    So if I understand the logic at work here we should take advantage of these low variable rates to run up the public debt to (ultimately) unsustainable levels so that when rates do return to more normal levels our debt service cost explodes and takes out our economy? I don’t get it. Isn’t that logic what got the consumers into the mortgage debt trap in the mid ’00s – so now the government should follow suit because we might be in a “liquidity trap?” Japan has run their debt up over 200% of GDP and they seem to be still stuck in their “liquidity trap.” What makes us think our luck will be better?

  22. biscuits says:

    He lost all my respect when he started gazing at pixels. He’s a knee jerk who has limited critical thinking skills, imo. I’m not even amused by his hysterics anymore.
    “It’s one you should respect [Deninger] for.”

  23. Gnatman says:

    Anosognosia or the Dunning-Kruger Effect. Their paper, “Unskilled and Unaware of It: How Difficulties of Recognizing One’s Own Incompetence Lead to Inflated Self-assessments,” was published in 1999

  24. efrltd says:

    So what’s the point? A series of quotes designed to show random commenters predicting hyperinflation and soaring interest rates. And on the other side, Krugman’s quotes have been equally wrong headed with his borrow more, spend more prescription, which I notice nobody, even the current administration buys. And even statistics are a morass, more revised than accurate. What we see is a ghostly stagnant economy wandering through the foggy night without much direction, without a real rudder. Keynes, long since dead. Friedman, long since dead. Both proverbial one-armed economists. And government’s EMT, having done little but stabilize the patient claiming it’ll fix all but wait until next year. Just like a broken leg that’s in a cast, a major part of the economy, the housing sector, and the labor force, not yet in a cast, keeps atrophying. Lots of physical therapy needed, and not from the government I’m afraid.

  25. DeDude says:

    For people to leave bonds they have to have somewhere else to put their money. Nobody gets out of an investment in order to stash cash into their mattress. The reason people are in bonds is that they are scared of stocks and other investments. When they again get confident in stocks, the economy will be growing and the government will no longer need to borrow nearly as much (because tax collections increase in a growing economy). If there ever was a slip and rates began increasing at a dangerous speed (or to a dangerous level), the central bank would purchase those bonds that the investors refused to purchase (and block drastic changes in rates). If you are both printing and borrowing in your own currency you have crisis management tools that are not available to anybody else. If all the foreigners abandon the dollar and sell their dollar assets then the exchange rates would drop and effectively cancel a large part of our foreign debt as well as greatly enhancing our exports (and boost our economy and tax collection). There are all kinds of automatic or easily implemented brakes on the kind of “bond vigilante crisis” that the chicken littles are fearing.

  26. carleric says:

    With the Federal Reserve manipulating the money supply and the bonmd market to support what some might call its misguided policies, it is small wonder that the bond vigilantes have failed to appear. Some of them would argue that inflationn is already prevalent based on John William’s work on Shadow Statistics but of course Krugman’s followers point to a highly distorted CPI and holler there ain’t no inflation. Wonder when was the last ime they bought fuel or energy or a few other items hedonically repriced or substituted in their version of financial utopia?

  27. pmarlow says:

    The “Bond Vigilantes” have failed to appear because they can’t. You can’t fight the Fed and win. The USD is a non-convertible floating currency. The only constraint is productive capacity i.e. inflation. We are no where near that bound now. If anything, we have a boatload of slack in the system. As long as the “hyperinflationistas” continue to completely misunderstand our monetary system they will continue to make silly predictions.

    Also, the QEs and OpTwists etal are asset swap operations, there is no change to the net financial assets.

    The “highly distorted” CPI actually tracks pretty well. Compare it to the Billion Prices Project from MIT for example. It’s also worth noting and somewhat comical that the subscription price ($175/year) for John Williams’ Shadow Statistics hasn’t increased in at least six years.

    Invictus: It’s also worth noting and somewhat comical that the subscription price ($175/year) for John Williams’ Shadow Statistics hasn’t increased in at least six years.

    If that’s true, it’s hilarious.

  28. wally says:

    “For people to leave bonds they have to have somewhere else to put their money”

    First, they sell. To somebody who buys.

  29. mad97123 says:

    I think Mark Hulbert’s column today gets it about right.

    ” if you are like the vast majority of investors, you also have a significant portfolio allocation to bonds, especially in your 401(k)s. How is that consistent with your belief that Treasurys will produce losses over the next decade?

    The answer, of course, is that you are confident that you will be able to identify when the bond market finally hits it top, getting out before the next decade’s losses are produced.

    Far from understanding that confidence, I call it a triumph of hope over experience.

    Consider the several dozen bond market timers tracked by the Hulbert Financial Digest. Care to guess how many of them beat a buy-and-hold over the last decade?

    The answer: Zero.

    Given your belief that bonds in a decade’s time will be lower than where they are today, and the dismal failure of bond market timers to successfully time the market’s gyrations, the rational thing to do is get out of bonds now.”

    http://www.marketwatch.com/story/bond-market-investors-delusions-2012-05-11

  30. hdoggy says:

    This one kills me as well.

    As I’m reading “The Most Important Thing” by Howard Marks I can’t help but think bonds are the worst bet ever.

    According to Marks,

    * “If everyone likes it, It’s probably because it’s been doing well”
    * “If everyone likes it, it’s likely the price has risen to reflect a level of adulation from which little further appreciation is likely”
    * “If everyone likes it, it’s likely the area has been mined too thoroughly”
    * “If everyone likes it, there’s significant risk that prices will fall if the crowd changes its collective mind and moves for the exit.”

    From experience and some baseless guessing from experience, I think retirement funds have been moving into bonds at healthy pace. We’re all risk averse now. Bond vigilantes be damned. I think this one ends badly. This bond vigilante argument is the biggest this time is different argument in play right now.

  31. Greg0658 says:

    hdoggy interesting pov bullet points

    pov of a rent seeker from muscle* labor ..
    thanks for offering this talking point .. THAT is our dilemma with the system in charge .. stocks are contantly under pressure by rent seeker paper pushers
    (and why – because its their job on the planet – their AIR)

    * add – the brain is a muscle (sorta)

  32. pmarlow says:

    Invictus: Go to the following URL and you will see the subscription payment options page for Shadowstats.com from July of 2006. That’s as far back as I could readily find.

    http://web.archive.org/web/20060716113952/http://www.shadowstats.com/cgi-bin/sgs/register

    Invictus: Too funny. Thanks for that.