Powerful Bond Market Is Due for a Reality Check
Suddenly, something called “the bond market” has become a bogyman, said to be exerting a baleful influence on national policy and holding back economic growth lest inflation increase.
A hot new book on the Clinton Administration, “The Agenda” by Bob Woodward, reports that the President was surprised and angered to learn upon taking office that the success of his economic program hinged on financial markets or, as he is quoted, “on the Federal Reserve and a bunch of ------- bond traders.”
The book suggests that Clinton would have boosted the economy, accelerating job creation, were it not for fears that bond traders would send interest rates skyward.
Wall Street exhibits similar fears today. The bond market’s reactions to economic growth last week were credited or blamed for stock prices rising or falling.
But it’s all half-truths and nonsense, akin to ancient Romans consulting chicken entrails and dreams to predict the future. Commentators in our own day have previously focused on the money supply, unemployment statistics, the behavior of Japanese or Arab investors to explain and predict the giant U.S. economy.
What is seldom said is how often such indicators, which depend on context and interpretation, can be wrong. Caesar’s wife, Calpurnia, troubled by a dream, warned Julius not to go to the Senate on the Ides of March. But soothsayers called her dream a positive indicator, so Caesar went and was killed.
Today bond traders are pushing up interest rates on fears of rising inflation and are said to act like a throttle on growth and job creation.
But that interpretation ignores several realities: that evidence of inflation in the real economy is debatable; that the bond market itself is partly distorted by trading in derivatives, and, most important, that the long-term outlook for the real economy is for disinflation and rising productivity, a reality the bond market seems to miss.
What’s the relation of the bond market to the real economy? That of a banker to a business owner. What we call the bond market represents the worldwide trading of government and private debt, including roughly $4 trillion in U.S. Treasury bills, notes and bonds. Bond investors, including your pension and mutual funds, literally are lending money. So traders strive to keep interest high enough that inflation doesn’t erode principal.
By doing so, they affect global interest rates, including the rate for your mortgage or personal loan. But that doesn’t mean that every nick in interest rates stops a growing economy. Your mortgage and credit card debt doesn’t limit what you can earn, after all, though making payments limits what you can spend.
In the 1980s, economic growth ranged from minus 2% in the recession to 6.2% in 1984 and back to 2.9% in ’86. Yet mortgage rates stayed above 10% throughout the decade, according to statistics compiled by Advisers Capital Management, a New York-based investment firm.
Now mortgage rates are at roughly 8.3%, the economy is growing at more than 3% and housing starts are strong. No obstacle to growth in those statistics.
The inflation fears that have driven markets recently are centered on industrial commodities such as copper and other metals, which have risen in price from depressed levels. But that’s looking at “the old industrial model,” says Charles Clough, chief investment strategist for Merrill Lynch. He means that those commodities feed manufacturing industry, which is 20% of the economy.
That’s important, sure, but concentrating on commodities, the bond traders are overlooking other evidence--such as that H.J. Heinz and other consumer goods companies have recently had to call off attempted price increases.
Also, there is abundant capital in banks, with no pressures on credit, and companies such as McDonald’s, Coca-Cola and Toys R Us are using surplus capital to buy their own stock. That means they see no surging demand to open new stores or build new plants, and no investment looks better than their own companies--which, like most U.S firms, have grown extremely efficient.
And that brings up the true liberating and encouraging outlook for the economy. The service industries--transportation, communications, retailing, financial and business services, even medical services--are showing gains in output without rising costs. Productivity, in a word.
A revolution in services has been building for years as more than $200 billion has been invested in computing and telecommunications, notes economist Stephen Roach of Morgan Stanley. Now the promise of all that investment is being realized. And that means the long-term outlook in the service sector, which accounts for two-thirds of U.S. economic output, is for rising productivity and disinflation.
The Clinton Administration understands this. The Council of Economic Advisers last week issued a study on the effects of phone deregulation on the telecommunications and computing industries. They projected a great flowering, with growth of 2 million telecommunications-related jobs by 2003.
Telecommunications and computing, the study found, would then compose more than 18% of the U.S. economy. Communications will far surpass automobiles as the biggest employer.
Will that be inflationary? On the contrary, it will be efficient and disinflationary--while creating jobs. And that outlook argues for low interest rates and strong bond markets.
Make no mistake. We will still have problems to solve: education, poverty, race relations. But the bond market won’t stop anybody from innovative solutions on such issues.
Also, the world changes. The old-fashioned way to boost the economy was by pumping in public spending. But that is not what Clinton’s economic advisers are touting today. Rather, deregulation and industrial efficiency are seen as the real way to create 2 million jobs.
A revolution is occurring here. Does the bond market know this? Shouldn’t it?
