Bond Holders Rule the World

Bloomberg has an exclusive story on how bond vigilantes are using the markets as a protest trying to play a game of economic chicken with the administration to reduce the deficit.

For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernanke’s efforts to cut borrowing costs for businesses and consumers.

The 1.4-percentage-point rise in 10-year Treasury yields this year pushed interest rates on 30-year fixed mortgages to above 5 percent for the first time since before Bernanke announced on March 18 that the central bank would start printing money to buy financial assets. Treasuries have lost 5.1 percent in their worst annual start since Merrill Lynch & Co. began its Treasury Master Index in 1977.

“The bond-market vigilantes are up in arms over the outlook for the federal deficit,” said Edward Yardeni, who coined the term in 1984 to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds. He now heads Yardeni Research Inc. in Great Neck, New York. “Ten trillion dollars over the next 10 years is just an indication that Washington is really out of control and that there is no fiscal discipline whatsoever.”

First I ever heard of a group of investors literally manipulating the bond market to force a government to do their bidding.

Not that it doesn't go on, maybe just that Bloomberg covered it.

Bloomberg is reporting this round of bond intimidators are foreign investors.

Economic war games anyone?

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Creditors hold the power

I am not really shocked by the article.

The U.S. is too close to utilization boundaries. With no real avenues to fix the problem (increase jobs, manufacturing, exports), IMHO this is just the beginning of foreign (Asian, Mid-East) investors calling the shots in the U.S.

To preserve our independence, we must not let our rulers load us with perpetual debt. We must take our choice between economy and liberty, or profusion and servitude. If we run into such debts, we must be taxed in our meat and drink, in our necessities and in our comforts, in our labors and in our amusements. If we can prevent the government from wasting the labor of the people under the pretense of caring for them, they will be happy. - Thomas Jefferson

 

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In their defense

Many have lent this country a ton of money. They look at economic history and see it repeating. Everyone from pension funds to George Soros has done this "deficit hawk" thing. When Soros "attacked" the British Pound, he figured given the situatation with interest rates relative to other European nations and that of the UK, that something had to give. The BOE wanted to keep rates firm, but knew that in the long run they would have to raise them; Soros' action on the currency market merely forced their hand. Regarding bond yields, well once more in their eyes they see that spending is going up exponentially regardless what it is for. Also, they see the Fed pumping out money, plus you see new sales on government securities. For them, going by the book, rates must go up.

Now if you're an institutional investor that has purchased debentures, be it government securities or corporates, any rise in rates will hurt. Remember, rates go up, bond prices go down. If you've already purchased paper, you really don't want to see your investment go down. So what do you do? You hedge, like any smart investor would do, be it some foreign bank or Joe Schmoe. If rates go up, they're hedged against the losses on their position. Keep in mind, there are no, for example, futures contracts on corporate debt. So it gets kinda tricky.

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Wrong!

My Great Uncle once said, "He that owes...is king. Even if a borrower can pay, it is his option to follow through on his promise. Even after you've worked for a man, if he refuses to pay you, very often in certain places you must take him to court to collect, which is money out of your pocket. So, know who you're dealing with." Fact: when there's a willingness to repay matched with ability to repay a bondholder is protected. Once the ability is diminished, the bondholder has only discounted assets. So, no...bondholders do not rule the world; indeed, they're very vulnerable.

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Hence the sale

Which is, if they believe there is risk, you will see it reflected in the market for these instruments. Name the television channel or radio, it doesn't matter, CNBC or even MSNBC or even NPR, bond buyers are a bit nervous right now. And at the risk of being banned (again), one theme being applied right now is weariness towards industries with unions; both Bloomberg and CNBC (don't really watch Fox Business) had on guys who traded a lot of paper who said they aren't touching industrials' debt if there is a union; or really any paper that has a union associated with that company. And it was a message being echoed over and over again, because they saw what happened at GM. Now you take this as you want, frankly I think its a bit overblown, because GM was really a special case in my opinion. Really time will tell if the market is somewhat shy on those bonds, but if it is true, then those companies are going to be forced to offer a higher rate, that's really it.

Regarding government bonds, be it treasuries or even agency paper, folks who regularly buy this stuff in gobs and gobs are too feeling vulnerable. I don't think it was just the Chinese who were laughing at Geithner when those remarks were heard. Only, I suspect in both the Chinese and here, the laughter was one of the nervous variety. The Chinese are long term players like other bond holders, and both aren't sure they see a light at the end of the tunnel. Deficit is what, 12%? It is supposed to drop, but still the numbers are astronomical. Even raising taxes on the rich may not be enough. Between the pumping of the money and the government spending, many are thinking that longer term inflation is going to kick in. And to folks, like the Chinese, it is beginning to look like they will be paid back in cheaper dollars. Competition for money is coming, be it from Europe or here, to meet needs not being met by declining taxes or what have you. At the end of the day, rates could be going up. That is why, for the most part, you see the sell offs.

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counterpoint - Suez Canal

1956


The United States also put financial pressure on Great Britain to end the invasion. Eisenhower in fact ordered his Secretary of the Treasury, George M. Humphrey to prepare to sell part of the US Government's Sterling Bond holdings. The Government held these bonds in part to aid post war Britain’s economy (during the Cold War), and as partial payment of Britain’s enormous Second World War debt to the US Government, American corporations, and individuals. It was also part of the overall effort of Marshall Plan aid, in the rebuilding of the Western European economies.

Britain's then Chancellor of the ExchequerHarold Macmillan, advised his Prime Minister Anthony Eden that the United States was fully prepared to carry out this threat. He also warned his Prime Minister that Britain's foreign exchange reserves simply could not sustain a devaluation of Pound that would come after the United States' actions; and that within weeks of such a move, the country would be unable to import the food and energy supplies needed simply to sustain the population on the islands. 

 

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The Suez Canal moment for us

was Iraq. Where we had to end up financing the whole damn debacle, and ended up losing what remained of our imperial ambitions. Only this time, instead of one single phone call threatening us, it's been a prolonged ordeal, where Eisenhower this time around is Hu Jintao.

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So what you're saying

Is that the best way to end the financial industry's control over our economy and lives, is for the borrowers to default en masse?
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Maximum jobs, not maximum profits.

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Maximum jobs, not maximum profits.