Listening To The Bond Markets

Sep 7 2011 @ 2:15pm

They are telling us to borrow and spend now. Martin Wolf:

[The markets] are saying: borrow and spend, please. Yet those who profess faith in the magic of the markets are most determined to ignore the cry …

Contrary to conventional wisdom, fiscal policy is not exhausted. This is what Christine Lagarde, new managing director of the International Monetary Fund, argued at the Jackson Hole monetary conference last month. The need is to combine borrowing of  cheap funds now with credible curbs on spending in the longer term. The need is no less for surplus countries with the ability to expand demand to do so.

It is becoming ever clearer that the developed world is making Japan’s mistake of premature retrenchment during a balance-sheet depression, but on a more dangerous – far more global – scale. Conventional wisdom is that fiscal retrenchment will lead to resurgent investment and growth. An alternative wisdom is that suffering is good. The former is foolish. The latter is immoral.

But isn't some suffering good for the sake of moral hazard? Is it not important to learn that gamely sucking prosperity from the future into the present and then whining loudly when the future arrives deserves some kind of penalty? I guess this payback can apply collectively but the individual impacts are brutally unfair, especially as hedge fund managers continue to gamble for billions while many thrifty skilled workers are in the financial shitter for good.

But the evidence of the past couple of years does suggest Wolf is onto something. If hyper-inflation were around the corner, the bond markets don't look as if it has occurred to them yet. If borrowing even more is reckless for short-term stimulus, why are borrowing rates so astonishingly and persistently low?

What we need, obviously, is some short term stimulus, tax reform to encourage investment and hiring, combined with a long-term debt reduction plan. It's doable. My sense is that Obama is going to propose exactly such a policy blend Thursday night. And tonight, we'll see what actual policies the GOP candidates propose for turning the economy around. Or not.