Hard as it may be to believe right now, the most important thing Bill Clinton ever said was not "I did not have sexual relations with that woman." Although that statement did have the virtue (from the perspective of memorability) of being, well, a bald-faced lie, there's nothing especially profound about it. Consider, by contrast, the passage from Bob Woodward's The Agenda in which Clinton asks the rhetorical question "You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of fucking bond traders?"
Now, that's poetry. And for a time, that moment when Clinton realized that the U.S. bond market had effective veto power over all of his economic plans took on the force of a primal scene. Bond traders, with Fed chair Alan Greenspan as their honorary leader, were understood as controlling the secret levers of the economy. If they didn't like what they saw in Washington, or in the housing market, they'd stamp on the brakes, sending interest rates soaring and mak-ing unemployment lines longer. Keeping the bond market happy was, it seemed, a president's first priority.
In the past couple of years, though, the bond market has receded in importance, at least in terms of the way the press has covered it. Greenspan is, to be sure, more deified than ever. But the U.S. economy has been humming along so nicely, with low unemployment, no inflation, impressive growth, and a budget surplus, that the idea of inflationary storm clouds on the horizon -- which is what bond traders worry about (and by worrying, they make everyone else nervous, too) -- has seemed almost inconceivable. At the same time, the explosive rise in the stock market has kept everyone's attention focused there.
As a result, when people worry about the health of the economy today, they don't talk about inflation. They talk about a stock-market crash and what it might do to the rest of the economy. Today, in fact, Clinton might be expected to say instead, "You mean to tell me that the success of the economic program hinges on the Federal Reserve and a bunch of fucking NASDAQ traders?"
The irony, of course, is that even as the bond market has seemed to recede in importance, it's been booming. In 1997 and 1998, the yield on the 30-year U.S. Treasury fell more than a full point, which means that people were buying Treasuries as if they were Furbys. (A bond's yield and its price move in opposite directions, so as a bond's price rises, thanks to higher demand, its yield falls.) In 1998, 30-year Treasuries returned 18 percent, which is better than a lot of mutual funds did over that period.
But although the "inflation vigilantes" -- those bearish traders whom Clinton felt he had to appease -- may have been in hibernation, they hadn't gone away, nor had their power diminished. In the past two weeks, those bears have come out of their caves, and in combination with a host of other global forces, they've sent long-term interest rates soaring, making the stock market tremble and making everyone wonder whether Greenspan will follow their lead. And what this has made obvious is that the bond market has only seemed to matter less in the past couple of years. No matter how much money floods into the stock market, determining interest rates remains the most important thing markets do.
Okay, so bond traders matter. But why have they suddenly decided that it's once again time to worry about inflation, driving up interest rates? In the two weeks between January 29 and February 12, the yield on the 30-year Treasury rose from 5.09 percent to 5.42 percent. Considering that just a month ago, many analysts were talking about a continued bull market in bonds, that spike was a remarkable move. What prompted it?
In the simplest terms, there are two real answers: congenital fear and Japan.
To generalize wildly, people who buy and sell bonds see inflation behind every corner, and they see economic growth as a good indicator of inflation. For most of this century, and especially in the period stretching from the late sixties through the eighties, the idea that current growth necessarily leads to future inflation has, for what have often been excellent reasons, governed not only the bond market but also the Federal Reserve and most economic thinking. So when the most recent numbers on U.S. GDP showed that the economy grew at a blistering 5.6 percent clip in the final quarter of 1998, and at a 3.9 percent pace for the year as a whole, red flags began waving furiously in the breeze.
Of course, the most recent numbers also show that global commodity prices are now at a 21-year low and that the employment-cost index -- which measures, as its name suggests, the cost to businesses of employees -- rose less than expected in the last quarter. And then there's the actual inflation number, which is minute. Advocates of the so-called New Economy would say that all this is further evidence that we're in a new era, where the economy can grow quickly without generating inflation -- because of heightened global competition, new technology, the Internet, etc. But the bond bears are saying: Just wait.
Still, while "congenital fear" is an efficient answer, it's hardly the only answer. The thing about the bond market, after all, is that it's a market, and a global one at that. As a result, while "the bond traders" are excellent cardboard villains, it's a mistake to think that there's this small group of people out there sending interest rates up and down according to their current whims. Actually, they're a big group of people, and their whims have to do not only with inflation but with things like the price of bonds from other countries, the value of the dollar against the yen, the demand of corporate bonds, and the frequency with which U.S. bonds are sold.
Of all these other factors, one stands out: Japan. The U.S. Government's debt is effectively funded by foreign investors, who love the security and the high (relatively speaking) returns of U.S. Treasuries. A large fraction of those investors are Japanese companies and pension funds. But in the past couple of months, as the yen has risen in value against the dollar (making foreign assets less valuable), those companies and funds have been repatriating assets back to Japan, to lock in profits in advance of the end of that country's fiscal year and, more recently, to take advantage of the higher yields on government bonds there. It's possible that fears about repatriation -- which have been a staple of this market since the eighties -- are overblown. But Japanese firms did sell 676 billion yen's worth of foreign bonds in January, the first time since March 1998 that they were net sellers of foreign assets.
Of course, no sooner had traders been seized with fear over what all this meant for U.S. bonds than news came that the Japanese Ministry of Finance was going to start buying Japanese government bonds. What that really means is that it's taking tentative steps toward re-inflating the Japanese economy by printing yen and pouring them into the economy. Inflation in Japan would mean a weaker yen, which would be good for U.S. bonds. (It would also be good for the Japanese economy, but let's stay focused here.) So last Tuesday, bond prices jumped, and interest rates fell. It's like watching Internet stocks move.
Well, not quite. But the comparison is a valuable one. Because of the nature of bonds -- what, after all, is less sexy than a 30-year Treasury note? -- we tend to think of the bond market as sleepy. But it is instead almost preternaturally attentive. One reason -- apart from simple insanity -- why the prices of Internet stocks change so quickly is that those prices are attempts to figure out the value of these companies ten or fifteen years from now. As a result, even a small change in your current expectations can have an enormous effect on your long-term projections. (Changes are magnified over time.) Exactly the same is true of the bond market. Over 30 years, the difference between an inflation rate of 1.5 percent and one of 3 percent is not minor; it's everything. Eternal inflationary vigilance, you might say, is the price of bondholding.
What we've also seen in the past two weeks, though, is that eternal inflationary vigilance is, if only indirectly, the price of stockholding. After sixteen years of a bull market, it's become easy to think not only that stocks will keep going up but that the stock market is, in some sense, independent of everything except what's inside it. But it's no coincidence that the recent sell-off in the NASDAQ -- full of highly valued stocks -- and the flatness in the stock market as a whole coincided with the falling bond market. Stocks, especially expensive stocks, need low interest rates to thrive, both because low interest rates are good for the economy and because low interest rates make stocks look like better investments. For a couple of years, the bond market's own boom helped make the stock market look like the most powerful player on Wall Street. But even if the past few weeks have been but a blip, the lesson has been relearned. Clinton's bond traders still rule.