Traditionally, the bond market is where governments are kept accountable. In the 1980s, after the inflation nightmare of the 1970s, we have the bond ‘vigilantes’ who watched money supply growth like hawks. Any governments that print money will be punished by the bond vigilantes selling government bonds, thus raising their yields.
Today, the bond vigilantes are neutered. Central banks (obviously we don’t have to name names here) are buying up their governments’ bonds to prop up their prices. This means government bond prices cannot fall. That in turn makes government bonds an attractive destination for those who wants to preserve their capital. The bond vigilantes cannot do their job of punishing irresponsible governments.
Long-term interests was supposed to be determined by the free market via long-term government bond prices. That is supposed to reflect the market’s belief about long-term price inflation rate and the governments’ ability to honour its debts. Today, with governments (via their central banks) sticking their dirty paws on the bond market, bond prices are useless indicators of the credit-worthiness of governments.
Now, we have to rely on credit rating agencies to do that job. This week, the Greek government was infamously downgraded by Fitch. Greek government debt is on par with junk bonds. S&P revised the Spanish government’s credit outlook to negative. Downgrades on bigger fish governments are coming. In fact, Moody is putting the US and UK governments on notice.
Lending at 3.4% for 10 years to the US government is the most mind-boggling stupid investment. Is the market that stupid? Or is it the work of the Federal Reserve?
