Taming the bond market vigilantes

June 3, 2009

Whatever the politics, fixing Social Security is easy conceptually.  And if Team Obama is starting to get a bit anxious about an adverse reaction from the bond market to its fiscal policies, why not offer a fix as evidence of its seriousness about America’s entitlement woes? Here is Ed Yardeni on this very topic:

The Obama Team needs to negotiate a peace treaty with the Bond Vigilantes. The Administration will agree to slash the structural federal deficit. The Vigilantes will stop pushing bond yields and mortgage rates up to levels that will abort the recovery. This would be a win-win solution in the spirit of doing what is best for the country. The President could do what Nixon did. It took an anti-communist hawk to recognize Red China. It may take a liberal community organizer to address the looming financial crisis in the social welfare state, particularly Social Security and Medicare. Now is a good time to push for means testing of these two programs. Actually, there is already some means testing in both programs, but the testing should be expanded. The programs shouldn’t be entitlements. They should be insurance programs that provide a safety net for those who are truly in need of public assistance. If the Obama Administration seriously addresses this issue, the outlook for the structural deficit will improve dramatically. In this scenario, both Treasury bonds and the US dollar could rally as the Administration actually delivers on its promise to reduce the structural federal deficit.

Me:  I wonder if bond investors are more worried about inflation, default or inflating to avoid default? I would also be concerned that any Obama solution would include higher payroll taxes. Some economists blame FDR’s institution of a payroll tax in the 1930s for extending the Great Depression. Raising the retirement age and linking benefits to inflation rather than wages would actually create huge budget surpluses, by the way.

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