Since the deficit ceiling deal passed on Tuesday, there has been a lot of discussion about the winners and losers of the tumultuous past month. But nobody has mentioned one class of losers: the inflationistas. You know, the people who lay awake at night, their sleep disturbed equally by the gold bars under their pillows and the concern that prices are rising across the board. The people who keep warning that, any day now, the bond vigilantes will ride over the hills and demand that everybody pay higher interest rates. The folks who, like House Majority Leader Eric Cantor, are short Treasuries and counting on a spike in interest rates.
The inflationistas' case always seemed more than a little weak. Sure, prices of energy and food have been high. And, yes, the consumer price index has been in elevated territory. In the 12 months that ended in June, the CPI was up 3.6 percent (1.8 percent excluding food and energy costs). But in order to have inflation, you need a wage-price spiral. And it's hard to have a wage-price spiral when wages aren't rising, let alone spiraling. What's more, aside from the price of gold, it was difficult to detect the symptoms of inflation. For example, if prices were rising broadly in an out-of-control manner in the U.S., one would expect the price of money to rise as well. You'd expect that interest rates on government and corporate debt would spike. That never happened. In fact, in recent months, the interest rate on the 10-year bond has been falling.
Well, came the counter-argument, interest on government debt stayed low because the Fed was buying lots of bonds and expanding its balance sheet like crazy. Once that stopped, they argued, the bond vigilantes would come riding over the hill and demand that the government (and everybody else) pay higher interest rates. But the Fed wasn't buying 10-year Treasuries. And the Fed's second effort at quantitative easing — a promise to buy $600 billion in government debt — was never as large as advertised. Why? Other parts of the Fed's balance sheet were shrinking even as holdings of Treasuries were expanding. By the way, that process is continuing. The Fed's weekly report on its balance sheet, to be released Thursday afternoon, will show that assets have fallen for three straight weeks. Needless to say, interest rates on long-term government debt have plummeted since QE2 ended.
But, say the inflationistas, perhaps the debt-ceiling deal made investors around the world suddenly optimistic that the U.S. had fixed its problems and that public borrowing would no longer threaten to crowd out private borrowing. That doesn't wash either. As critics have correctly noted, the deal doesn't cut the deficit all that much, it doesn't reform entitlements, and it paves the way for more borrowing. (The deal, remember, was to raise the debt ceiling by more than $2 trillion). Besides, the past years have shown pretty definitively that a sharp increase in the amount of funds borrowed by the U.S. government doesn't lead to higher interest rates — for the government or for businesses and consumers.
It's quite possible, even plausible, that interest rates are falling because there isn't much inflation to speak of, and that investors, rationally, are coming around to the view that there will be even less inflation going forward. For in the past few weeks, fears of overheated economies in the developing world have quickly been replaced by fears of underheated economies in the developed world. The brinksmanship of recent weeks acted like a paralytic agent, causing consumers and companies alike to hold off on making purchases and investments. The resolution of the crisis didn't bring much relief. Fiscally contractionary actions, whether they are tax increases or spending cuts, tend to be contractionary, no matter what the avatars of austerity say. With the debt ceiling deal, the austerity meme, heretofore confined to Europe, has jumped the Atlantic. Not since the Spice Girls has the U.S. imported such a bad concept from the U.K. Regardless of how the GDP or retail sales numbers pan out over the next several months, the U.S. government, as currently configured, is not going to respond with stimulus.
In other words, the data points and the policy stances in the U.S. and Europe all seem to be pointing toward lower demand -- for commodities, for money, and for goods and services. Look around, and it sure seems like the prices of an awful lot of things are falling. As I write, oil is trading at $87.68 per barrel. The price of money is sharply down. The 10-year U.S. government bond is trading at about 2.5 percent. Liz Rappaport of the Wall Street Journal reports that "Bank of New York Mellon Corp. is preparing to charge some large depositors to hold their cash, in the latest sign of the worries roiling global markets." (A neat trick, that.) What about the stock markets? Well, the prices of shares of companies that make and sell goods and services are down, too.
As for the bond vigilantes, they're still on permanent vacation. I was in Budapest last week, and I think I saw them lazing in the Szecheny baths.
Daniel Gross is economics editor at Yahoo! Finance.
- interest rates
- consumer price index
- winners and losers
- balance sheet