President Clinton, we're advised, checks in with the bond market two or three times a day, ever since he was told that it is a better guide to his performance than the stock market -- which you will remember sank like a stone February 16 when he announced the deepening of his tax-the-rich economic plan. In his Sunday column yesterday, Floyd Norris of The New York Times tells us Mr. Clinton was worried that the bombing of the World Trade Center would affect the bond market. Norris tells us that the bond traders with whom he talks are equally delighted with the President, as they attribute the rally to his determination to reduce the deficit. Congressional Democrats last week made Mr. Clinton happy by making the bond market happy by promising deeper and deeper budget cuts, or so the theory goes. Alas, what of the steep decline in bonds on Friday, attributed to a spurt in producer prices? Or today's hit, attributed to the Blizzard of '93, which caused orange juice futures to soar? Is the President unhappy? If so, what can he do to get producer prices under control? How about OJ?
We have only deep sympathy for the President as he pursues his latest hobby. Of course, we would not be in business if reliable financial commentary were available in the news media. Lately, though, it has become almost painful to follow the usual sources. Almost everything being written and said about the bond market these days is blather; some of the bond commentators border on the criminally incompetent. Even a few of our old friends, especially those who predicted a bond market collapse with the election of Bill Clinton, are twisting themselves into pretzels to explain why the bond market is in for a rude awakening -- as with this non sequitur: Clinton's higher personal income tax rates will increase bond yields because investors will demand a higher after-tax rate of return -- which presumes that investors can dictate their rate of return (when they can in fact only assess risk). On this point, Norris reports that Robert Barbera, chief economist at Lehman Brothers, says "There is more risk than reward in the bond market now." That is, because bonds have gone up, it's more likely they will go down than further up.
Our conclusion is quite the contrary. We now have the first President of the United States in living memory who watches bonds, feeling good when bonds rise in value and bad when they fall. We also have a Fed chairman who knows what he is doing, rather than taking shots in the dark. With this combination, investors have less risk and more reward in the bond market than they have had in quite a spell. If they work at it, they could get the bond yield down to 3.5%, and in the process save the taxpayers $1 trillion over the next ten years.
They cannot reduce the bond yield by lowering the personal income tax rate to attract investors, as the above argument would suggest. Only by taking risk out of the 30-year bond will they be able to drive down the yield, as investors would clamor to lock in a 6.9% yield, knowing it would soon be at 3.5%. Alan Greenspan can't do this by himself, as he only has influence over the value of dollar assets for the remainder of his term. The bond market is surely impressed with the fact that there is an accumulation of wisdom at the Fed, which began with Paul Volcker. This should carry us at least beyond the next two Greenspan years. It would take the President's help to squeeze most of the risk out of the long bond; only an Act of God could remove all risk.
Fixing the price of gold would do it. The Greenspan Fed has done an amazingly good job of taking the volatility out of the U.S. dollar, by steadying its value in gold. He has accomplished this feat despite the demands of the last President, who was not a bond watcher, that he lower the price of spot money (to hell with bonds). If President Clinton would tomorrow publicly announce that he would be a happy man if Chairman Greenspan kept the gold price where it is now, we would expect the bond market to go through the roof. If he would ask Congress to formalize the deal, the bond market would shoot to the moon.
I asked my staff to do a ballpark calculation of what this would do to projected debt service during the years 1992-2001. They made the following conservative assumptions: 1) The average yield on Treasury bonds outstanding would fall gradually to 5% from the present 9.43%; 2) The average yield on Treasury notes outstanding would fall to 4% from the present 7.4%; the average Treasury yield on Treasury bills remains at 3%; 4) outstanding debt grows at 6% per annum. Under this gold stabilization scenario, Treasury would enjoy a cumulative savings in debt service costs of $994 billion over 10 years.
What is the likelihood this will happen? At the moment, none. But the political forces we observe are pointed in that direction, which is how we came to enjoy the 100-basis point rally in bonds that began last November 6. The rally will continue if the government continues to remove risk from the bond market, which can occur in a big way by moving further in the direction of gold stabilization. The rally will dissolve if President Clinton and Treasury Secretary Lloyd Bentsen suddenly decide: a) they don't care if the bond market goes to hell and b) they decide Greenspan doesn't know what he's doing and begin yelling at him. Otherwise, bonds will wobble about as they have these past few days when new information comes into the market -- producer prices, currency movements, juice futures -- that raise question-marks about policy over the short run.
As much as he would care not to think of the implications of the February 16 sell-off, President Clinton will be reminded time and again in the months ahead of the torture Wall Street can administer in the stock market. At best, if we went to a gold standard tomorrow, the direct savings on debt service would yield approximately $1 trillion over ten years. The indirect budget benefits from perfectly sound money would exceed that amount by several times. Taking risk out of the money also takes part of the risk out of investment in equities, and here is where we would get the dramatic increase in employment the President is aiming for. A rally in bonds for this reason translates into a rally in stocks. Cutting against this trend will be the President's economic program, which he mistakenly believes is the reason for the strength of the bond market. Insofar as he is successful in adding a new burden of taxation on the economy, the President only adds to risks in the equity market. Bonds may well stay anchored while stocks falter, as happened on February 16.
Having a President fascinated by the 30-year bond is like money in the bank, especially when the Fed Chairman enjoys his confidence. Next, we would like to find a way to get Mr. Clinton to understand the importance of NASDAQ, a lesson that we hope would be a pleasant one, but, we're afraid, will not be.