In the 1980s, investment strategist Stanley Salvigsen coined the term “bond vigilantes” to describe the sometimes harsh oversight function that bond market investors provide sovereign governments. If a government’s monetary or fiscal policy got out of control, the vigilantes were there to string them up in a hurry—typically by reducing purchase demand enough to drive up interest rates. Interest rates have been in a long secular decline since the early 1980s, so the bond vigilantes haven’t been seen for quite some time. One might be forgiven for thinking they had galloped off to another movie set.
Events in Europe last week showed clearly that the bond vigilantes are still on patrol. Investors were none too happy with the balance sheets of Greece and the U.K., and both countries were socked with an increase in interest rates on their sovereign debt. Indeed, although central banks like to believe that they have control of short-term interest rates, ultimately it is the market—through supply and demand–that controls the rate at which governments must borrow.
Although our national balance sheet is not quite as strained as that of Greece, the U.S. will not be immune from the bond vigilantes. In fact, they’ve already made their presence felt by punishing the dollar when the current account deficit got out of control. I noticed that the recent report from the Commission on Budget Reform has lots of suggestions for reducing the deficit, but doesn’t want them to take effect until 2012. Let’s hope that it is not too late to head the bond vigilantes off at the pass.
