Bond vigilantes in the shade as growth slows

Say goodbye to the bond vigilantes and hello to the budget brigade.

A posse of investors, academics, and even central bankers are calling on governments to spend more and tax less to provide a budgetary boost to the struggling global economy.

That is a 180 degree turn from the bond vigilantes of yore who pressed for smaller deficits and less debt about a quarter of a century ago.

To hear the budget backers tell it, bigger shortfalls are a no-brainer. With interest rates at — or even below — zero in much of the industrial world, central bankers are pushing up against the limits of what they can do to buttress growth.

Yet those same low-interest rates make it exceedingly cheap for governments to borrow money to finance bigger budget shortfalls.

“A large part of what monetary policy can do, it has done,” former Treasury secretary Lawrence Summers said last month. “In Japan, in Europe, and perhaps on a forthcoming basis, in the US, we need further impulses to growth,” including from fiscal policy.

The dirty little secret is that budgets are starting to be loosened in some countries after years of austerity. Yet in many cases, that is more by happenstance than by intent.

And the size of the resulting stimulus is small and far short of the more sweeping steps advocated by card-carrying members of the budget brigade.

A grab bag of factors is preventing more dramatic action on the fiscal front. Together they suggest that it would take a major economic downturn to galvanise policy makers into launching a budgetary binge to stimulate growth.

The world economy certainly could use some help. Downside risks are piling up, from slowing growth in China and other emerging markets to violent swings in financial and commodity markets that are sapping investor confidence.

“Protracted low global demand and adverse feedback loops between the real economy and markets” are “putting us at risk of secular stagnation” of little or no growth, IMF deputy managing director David Lipton said.

Normally in such a circumstance, central banks would mobilise monetary policy to arrest the downdraft.

And they are trying to do just that. ECB president Mario Draghi unveiled a multi-pronged package last week to combat deflation that included a bigger and broader bond-buying programme and a further reduction in already negative interest rates.

The muddled market reaction to Mr Draghi’s move — the euro and European stock prices swung widely on the day it was announced — though suggests monetary policy makers may be reaching the limits of the good they can do for the economy.

That’s why such top money managers as Bridgewater Associates’ Ray Dalio and Janus Capital Management’s Bill Gross say governments may need to boost budget deficits to help out.

* Bloomberg