A bond is a promise by a company or government to repay principal (the amount borrowed) plus interest to an investor at a specified time in the future.
In the 1990s, bankers had a slang term for bonds that were losing or had no value. They were called “Clinton bonds.” The joke was that Clinton bonds were composed of an Al Gore bond that had no interest, a Monica Lewinsky bond that had no maturity, and a Bill Clinton bond that had no principle.
The term was a buzzword for the deteriorating value of US government bonds, which was caused by former President Bill Clinton’s inflationary policies early in his presidency. Negative perceptions of Clinton’s ability to manage the economy also formed the basis for the term.
At first, investors feared that inflation and credit risks were rising. Because the price and yield of a bond move in opposite directions, the fears caused bond investors to sell, which resulted in falling prices, and investors demanded higher yields to compensate for the added risk. Bondholders and traders lost billions of dollars.
Eventually, Clinton listened to the bond market, reined in his inflationary policies, balanced the budget instead of increasing the federal deficit, and made peace with Federal Reserve Chairman Alan Greenspan.
Clinton discovered a new meaning to the old concept of checks and balances. He did not have to deal just with Congress, his critics, or the press; he also had to contend with the bond market. Whenever his political aids proposed spending a large sum of money on a new policy, the economists and bankers would respond that the bond market would go ballistic.
Clinton’s top campaign aide, James Carville, was stunned at the power the bond market had over the government. This provoked him to quip:
“I used to think if there was reincarnation, I wanted to come back as the president, or the pope, or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”
Governments in democratic countries typically have to face their electorates every four or six years. But a more up-to-the-minute judgment on how well they are doing, at least in the financial sphere, is provided by the bond market. The price of a government’s bonds is a running commentary on how well it is managing the country’s money, just as a share price is a snap judgment on how well a company is being run.
As of Sept. 7, the price of 10-year Philippine government bonds, for instance, has fallen over the past year due to Duterte’s inflationary policies, and the yield has risen from 4.6 percent to 6.67 percent. The bond market expects prices to continue to fall and yields to continue to rise.
The bond market is saying that President Duterte is not managing the country’s money well. Investors are demanding a higher return because they are judging Duterte and Philippine government bonds to be either riskier than they originally thought or there are better investment opportunities elsewhere. And if investors decide there are better opportunities elsewhere, it’s only natural that bond prices fall. As a consequence, the yield goes up.
Moreover, bond markets do not just comment on the public finances. They have a way of disciplining profligate governments. This does not mean that governments can never spend more than they raise in taxes. A bit of borrowing does nobody any harm provided it is being used for a good purpose and it is clear where the money to repay the debt is coming from. But investors get worried when a government resorts to deficit financing with no obvious end in sight. They mark down the bonds of governments that live beyond their means, pushing up the cost of borrowing new money.
Even a small rise in the cost of borrowing can be enough to persuade governments to adopt more responsible policies. They tighten their belts by cutting public spending or raising taxes. But such actions are unpopular with voters. So politicians are reluctant to do them. The snag is that the longer they delay taking remedial action, the more worried bondholders become. The cost of borrowing continually mounts. In the extreme, it can be so expensive to raise money that the government defaults on its debts, as Greece did in 2012.
Governments have an escape route that is not available to companies when they run out of money: they can print money. That might seem to negate the capacity of bond markets to discipline profligate behavior. But, in fact, the ability to turn on the printing presses is at best a temporary palliative. Such “monetization” is a sure way of debasing the currency. It feeds inflation, possibly even hyperinflation. It may avoid the technical default. But bondholders will still have to be robbed. The money they are paid back will be worth a fraction of the money they lent. Not surprisingly, bondholders watch out for inflation with an eagle eye. And they punish any government that seems to be embarking on inflationary policies by marking down their bonds.
But it is not just bondholders who suffer from inflation. Ordinary savers who have cash deposits suffer too. The way in which inflation erodes the value of cash is sometimes called the “inflation tax.” And, like all taxes, it is unpopular. As such, printing money does not really offer politicians an escape route. Even if the discipline of the bond market is too weak, they have to face the consequences of debasing their currency at the ballot box.
The bond market teaches governments the virtues of fiscal and monetary conservatism. Inflationary policies are detrimental to an economy’s long-term health and public finances should be managed responsibly.
Old-style tax-and-spend politicians may not love the bond market. But ordinary citizens can be grateful that it holds politicians in check. And even politicians can develop a healthy relationship with the bond market. If they manage the country’s money sensibly, they will be rewarded with lower borrowing costs and promote economic prosperity.
If Duterte doesn’t listen to the bond market, Philippine government bonds may soon be jokingly referred to as “Duterte bonds,” composed of a Leni Robredo bond that has no interest, a Mocha Uson bond that has no maturity, and a Rodrigo Duterte bond that has no principle.
eric.jurado@gmail.com