What has been the market’s response to the economic stimulus plan? The Wall Street Journal editors and other writers are pointing to continued drops in the stock market.
Yes, the stock market is a forward-looking indicator of economic activity. But the U.S. stock market is not sufficiently global so as to provide clear indication of the investing preferences, and therefore the consensus economic outlook.
More truly global markets include key commodities like gold and oil, and most importantly for economic policy, the U.S. Treasury market. With nearly $4 trillion in marketable securities, direct U.S. Treasury debt is the largest and most liquid world market. Further, as a direct obligation of the U.S. Government, pricing in this market is a direct gauge of national economic policy.
As I have written previously, the borrow-to-spend programs of the U.S. government will only succeed as long as investors from other countries continue to put their faith in the U.S.
So far so good. The continuing flows of capital into U.S. Treasurys are only possible because households around the world have extensive savings. As other countries experienced strong economic growth this past decade, they saved much of their newfound income in the United States.
That party is over. As the situation worsens in what is now a clearly global slowdown, we are going to see it in the voice of the bond market – the yield curve.
In November, the yield curve for U.S. Treasury notes and bonds steepened dramatically. It has since flattened slightly along with positive moves in the stock market, which is off its lows of late November.
This week, however, things are changing again as the stock market falls and the spread widens. The return on short-term Treasury bills remains near zero, and the 10-year Treasury debt only pays investors around 2.7 percent. The U.S. Treasury 30-year bond was selling off strongly Tuesday morning, raising its yield to more than 3.5 percent.
The yield spread, the difference between the two- and 10-year yields, is currently at 1.9 percent. When this spread moves above 2 percent again, we know are hearing cries against U.S. economic policy.
Alice M. Rivlin, an economist at the Brookings Institution and a former member of the Federal Reserve, is quoted in The New York Times on the possible consequences of the current government-spending bill.
Ms. Rivlin argues that since a huge amount of U.S. Government debt is held by China, policymakers must be assuming that China will not lose confidence as we spend more on government programs. “And I’m just not sure that’s the right assumption.”
Why should households and governments outside the U.S. lose confidence? Consider how the American Recovery and Reinvestment Act of 2009 could affect international trade policy.
Other countries are bound to stop doing business with the U.S. as we become increasingly home biased. The steel industry persuaded the House to insert a “Buy American” provision in the stimulus bill passed last week. Additional protectionist policies in the bill include provisions for only American-made textile products and other government purchases.
Economists agree that trade makes everyone better off. If we fight this principle, the financial consequences of trade-protection policies will continue to be seen in the bond market.
Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon