Deficit concerns trumped jobless aid last week in the House, as moderate Democrats and Republicans slashed a stimulus bill in half and cut out health insurance for the unemployed in an effort to curb the bill's impact on the deficit.
At the same time, investors are still buying up US Treasury bonds -- the instrument with which we finance our deficit -- at high prices and low interest rates, indicating that they see no short-term deficit crisis. What's going on here?
My theory would be a double flight to safety. Investors are looking for a safe bet, relative to all other bets, and politicians are looking for a safe vote, relative to all other votes.
The bond story is easier to explain. With the eurozone in slo-mo free fall, investors are looking for a safer place to park their cash, and US Treasuries fit the bill. Europe's loss of trust is our gain.
In Washington, the electoral success of ultra-conservative candidates in the early primaries might be scaring some moderate and conservative Democrats to call for attention to the deficit. What's also happening is that Washington politics, per usual, is gravitating toward the middle. Liberals are calling for $200 billion stimulus. Conservatives are calling for a bill with zero impact on the deficit. So moderates are finding virtue is casting a vote that positions them in the middle of the spectrum.
The "jobs bill" in the House was originally projected to add more than $130 billion to the deficit. Rank-and-file Democrats wrangled with party leadership until the deficit impact shrunk to $50 billion. Some of the slashed proposals were pure pork. Others left on the cutting room floor were important relief measures like COBRA insurance for the jobless.
Readers of this blog know that while I support efforts to curb our long-term debt crisis, I don't think those efforts should begin in 2010. For example, voting against a $23 billion public education bailout would reduce federal spending in one year by 0.6%. It's not particularly far-sighted or impactful. The nation is still teetering on the edge of deflation, and we need more stimulus (and higher deficits) to bring relief to revenue-starved states and cash-strapped Americans, who are also more likely to spend their next checks immediately on necessities.
But just because Washington is wrong to preference deficits over stimulus, and the bond market disagrees with Washington, doesn't mean that the bond market is smart. As Bruce Bartlett explained, "there is a tendency for markets to ignore certain things for long periods of time, then suddenly notice them all of a sudden." For evidence, take a look at the 10-year bond yield on Greek debt. Between October 2009 and May 2010, it practically tripled from 4.4% to 12.4%.