During the 1970’s and the 1980’s, the Federal government had been fighting a war in Vietnam, building a Great Society, and running up the national debt for years. In 1992, President Clinton has ambitions to increase deficit spending, which means adding even more debt, before he was blind-sided by the Great Bond Massacre. Interest rates rose from 6% to 8%, causing a trillion dollar decrease in the value of bonds. (Increasing interest rates decrease the value of bonds.) Suddenly, Clinton’s grand plans went nowhere. He was quoted as saying “You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of [expletive deleted] bond traders?” Wall Street analyst Edward Yardeni called them “bond-vigilantes”. They were holders of bonds who were increasingly concerned about the rapid rise in government debt — concerned enough to sell their bonds at a loss.
During the 2008/9 Financial Crisis, the Federal Reserve effectively neutered bond-vigilantes by taking control of the long-term Treasury market. The Fed became the buyer-of-last-resort for Treasury debt. If the former bond vigilantes were afraid of holding Treasury bonds, that was no longer a problem, because the Fed would hold those bonds. This controlled interest rates, keeping them low enough to stimulate the economy.
So, with the bond-vigilantes no longer able to voice market fears about government debt, who is left to holler “FIRE?” Traditionally, rising gold prices suggest domestic worries, while a falling dollar suggests international worries. Over the past year, gold is up, while the dollar is down.
I have often asked “what can you do with crypto-currencies, like Bitcoin, that you cannot do with U.S. dollars?” The recent nosebleed rise in the value of Bitcoin may reflect increasing uneasiness with the enormous deficit spending and increasing debt levels. (There is no way for the Fed to take control of the market for crypto-currencies, like they took control of the bond market.) Rising bitcoin prices may reflect both domestic and international worries, at least partially.
After the Great Bond Massacre, President Clinton learned from the experience and started balancing the budget and even started reducing the level of government debt. Have the bond-vigilantes been replaced by the crypto-vigilantes? Is the rise in Bitcoin yet another warning of fire, or is it a market repudiation of Modern Monetary Theory? I think it is both.