The Resurrection of the Rentier

In the 1920s, as we have seen, Keynes had predicted the 'euthanasia of the rentier\ anticipating that inflation would eventually eat up all the paper wealth of those who had put their money in government bonds. In our time, however, we have seen a miraculous resurrection of the bondholder. After the Great Inflation of the 1970s, the past thirty years have seen one country after another reduce inflation to single digits. (Even in Argentina, the official inflation rate is below 10 per cent, though unofficial estimates compiled by the provinces of Mendoza and San Luis put it above 20 per cent.) And, as inflation has fallen, so bonds have rallied in what has been one of the great bond bull markets of modern history. Even more remarkably, despite the spectacular Argentine default - not to mention Russia's in 1998 - the spreads on emerging market bonds have trended steadily downwards, reaching lows in early 2007 that had not been seen since before the First World War, implying an almost unshakeable confidence in the economic future. Rumours of the death of Mr Bond have clearly proved to be exaggerated.


Inflation has come down partly because many of the items we buy, from clothes to computers, have got cheaper as a result of technological innovation and the relocation of production to low-wage economies in Asia. It has also been reduced because of a worldwide transformation in monetary policy, which began
with the monetarist-inspired increases in short-term rates implemented by the Bank of England and the Federal Reserve in the late 1970s and early 1980s, and continued with the spread of central bank independence and explicit targets in the 1990s. Just as importantly, as the Argentine case shows, some of the structural drivers of inflation have also weakened. Trade unions have become less powerful. Loss-making state industries have been privatized. But, perhaps most importantly of all, the social constituency with an interest in positive real returns on bonds has grown. In the developed world a rising share of wealth is held in the form of private pension funds and other savings institutions that are required, or at least expected, to hold a high proportion of their assets in the form of government bonds and other fixed income securities. In 2007 a survey of pension funds in eleven major economies revealed that bonds accounted for more than a quarter of their assets, substantially lower than in past decades, but still a substantial share. With every passing year, the proportion of the population living off the income from such funds goes up, as the share of retirees increases.

Which brings us back to Italy, the land where the bond market was born. In 1965, on the eve of the Great Inflation, just 10 per cent of Italians were aged 65 or over. Today the proportion is twice that: around a fifth. And by 2050 it is projected by the United Nations to be just under a third. In such a greying society, there is a huge and growing need for fixed income securities, and for low inflation to ensure that the interest they pay retains its purchasing power. As more and more people leave the workforce, recurrent public sector deficits ensure that the bond market will never be short of new bonds to sell. And the fact that Italy has surrendered its monetary sovereignty to the European Central Bank means that there should never be another opportunity for Italian politicians to print money and set off the inflationary spiral.

That does not mean, however, that the bond market rules the world in the sense that James Carville meant. Indeed, the kind of discipline he associated with the bond market in the 1990s has been conspicuous by its absence under President Clinton's successor, George W. Bush. Just months before President Bush's election, on 7 September 2000, the National Debt Clock in New York's Times Square was shut down. On that day it read as follows: 'Our national debt: $5,676,989,904,887. Your family share: $73,73 3.' After three years of budget surpluses, both candidates for the presidency were talking as if paying off the national debt was a viable project. According to CNN Democratic presidential nominee Al Gore has outlined a plan that he says would eliminate the debt by 2012. Senior economic advisers to Texas Governor and Republican presidential candidate George W. Bush agree with the principle of paying down the debt but have not committed to a specific date for eliminating it.

That lack of commitment on the latter candidate's part was by way of being a hint. Since Bush entered the White House, his administration has run a budget deficit in seven out of eight years. The federal debt has increased from $5 trillion to more than $9 trillion. The Congressional Budget Office forecasts a continued rise to more than $12 trillion by 2017. Yet, far from punishing this profligacy, the bond market has positively rewarded it. Between December 2000 and June 2003, the yield on ten-year Treasury bonds declined from 5.24 per cent to 3.33 per cent, and remains just above 4 per cent at the time of writing. It is, however, impossible to make sense of this 'conundrum' - as Alan Greenspan called this failure of bond yields to respond to short-term interest rate rises - by studying the bond market in isolation. We therefore turn now from the market for government debt to its younger and in many ways more dynamic sibling: the market for shares in corporate equity, known colloquially as the stock market.