Fighting the Bond Vigilantes with Security Theater

The RFID bracelets are what I’ve come to call security theater: security primarily designed to make you feel more secure. I’ve regularly maligned security theater as a waste, but it’s not always, and not entirely, so.
It’s only a waste if you consider the reality of security exclusively. There are times when people feel less secure than they actually are. In those cases — like with mothers and the threat of baby abduction — a palliative countermeasure that primarily increases the feeling of security is just what the doctor ordered.

In Praise of Security Theater, Bruce Schneier

WSJ report out today about the fruitless (to say nothing of pointless) fiscal cliff talks this past week between President Obama and Speaker Boehner. This one paragraph could not be sadder if he started asking Boehner what kind of presents he thought John Frum would bring them when he came back.

The president told him he could choose one of two doors. The first represented a big deal. If Mr. Boehner chose it, the president said, the country and financial markets would cheer. Door No. 2 represented a spike in interest rates and a global recession.

There’s so much wrong with it, not least of which everyone know that Monty Hall gave you three doors to choose from on Let’s Make it Deal, not two. Paul Krugman made a few, perhaps more salient points.

Oh, dear — does the president still believe that failure to reach a Grand Bargain will cause an attack by the invisible bond vigilantes, and that this is the reason we should fear the fiscal cliff? How many times do we have to show that this notion is wrong both in theory and empirically? America can’t run out of cash (except politically, if Congress refuses to raise the debt ceiling); it basically can’t experience an interest rate spike unless people see an increased chance of economic recovery and hence a rise in short-term rates. And the people who have been predicting an interest rate spike any day now for four years shouldn’t have any credibility at this point.

Oh yeah, and a global recession would surely mean lower, not higher, interest rates.
If Obama is still confused about this, it has real-world consequences — in particular, it makes him too eager to reach a deal now now now, and hence too willing to concede on fundamental priorities.

I’ll disagree with Krugman on one point. I believe the president meant IF the bond vigilantes bend America to their will and jack up interest rates, THEN we’ll have a recession— cause and effect. This is a curious thing to worry about considering we’ve pretty much been in a recession the past 4 years. President Obama’s logic is that of a man lost at sea on a raft who refuses to board a passing ship because he’s read that cruise ships sometimes sink, so why take the risk?

This fear of invisible bond vigilantes is as widespread as it is irrational (Boehner is infected with it too). And yet the Doctor Krugmans of the world will never be able to reason with these people that they should put their trust in science until their fears are alleviated by palliative countermeasures. What’s needed here is some\\\\ security theater. What I’d suggest is a Pigouvian tax on the bond vigilantes.

Last year Sen. Tom Harkin and Congressmen Peter DeFazio, sponsored a securities transaction tax, a 0.03% rate that the Joint Committee on Taxation (estimates future tax revenue just as the CBO estimates spending) said would would raise approx $400B over 10 years.

http://www.harkin.senate.gov/press/release.cfm?i=334643

Instead of a fixed rate, Harkin and DeFazi should peg transaction tax rate at, say, one-tenth of 3 month T-bill rates. Scaling up JCT estimate, a 0.10% rate (consistent with a 1% T-bill rate) would raise $1.2T over 10 years. Meanwhile, the CBO estimates 10 yr net interest cost at approx $4T. In the CBO’s August deficit report, it made the interesting point that every 1% in higher interest rates (over CBO model estimate) would add $1T in net interest. Presumably, 1% in LOWER interest rates would reduce net interest by like amount. So if Harkin and DeFazio pegged transaction tax to a tenth of previous week’s (or month’s or quarter’s) average 3 month T-bill rate, well, that would certainly throw a boat anchor on interest rates. For Tsy’s purposes, it wouldn’t matter where T-bill rates go, they could stay under 0.10% or go to the stratosphere like in the day of JKH’s ancient nemesis Paul Volcker or somewhere in between; over 10 years the deficit would be reduced by trillions of dollars compared to CBO baseline (or even the original Harkin-DeFazio bill).

What’s interesting is that there’d be three different moving parts working The tax itself would collect tax revenue; the fiscal drag created would reduce pressure to raise interest rates thereby reducing Tsy’s net interest costs; and then there would group of investors who’d have a vested interested in bidding T-bill rates down to 0% at, as we’ll see, very little opportunity cost.

Mike’s been a trader in Chicago for years and his comment on the above plan raised an important point.

“.1% ends up being 10 pips on a EURUSD currency transaction, which is pretty huge. Essentially the entire market making structure of the current FX market would be disrupted by a transaction tax of this size.
For Treasury Futures I think this would end up being 4.5 ticks. This is huge.
I guess what I am saying is that volumes would be 100th of the current levels if these transaction taxes were put into place.”

This is a good point, which is the reaso setting transaction tax rates based on a T-bll rates (as opnposed to, say, the Fed Funds rate) lends itself to a certain encouragement for traders to step into to the T-bill auction every week with 0% bids, which would makes their transaction tax, one-tenth of 0%.
What’s neat is that brokers accept T-bills in margin accounts. So the traders would be exchanging cash for T-bills in order to bid down their own tax rate, but, happily enough they can use then those T-bills like cash in their margin account (up to 95% margin, IIRC). So any trader worried about the transaction tax would be be crazy not to sink T-bill rates. The funny thing is, you know who regulates margin accounts? If the Fed wanted interest rates to ever rise from the cellar, they might have first start by tightening up on margin requirements. :o)

Anyway, all of this is unnecessary if both parties (even one would be good) understand that the only deficit that matters is the one in aggregate demand. If the politicians understood that the bond vigilantes lived rent-free in their head and nowhere else, they wouldn’t waste their time seeking grand bargains about deficits in the future instead of focusing on unmet needs in the present. No matter, we must take people as they are, and their first step to recovery is security theater. I believe just the words “Pigouvian tax” will make them start to feel better.

Comments

  1. I disagree on one detail. Krugman doesn’t represent any “science” here, he was one of those “experts” who were and are dead wrong on this, he repeatedly warned of bond vigilantes as recently as Mar 2011. Finally in July that year he was called out by commenters on his blog pointing him to MMT and in November he miraculously “discovered” the answer. He only got it in Nov 2011! Barack is a freaking lawyer, he doesn’t have to know this, he relies on economic “experts” like Summers and Krugman and the like who feed him BS. The real shame here is on Krugman and his pals whose JOB is to know this stuff down cold and they dismally failed.

  2. We’re all works in progress, why criticize people who mostly agree with you?

  3. Will Richardson says:

    Shouldn’t that be security placebo?

  4. In medical trials, a placebo has no actual effect on subject (other than psychological), its simply a sugar pill. What I’m talking about here is something with both actual and psychological effects on subject.

    I probably should have linked to security theater wiki to explain what Schneier meant by the term.
    “Security theater is the practice of investing in countermeasures intended to provide the feeling of improved security while doing little or nothing to actually achieve it. The term was coined by computer security specialist and writer Bruce Schneier for his book Beyond Fear, but has gained currency in security circles, particularly for describing airport security measures. It is also used by some experts such as Edward Felten to describe the airport security repercussions due to the September 11 attacks.”
    http://en.wikipedia.org/wiki/Security_theater