Normal countries, countries with “exorbitant privilege”, and the threat of the loss of same. For even for those those with “exorbitant privilege” cannot be confident the privilege will stick. For them the rules are different—until they aren’t. Looking back at the fall of Liz Truss and the rise of Bill Clinton’s “fabulous decade”. The looming question for today: When do bond markets start cracking the whip? The leash is short for most economies—but even the strongest currencies can lose their safe-haven status if policymakers forget the risks…
J. Bradford DeLong: What Role for the Bond Vigilantes?: “Bond vigilantes”—investors who sell off a country’s bonds if they fear irresponsible fiscal policy—have long played a crucial role. Their appearance disciplines governments’ borrowing and spending decisions. And fear of their sudden appearance on the horizon anticipatorily disciplines, governments’ borrowing and spending decisions.
In most countries, their influence is both immediate and can be severe.
If investors lose confidence, interest rates spike. If the country has any significant debt that needs to be rolled over soon, borrowing costs threaten to become unsustainable. Economic turmoil often follows, and political turmoil always follows as the debt-servicing shock hits the government budget.
The leash, in other words, is short for countries with any considerable amount of debt that they soon need to rollover.
However, there are a few exceptional countries that possess what Valér Giscard d’Estaing labeled and what economist Barry Eichengreen has popularized as exorbitant privilege. That is the ability to issue debt and currency that the world treats as one of its ultimate safe assets. Whenever there is a “flight to safety” in the world economy, demand for such assets rise. And, as long as the country retains its exorbitant privilege, there is no place safer in terms of asset classes to flee to.
For these nations—most notably the United States, and to a lesser extent historically the United Kingdom and, today, the eurozone and Japan—the typical bond market constraints are much looser.
Investors are willing to hold their debt even at very low interest rates because they see it as a secure store of value, rather than a risk-laden financial asset. In a sense, these countries’ government debt functions more like deposits in a highly trusted bank—akin to the role played by early-modern institutions like the Medici Bank—where people effectively pay for the privilege of storing their money safely, rather than expecting high returns in compensation for risk.
Yet even for countries with exorbitant privilege, the bond market’s discipline is not entirely absent. The key risk is the potential loss of that privileged status, which, if it happens, can be sudden, destabilizing, and extremely difficult to reverse.
The United Kingdom under Liz Truss and Kwasi Kwarteng in 2022 provided a stark reminder. Their ill-conceived fiscal plans—massive unfunded tax cuts in an already fragile economic environment—shattered market confidence almost overnight. Gilt yields soared. The pound plummeted. Their government collapsed in record time. Most of the fallout was the result of the peculiar politics of the Palace of Westminster, rather than any material harm to the U.K. economy. But there was fallout.
By contrast, U.S. policymakers in the 1990s in Bill Clinton’s administration were acutely aware of the need to maintain financial market confidence and to guard and protect the U.S.’s exorbitant privilege. Their fiscal strategy—centered around deficit reduction, careful monetary-fiscal coordination, and a commitment to preserving the dollar’s status as the world’s reserve currency—helped sustain America’s exorbitant privilege, reinforced global trust in U.S. debt markets, and produced what Alan Blinder and Janet Yellen named the “fabulous decade” of extraordinarily good macroeocnomic performance.
Thus, even in the most privileged nations, policymakers need to keep this reality in their peripheral vision. Markets may seem forgiving, but the moment they turn, the consequences can be swift and brutal. And they can turn whenever there are alternatives—other assets than their debt—that can fulfill safe-harbor roles equally well.
<https://www.project-syndicate.org/magazine/bond-vigilantes-will-they-come-for-us-other-major-economies-by-j-bradford-delong-et-al-2025-03>
Others commented as well. What do I think of their comments?
