Trouble in the bond market: a plea to nip inflation
H. Erich Heinemann was "up on his soapbox," as he put it. The scholarly vice- president of Morgan Stanley & Co., a Wall Street underwriter, was talking about a topic that should be dear to the pocketbook of nearly every middle-class American -- bonds and other fixed-interest securities.
Mr. Heinemann says the bond market is not dead in early 1981. But, he warns, misdirected government policies could easily wound it mortally.
What's hurting the bond market?
Who would get hurt by its demise? he asked rhetorically in a telephone interview.
"Millions of people."
By the effect inflation has on the huge investments in bonds of pension funds , insurance companies, and thrift institutions. These institutions, Mr. Heinemann notes, hold the life savings of a large cross section of the American public.
As he testified several days earlier to the Senate Banking Committee, the fixed- interest bonds and mortgages held by these institutions "are most vulnerable to the tax on wealth that inflation represents. In a social sense, we seem to be according the lowest priority to protecting the capital values of our most productive citizens."
Older citizens with fixed pensions on top of social security are finding that their private pensions are losing half their purchasing power in seven or eight years. Life insurance is losing much of its value for widows, widowers, or their children. Savings accounts are being robbed of their worth; and, perhaps less recognized, the accumulated retained earnings of mutual savings banks and savings-and-loan associations are diminished in real value by inflation, again indirectly hurting their depositors.
Of course, the homeowner with an old fixed-interest mortgage benefits from double-digit inflation. In reality, he gets his mortgage money free at, say, 8 percent when inflation is running around 11 percent.
On balance, however, individuals in the United States represent a net creditor interest, not a debtor interest. At the end of the third quarter last year, the financial assets of individuals (exclusive of the value of residential real estate) totaled about $4.1 trillion. That compares with total debts of about $1.8 trillion.
Moreover, taxpayers still outnumber the beneficiaries of government transfer- payment programs (such as social security, food stamps, welfare, and so on), despite the rapid growth of these programs in the last decade.
In fact, Mr. Hainemann figures that the working middle class (the board center of the electorate) is a net lender rather than a net borrower. Since more than three-quarters of the financial assets held by individuals are estimated to be fixed-income in character, these middle-class workers are vulnerable to the tax on wealth that inflation represents.
Moreover, he notes, as people grow older, they tend to accumulate a higher net worth and to participate more in elections.
Thus, he adds, "there is an odd perversity in governmental policies that have systematically rewarded the debtor over the creditor during the past 15 to 20 years.
"Plainly, the recipient of government transfer payments (whose real benefits have been rising rapidly in recent years) has enjoyed a higher rung on the political ladder than the workingman who has tried to safeguard his savings in Treasury bonds (whose real principal values have been steadily eroded)."
This effect of inflation on fixed-interest securities not only hurts the saver, Mr. Heinemann says. It also hurts everyone by causing low investment, low productivity, and low growth. Those nations with effective long-term capital markets tend to enjoy hugher growth rates. Their standard of living rises faster.
Government uses long-term money to build schools, sanitation facilities, highways, subways, and so on. Private corporations need long-term money at stable costs for expansion of productive facilities.
But the bond market, Mr. Heinemann continues, is already suffering from inflation and the general malaise in the economy. It has become "notoriously thin and unstable," he says. "There have been several episodes over the past 12 to 18 months when long-term money has been largely unavailable even to high-grade borrowers -- no matter what the interest rate."
Bond prices, traditionally thought to be relatively slow-moving, have been exceptionally volatile. Average maturities of bonds are shortening. Some 42 percent of total bonds sold last year were for maturities of 10 years or less. In 1979, the comparable figure was 29 percent. Investors are less willing to tie up their funds for lengthy periods in an unstable market.
Mr. Heinemann says that few if any of the nation's largest life insurers are now willing even to consider providing funds for commercial mortgages on a fixed-rate basis -- no matter what the interest rate. Banks or thrift institutions also are more likely to demand home mortgages with interest rates that vary according to the current market or inflation rate.
He concludes that "we are reaching the point where continuing failure to deal with inflation could permanently damage one of our great national assets -- the broadest and most effective capital market in the world . . . the cost in real e conomic terms will surely be great."