THE CONVENTIONAL WISDOM IS ALWAYS WRONG:

Amid Gigantic Deficits, the Bond Market Shrugs: With the U.S. budget gap reaching a mind-bending level, why are Treasury yields lower than when the government ran a surplus more than a decade ago? (Chris Farrell, 2/19/10, Business Week)

But here's the puzzle: If the federal government's fiscal position is so financially parlous, its need for debt financing so insatiable, and our political system so bankrupt, then why is the interest rate on U.S. government bonds lower than at the beginning of the 2000s, when the government ran a budget surplus and was paying down its debt? For example, the yield on the benchmark 10-year U.S. Treasury bond is currently around 3.8%. Last year, the yield averaged 3.3%. The budget deficit in the latest Economic Report of the President is projected to be -$1.5 trillion in 2010. Last year, the White House Council of Economic Advisers pegged it at -$1.4 trillion. Yet from 1998 through 2001, when the U.S. government was in a budget surplus for the first time in three decades, the 10-year Treasury bond yield ranged between 5% and 6%.

What is the message in government bond yields? That the conventional fiscal pessimism could be wrong, deeply wrong. [...]

The most important factor behind investor steadiness may be a considered judgment that the U.S. political system may be messy and noisy, but it has also proven itself to be highly flexible and adaptable. The insight was noted by Daniel Cohn-Bendit in the mid-90s. Better known as Danny the Red, the charismatic student who briefly led the 1968 revolt in France, Cohn-Bendit was equally dismissive of the French government three decades later when the mandarins abruptly announced a series of major policy changes to close yawning deficits. The nation was rocked by strikes, and the government retreated. "In America, before major changes in anything there are Congressional hearings, public debates between Congress and the President, and a whole process of public discussion that is completely absent in France," Mr. Cohn-Bendit told the New York Times. [...]

Resilience is a hallmark of the American political system. A major strand of America's political history is that whenever widespread economic abundance is threatened, the political system adapts. In his magisterial People of Plenty: Economic Abundance and American Character, the historian David Potter argued in the 1950s that what American democracy was really committed to "was realizing the potentialities of our unmatched assets and raising our standard of living." From 19th century land reform through the New Deal, the "tactics by which this was done changed as the form of abundance itself changed, but the basic purpose—to keep our population in contact with the sources of wealth—has remained steadily in the ascendant throughout our history."

Simply put: Wall Street is betting that history still holds.