What does the collapse in US Treasury Bond interest rates really portend?
posted at 12:31 pm on June 2, 2012 by Jazz Shaw
It was the biggest story of the week… at least among the financial geeks. What’s that, you say? You missed it? Well, here’s the screaming headline for you. The interest rate on a ten year US treasury bond hit 1.53760 percent.
So what? Here’s what.
The current title on our CHART OF THE DAY today is simply 1.53760 percent, which represents the current yield on a U.S. 10-year Treasury.
For folks in the financial industry, that number is “mesmerizing,” but we also recognize that a huge swath of the population has no idea what this means or why it matters.
The U.S. Treasury rate just represents the rate at which people are willing to lend money to the U.S. government. So when the 10-year U.S. Treasury is at 1.53670 percent, it means people are willing to lend to the government, and receive only 1.5370 percent interest each year for the next 10 years.
If you lent the government $100, each year you’d get a payment of about $1.53 (the principal is ony repaid at the end of the 10 years).
The important question is: Why are people willing to part with their money for so long and receive such a pittance in payback? The government’s debt-to-GDP is about 100 percent, and many mainstream pundits, politicians, and economists warn about an imminent U.S. debt crisis ala Greece.
Well, the fact of the matter is that the size of the U.S. debt or deficit just doesn’t matter that much. Actually, it’s never mattered at all.
(Emphasis mine above.) The idea that “the debt doesn’t matter” is pretty much anathema to conservatives, and for good reason. It’s a founding principle of political activism today and would seem to be supported by the impending collapse of European nations with liberal spending policies. But facts can be stubborn things. Here’s the money shot chart (if you’ll pardon the phrase) from Business Insider which charts the debt against the confidence of investors who place their cash in the hands of Uncle Sam.
You can read the long form explanation from the author, economics guru Joe Weisenthal, at the link above. But it just didn’t add up for me, so I thought it would be an opportune time to interview Mr. Money Game on the subject. The results follow.
Hot Air: Let’s start with chart #1 in your article where you say, “Well, the fact of the matter is that the size of the U.S. debt or deficit just doesn’t matter that much. Actually, it’s never mattered at all.” The numbers on the chart certainly seem to support it. But the conventional wisdom in conservative circles is that a vastly expanding debt is a huge threat to the future stability of the American economy and, in fact, its government. Do you interpret this data as meaning that there is no real threat from a spiraling debt, even if it completely swamps the nation’s GDP? Are the “smart people” still investing in US treasuries because they know this and we’re all fooling ourselves? Or could the “smart people” be wrong?
Joe Weisenthal: Out of control government spending could theoretically be a problem, but not in the way it’s typically thought of. The US is not going to “run out” of money, because the US prints its own currency. The real issue is: If the economy gets cranking again, and the government doesn’t slow its spending, inflation would be a problem. Also: Big deficits seem to be associated with a weak currency, so that could one day be a problem. So large scale government spending could be a problem, but not in the typical “interest rate surge sovereign debt
spiral” that’s usually imagined.
As for the “smart people” being wrong, I don’t think that’s the best way to think about this. In fact most smart people have been wrong about the Treasury bull market for the last decade. The fund flows.
HA: Sticking with the first chart, interest rates on treasuries seemed to respond to recessions (at least a little) in 70, 75 and the end of the Carter administration (to a large degree) but since then they seem to have completely ignored recessions, including the latest one. Does this mean that the “smart people” just ignore the state of the economy and assume that US treasuries will just always be the safest bet?
J.W.: That’s a good point that for the most part, interest rates have been grinding lower, though they still fluctuate with the economic cycles. One angle that I didn’t cover is demographics. As society ages, that prompts people to reallocate more of their investments from stocks to bonds, so that could explain a lot of the big multi-decade trend.
HA: Your third chart deals with growth in the economy (in GDP) and how that affects the confidence the “smart people” express in the future of America’s ability to pay back its debt a decade hence. Growth has been generally declining since the mid 80s, with some exceptions for the Clinton tech bubble in the 90s and the 2005 period, but interest rates continue to fall, expressing continued, increased confidence in the ability of the US to pay its debts over the long run. If we’re shrinking, how does this translate? Are we just the least crappy deal available in a generally crappy global investment market?
J.W: Again, this is why I think that “ability to pay” isn’t an issue at all. If it were, then yes, we’d be like Spain, where a recession would in fact threaten the tax revenues of the state and thus the ability to pay. As long as the US borrows in its own currency, which can be created at will, the market isn’t going to assign any kind of credit risk to US debt.
HA: I recently watched an analyst on CNBC talking about the “lost decade of private investors” since 2000. There has been a general sense of this for some time, but recent scandals seem to have brought it to the front, including Facebook most recently. Could some of what you are demonstrating in this column be attributed to a general sense in the public sector that the investment market is pretty much rigged, and “the rich get richer while Enron rips off the rest of us” and why should the little guy even bother investing if the fat cats will keep taking care of their rich friends and collecting their massive bonuses while they piss away our 401Ks? Not to put too fine a point on it, but is the jig up?
J.W.: There’s probably something to this. Since the burst of the tech bubble, there’s been a major decline in “retail” participation in the market.
Some of this could be due to individual scandals (Enron, etc.) but there are some other factors at play. One is, as noted above, the demographic shift. As people age, it just makes more sense for them to be more in fixed income, and less allocated in stocks. Also the emergence of stuff like index funds and ETF really have made it less appealing to trade individual stocks.
The FT recently had a “Death Of Equities” headline (alluding to some of these trends), which as market fans know, was the same headline that BusinessWeek once had in the late 70s, right before the biggest bull market of all time So all this talk about the jig being up, and nobody liking stocks could always represent some kind of bottom for equity participation.
There you have it. I’m still not sure if this is an argument for spending our way out of a problem or just an admission that the markets move in a different world of thought than the common guy on the street. I leave it to the reader to judge.