One of the biggest things that has frustrated and surprised a lot of people is that the long-term bond in the United States has declined to 1.50 percent in yield. This seems to make no sense, with a 1.5 trillion dollar debt, or about 8 percent of GDP. Even the so called PIGS of Portugal, Italy, Greece and Spain have for the most part smaller budget deficits.
In addition we have seen a turn in Chinese buying, where the chinese have actually sold or stopped increasing their buying in recent years. Less demand and more supply should mean higher yields. However, the opposite has occurred.
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The yield on the US bond continues to decline. Part of it is Operation Twist by the Fed, where the central bank is buying long-term bonds. Much of the U.S. debt is short-term, 5 years or less, so the buying of long-term bonds has had a big impact on this market. The Fed this week announced plans to buy another $267 billion of bonds in Operation Twist.
Some like myself have argued that as U.S. deficits get larger and larger rates will go up. We point to Italy, Ireland, Greece, Spain and Portugal, all of which have seen very high interest rates in the face of debt crisis. However, you can also point to Japan, which, despite a debt of over 200 percent of GDP and a 20 year stagnant economy, yields near 1 percent .
So the question is - to quote the 1980s hit song “Are we turning Japanese?” - the theory behind the Japanese rates is that the bubbles scared people away from taking risks and they are happy to see return of capital rather than return on capital.
However, I doubt this. First, the U.S. has been much more aggressive than Japan in terms of printing money and fighting the crisis. The yen has appreciated greatly in past years and the U.S. is trying to depreciate. Even with the recent dollar rally, the current dollar index value of 81 is a very very low level on a historical basis.
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Last, the big difference is the makeup of the debt. In Japan over 95 percent of its debt is owned by Japanese. In the United States, Americans own only about 46 percent of debt, meaning it's more at the whim of foreigners. In addition, the makeup of debt in the U.S. is more short-term orientated, so if there is a spike in rates as foreigners demand more return on their capital as the debt increases, this would severely harm the government.
I think we are near the bottom of the interest rate cycle, and rates will climb higher. However, rates have already fell longer and lower than I thought they would. It could take a while for this to play out. However, please do not think that the U.S. is above the law of economics. Its debt problems are just as bad as Spain , Italy, etc. Rates at some point will climb in the United States, and I highly doubt we are in a Japan situation.
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