Thursday, May 28, 2009

 

Rising rates reflect Obama/Bernanke stimulus

The ten year treasury closed today yielding 3.54%. Rising rates are a good sign only if they are caused by one thing, an improving economy. Higher rates caused by reckless spending and a too loose money supply is a recipe for disaster. First, we have a huge load of debt to finance and even a slightly higher rate will jack up our payments. This would not be as big a problem if the economy is coming back because of the likelihood that tax revenues would cut the size of the deficit. Stagflation with huge debts is a one way ticket to bananarepublicland, and I'm not talking about overpriced clothes for moderately hip suburbanite.

Given our circumstances I do not see how Obama can do much more of his ambitious agenda without further spooking the bond market. This is the silver lining. In the meantime we should all be doing what the Chinese are doing...not lending the U.S. gov't money for long periods of time.

Update:

I wrote this post a couple of days ago and then decided to post it today so it is a little out of date. Ten year rates got up to 3.68% and mortgage rates jumped even more. Marc Faber, the original Dr. Doom, is out with a prediction of Zimbabwean levels of inflation. I think it is a little early to say that and the fact that the market for U.S. treasuries is so huge will put a brake on the gov'ts ability to inflate our way out of deflation. The way this works is that the Fed has been buying up new U.S. treasury bonds, monetizing the huge deficits of the Obama administration. This money enters the economy and that is inflationary. This should stimulate the economy in the short run but eventually the bond markets, private and public, start to anticipate increased inflation and the process becomes a net drag on the economy.

The key is the anticipation of inflation which raises interest rates, borrowing costs, and that will negate the stimulative effect of inflation. The reason this matters in the U.S. more than Zimbabwe is that our economy is more dependent on the availability of credit at relative cheap prices. Without credit flowing our economy has a very serious problem, as we saw this past fall when the whole system was in danger of collapsing because banks would not lend even to the best creditors.

We are walking a tightrope. I don't envy the Obama administration because either deflation or inflation is not a good option. I favor just letting prices fall to wherever they may. The pulling the bandaid off method. Let's get the pain over with rather than do damage to the countries balance sheet in what I believe will be a vain attempt to stop and reverse the necessary process of bringing asset prices inline with incomes.

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