Friday, October 17, 2014

What Is The Market Saying About Debt?

Economists assume that markets usually get the price right.  The market price for US bonds is rising.  That means that the interest rate, which moves in the opposite direction of price, is falling.  The interest rate on ten year treasuries in the US is under 2%.  What is the market telling us about US debt?  It is telling us a couple of things: Investors are not concerned about the ability of the government to service its debt.  Moreover, the market is not worried about inflation.  The bonds would decline in value if inflation increased.  Investors would be receiving negative interest rates if inflation were greater than 2%.  Moreover, the interest rates on home mortgages is based upon the the yield of ten year treasury bonds.  Mortgage rates are falling.  That will stimulate the housing market and it will enable households to refinance their mortgages at a lower rate.  That will reduce interest payments and allow households to spend their money on other needs.

Robert Samuelson argues in this article that market is not getting the price right.  Apparently, he does not believe in the market system.  He must assume that investors do not appreciate the risk that they are taking when they purchase US treasuries.  He has been writing about rising debt and the threat of inflation for the last five years.  Investors are less worried about US debt and the threat of inflation than Samuelson.  He also fails to understand that investors who purchase US bonds receive an asset in return for their payment.  They are doing the virtuous thing and increasing their savings.  The falling price of US treasuries is telling us that the demand for US debt is higher than the supply.  Unfortunately, it is also telling us that the demand for US treasuries is high because investors are concerned about the risk that they perceive in other assets.  That is one of the reasons why the economy has been recovering slowly.  Businesses are not investing their retained earnings in new capital, or in R&D, at the level that is needed to increase employment.  In other words, they are saving too much or they are using their profits for other purposes.  They are sending dividends to households that are not spending it or they are investing in their own stock.  If business does not want to invest in private goods perhaps it is a good time to invest in public infrastructure.

Of course, every nation is not in the same position as the US, and most of the countries in Europe, which can borrow money to make public investments at very low rates.  Apparently, they do not see the opportunity to invest in infrastructure that might produce a return in excess of the interest rate.

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