Scared to Death

Assuming current fiscal policies remain in force, our economic model suggests that interest rates will rise considerably over the next decade, with the yield on the 10-year Treasury note reaching nearly 9% by 2021.

– Private interest rates will rise as federal borrowing competes for saving that might otherwise finance private investment.

– In addition, yields could rise if there is growing risk associated with current fiscal policy. If such risk is systemic, it raises yields generally. If it reflects a growing probability of sovereign default, it raises Treasury yields relative to private yields.

– Rising rates would be a precursor to something worse: a full-fledged fiscal crisis with further sharp increases in yields, declines in stock prices, and a plummeting dollar.

Macroeconomic Advisers as quoted by James Pethokoukis

Pethokoukis says “this is bad. Really bad.”

My take: this is bogus. really bogus.

At a time when the US government is getting free money, borrowing on the short end for zero percent and interest rates are 3%, not 9%, why would anyone believe this stuff? Riddle me this: why aren’t Japanese JGBs yielding 9% instead of 2% all the way out to 30 years when they have debt to GDP of 200%?


I’ll tell you why: this piece from Macroeconomic Advisors is another example of bogus, junk economics driven by ideology. The purpose is to scare people into supporting spending cuts to bring the debt burden down. It’s not like you want the US to be like Japan, so there are plenty of reasons and ways to bring the debt burden down without utilising voodoo economics.

Yields don’t rise if there is growing risk associated with current fiscal policy. This is just made up. The Federal Reserve controls short-term interest rates through open market operations The yield curve as represented by the term structure of interest rates reflects mainstream market place expectations of future short-term interest rates. We will need to see some serious inflation to get the Fed to start hiking rates enough to justify a 9% yield. More likely, the Fed will remain on easy street for “an extended period”.

If the Fed is destined to keep rates below three percent for the next ten years, why would you sell a 3% bond at a yield of 9%. That’s a price that is a massive loss when all you need to do is hold to maturity. It makes no sense at all. That’s why JGBs yield 2% out to 30 years despite a debt to GDP twice that of the US.

But, of course, people worry that the federal government won’t be able to sell its bonds. The Fed just showed us with quantitative easing that they can and will be the buyer of last choice. So unless the Fed is about to allow interest rates to spike and kill the economy, I don’t see how you get to 9%.

Fear mongers want you to be scared to death that interest rates will skyrocket. As I have said many times in the past, long Treasury rates reflect inflation and interest rate expectations. Full stop. The default risk isn’t there since government creates the currency in which the debt is denominated.

It’s only when government acts like it would default for political reasons that you might get a default premium, creating a non-existent problem for ideological purposes. And even then that doesn’t get you to 9%. Ignore the fear mongering and stick to cogent, objective analysis and you’ll be fine.

As for the economy, the scare tactics of bond market vigilantes seem to be working.


  1. The default risk isn’t there since government creates the currency in which the debt is denominated. Your assumption I take your assumption on “Print Baby Print”. Pay debt with monetized currency?

    • Yes, currency depreciation is the risk. And certainly inflation is too – that is implicitly what rising rate expectations signal.

      See here for the British example:

      You don’t get to 9% without the Fed hiking rates due to inflation.

      But for the US now, that’s a scenario which is deflationary because of private sector debt levels – as we have already witnessed via commodity price demand destruction. MA’s analysis makes absolutely no sense.

      • I’m not saying I buy the MA “analysis”, but I am confused about something. You seem to be claiming that yield will not rise even if investors refuse to buy treasuries (for whatever reason) because the fed can be the buyer of last resort. But if monetizing that much debt causes inflation and the fed raises rates to combat it is it not fair to say that refusal to purchase the debt led to higher rates albeit indirectly? The only way this cycle breaks down is if the debt monetization does not lead to inflation, or if the fed chooses to keep rates where they are in spite of inflation, but it’s not clear to me which if any of these scenarios you are presenting.

        • why would debt monetization be inflationary?

          Rates will only rise when inflationary expectations rise. The more buyers (government or otherwise) at a certain yield does not equate to inflation. It does equate to a greater savings rate however and greater demand at that level, which if anything will lower yields even further, and both points are actually deflationary pressures in and of themselves. Am I missing something here?

        • The scenario I present shows that investors are sanguine about liquidity and solvency issues for the US because they understand the US creates the currency. This is what accounts for the difference between countries like the UK and Japan versus Ireland and Greece where housing bubble and fiscal circumstances are similar. The rise in Greek and Irish yields are about credit/default risk.

          Moreover, to the degree the US had liquidity constraints because of ‘financial repression’, meaning investors like Bill Gross didn’t want the bonds at the yield/price level offered, the Fed could simply target rates with a rate guarantee which would cause investors to move to that rate.

          See here:

          The only way yields would go higher is because the Fed raised rates. And the only way they raise rates is because the economy has improved or because inflation expectations had become unanchored. None of this has anything to do with budget.

  2. you go harrison!!! Great article laying the smack down!!! I love it.

    and once again the “print baby print” comments come out right away too LOL…you make a great statement that if rates are going to 9% then we are into some serious inflation already so what are these “print baby print” people saying?!?! They have everything all mish-mashed up into a giant, perpetual ball of doom, terror, and gloom for the economy whichever way it goes. LOL

    Plus these “print baby print” people forget that we can also “unprint baby unprint” too if things get too overheated.

    Why this is so difficult to understand is so beyond me…but there we have it.

    Thanks again!!! I’m spreading this one around town. ;)

  3. To truly monetize debt you have to have inflation. Once the dollar is devalued and the debt is monetized the interest on said treasuries would need to go much higher. How high I don’t know. Default from lost reserved currency would also need to be considered since we now inflated the rest of the world with said Petro Dollar. If that status is removed SHTF ! Why would the rest of the world stand for it BRICKS, Swiss looking at Gold standard, China in a currency war and already trading with Russia in Yuan? It is a mish mash and the outcome doesn’t look good. Doom and Gloom I am aware!

    • To truly monetize debt you have to have inflation.

      not true, otherwise we’d only ever see rising yields forever. If what you say is true then how do interest rates drop?

      Once the dollar is devalued and the debt is monetized the interest on said treasuries would need to go much higher.

      you’re forgetting that there are other areas of the economy that are effecting the rate of inflation. Taxes, government spending, unemployment, investment, savings, not to mention the current and capital accounts. Just b/c you pay out interest on a bond does not automatically mean that your economy will be inflationary. You have to realize what’s going on at the macro and aggregate levels of all the sectors of the economy and how they are all effecting one another. Plus interest rates are being paid out (monetized) at the rate that was set for them BACK IN TIME when they were issued, which was tracking inflation from back then. In other words, the interest being paid out today has already priced inflation for today back when it was issued, making your “inflationary” argument null and void as a point of logic based on the very purpose and function of bonds. Am I missing something here?

  4. All you have to do is watch Europe. Same story

    debt ratio relative to its economy

    We will try to monetize but yeilds will go up with a risk off bet and flight to safety.

    EU calls emergency meeting as debt crisis stalks Italy
    The spread of the Italian 10-year government bond yield over benchmark German Bunds hit euro lifetime highs around 2.45 percentage points on Friday, raising the Italian yield to 5.28 percent, close to the 5.5-5.7 percent areas which some bankers think could start putting heavy pressure on Italy’s finances.

    • All you have to do is watch Europe. Same story

      no that’s not accurate at all. The USA and Japan’s monetary system is not the “same story” as the EU’s monetary system. That’s the whole point of what this article and many others is all about. All the EU nations (Greece, Italy, Germany, etc.) gave up their right to print money and service their debt on their own. That’s a real problem for these nations and I agree with you on your analysis there with those nations and economies. However that analysis does not hold up in the USA and Japan’s situation. They operate differently. This article here is proof of that.

      check out these as starters on how our monetary system works:

    • from the article you linked:

      But most ominously, the CBO report warns of a “sudden fiscal crisis” in which investors would lose faith in the U.S. government’s ability to manage its fiscal affairs. In such a fiscal panic, investors might abandon U.S. bonds and force the government to pay unaffordable interest rates.

      this very point is exactly what this article Ed wrote addresses. The debt ceiling is a self-imposed issue and is only a political obstacle NOT a functional obstacle in our monetary system. Big difference. None-the-less rates are still only dropping and the inflation bout has yet to hit. For some reason you just don’t want to except this fact.

      Since when did bond rates stop following the Fed Funds Rate and inflation expectations and start tracking congress? One of us is wrong here and up until this point it has been your perspective, which even Bill Gross shares. Only time will continue to tell us and prove to us who is the victor and what is really going on here.