Op-Ed: Default on Social Security Bonds
Only way to address skyrocketing national debt.
How low can interest rates go, and how long will they stay that way? A year ago, I projected that 10-year T-bond yields would fall from 5.35% to 3.35% - a 200-basis point drop. Rates fell steadily to the 3.5% level, stalled for a while, then plunged.
The drive up in demand for T-bonds certainly looks like a blow-off move; all logic -- and the long wave -- suggests a long trend reversal. Some buying a 10-year bond today for 2% will see much of their capital consumed by inflation, even if it returns to relatively modest levels (5%). 5% inflation should put T-bond yields in the 7% range, which would consume most of the capital of a 10-year T-bond purchase over the full term.
Such an investment makes no sense, unless current conditions are responding to different parameters. Therefore all logic suggests T-bonds are overpriced, and must fall off precipitously.
However, the conditions driving yields lower are merely side effects of forced liquidation - which I'm not convinced is over. Stock-market momentum is still negative. While T-bonds are extremely overbought, momentum hasn't declined, not even on a short-term basis.
I do think the economy will rebound very strongly by the end of 2009. The factors driving liquidity are unprecedented. But at the same time, Obama must keep interest rates low.
His administration will be walking a knife's edge. Just as Rubin pushed Clinton to pass NAFTA and made government financing short-term, to save on interest costs, Obama (employing some of the same players) will now want to transfer as much debt as possible to as far off as possible - and at as low an interest rate as possible. Locking in low rates on the massive US debt will be critical to continued policy renewal going forward.
If the US government remains short-term-oriented, the volatility in budget management and the rise in carrying costs will kill any new government spending - and will eventually consume most tax revenues.
15-20% T-bill rates (as seen during the Reagan era) could mean disaster for the new administration. If rates are forced too low, the dollar will get slammed, which could push more T-bills onto the market (as investors flee the currency), which would push short-term rates up. In flooding the marketplace with new paper to fund the new trillion-dollar debt, Obama will have to create a market for T-bonds.
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