Treasury Bond Rate

The Sorrow and the Pity of Another Liquidity Trap: Brad DeLong

There is only one real law of economics: the law of supply and demand. If the quantity supplied goes up, the price goes down.

Back in the third quarter of 2008, the public held about $5.3 trillion of U.S. Treasury bills, notes and bonds. As the recession hit, tax revenue plummeted, and government spending rose, that total reached $9.4 trillion by mid-2011.

We’re on target to have $10.7 trillion outstanding by mid- 2012 -- doubling the Treasury debt held by the public in just four years. Supply and demand tells us that a steep rise in Treasury borrowings should produce a commensurate fall in Treasury bond prices and thus higher interest rates -- and that increase should crowd out other forms of interest-sensitive spending, slowing productivity growth.

Yet the market has swallowed all these issues without so much as a burp. By all accounts, it’s smacking its lips in anticipation of the next tranches.

In the years of the Clinton budget surpluses -- remember those? -- the U.S. government was repaying $60 billion of debt each quarter. The Bush administration worked hard to make that surplus evaporate. It succeeded.

From 2002 to 2007, the Treasury issued, on average, $70 billion of debt per quarter. Like many watching this shift, I concluded that this expanded supply would exert substantial pressure on interest rates to rise.

The demand for Treasuries was inordinately high, in part because the supply of alternatives was low. Lacking confidence , corporate executives held back investment, reducing private issues of bonds. In addition, China and other emerging economies, eager to keep their currency values low, directed dollars earned from exports into U.S. Treasury debt. Reinforcing this demand, wealthy individuals around the world purchased Treasuries as a hedge.

Thus by late 2007, the 10-year U.S. Treasury rate was exactly where it had been when the Clinton surpluses ended at the close of 2001. “How long could this go on?” we wondered. Eventually the market’s appetite for Treasury bonds at high prices and low interest rates had to reach its limit, right? Supply and demand isn’t just a good idea -- it’s the law.

At the end of 2008, as the economy collapsed and the pace of net Treasury debt increases quintupled, it seemed we were about to discover that limit. I presumed we had a little time for expansionary fiscal policy to boost the economy -- a year, maybe 18 months -- before the bond-market vigilantes would arrive. They would demand higher interest rates on Treasury bonds, which would begin seriously crowding out the benefits of fiscal stimulus. The U.S. government would have to react, pivoting from fighting joblessness, via deficit spending, to reassuring the bond market via long-run tax increases and spending cuts to Medicare and Medicaid.

The Sorrow and the Pity of Another Liquidity Trap | TheCommonGood.org

Back in the third quar­ter of 2008, the pub­lic held about $5.3 tril­lion of U.S. Trea­sury bills, notes and bonds. As the reces­sion hit, tax rev­enue plum­meted, and gov­ern­ment spend­ing rose, that total reached $9.4 tril­lion by mid-2011.

We’re on tar­get to have $10.7 tril­lion out­stand­ing by mid– 2012 — dou­bling the Trea­sury debt held by the pub­lic in just four years. Sup­ply and demand tells us that a steep rise in Trea­sury bor­row­ings should pro­duce a com­men­su­rate fall in Trea­sury bond prices and thus higher inter­est rates — and that increase should crowd out other forms of interest-sensitive spend­ing, slow­ing pro­duc­tiv­ity growth.

Yet the mar­ket has swal­lowed all these issues with­out so much as a burp. By all accounts, it’s smack­ing its lips in antic­i­pa­tion of the next tranches. In the years of the Clin­ton bud­get sur­pluses — remem­ber those? — the U.S. gov­ern­ment was repay­ing $60 bil­lion of debt each quar­ter. The Bush admin­is­tra­tion worked hard to make that sur­plus evap­o­rate. It succeeded.

From 2002 to 2007, the Trea­sury issued, on aver­age, $70 bil­lion of debt per quar­ter. Like many watch­ing this shift, I con­cluded that this expanded sup­ply would exert sub­stan­tial pres­sure on inter­est rates to rise.

The demand for Trea­suries was inor­di­nately high, in part because the sup­ply of alter­na­tives was low. Lack­ing con­fi­dence, cor­po­rate exec­u­tives held back invest­ment, reduc­ing pri­vate issues of bonds. In addi­tion, China and other emerg­ing economies, eager to keep their cur­rency val­ues low, directed dol­lars earned from exports into U.S. Trea­sury debt. Rein­forc­ing this demand, wealthy indi­vid­u­als around the world pur­chased Trea­suries as a hedge.

Thus by late 2007, the 10-year U.S. Trea­sury rate was exactly where it had been when the Clin­ton sur­pluses ended at the close of 2001. “How long could this go on?” we won­dered. Even­tu­ally the market’s appetite for Trea­sury bonds at high prices and low inter­est rates had to reach its limit, right? Sup­ply and demand isn’t just a good idea — it’s the law.

At the end of 2008, as the econ­omy col­lapsed and the pace of net Trea­sury debt increases quin­tu­pled, it seemed we were about to dis­cover that limit. I pre­sumed we had a lit­tle time for expan­sion­ary fis­cal pol­icy to boost the econ­omy — a year, maybe 18 months — before the bond-market vig­i­lantes would arrive. They would demand higher inter­est rates on Trea­sury bonds, which would begin seri­ously crowd­ing out the ben­e­fits of fis­cal stim­u­lus. The U.S. gov­ern­ment would have to react, piv­ot­ing from fight­ing job­less­ness, via deficit spend­ing, to reas­sur­ing the bond mar­ket via long-run tax increases and spend­ing cuts to Medicare and Medicaid.

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