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Home Publications Blogs Beat the Press Panic About U.S. Debt Might Cause Interest Rates on U.S. Government Bonds to Fall or the People Who Say Such Things Might Just be Confused

Panic About U.S. Debt Might Cause Interest Rates on U.S. Government Bonds to Fall or the People Who Say Such Things Might Just be Confused

Sunday, 13 October 2013 14:33

When people worry about the security of an asset the price usually plummets, as was the case with mortgage backed securities when the housing bubble burst. It is pretty hard to envision the opposite scenario: that because people get concerned about the security of an asset its price rises.

However this is what Ezra Klein tells us in a column today. The story is that worries over the possibility that the U.S. government is becoming dysfunctional could actually result in the price of U.S. government bonds rising.

"The paradox is that defaulting on our debt could lead to a panic so severe that, in a desperate bid for safety, markets will buy even more of our debt. 'We are the only country in the world where a fiscal mess, rather than increasing spreads, pushes yields lower,' El-Erian said [Mohamed El-Erian, chief executive officer of Pacific Investment Management Co.]. 'If there was another round of debt-ceiling fight with no agreement, we might have lower 10-year Treasury yields, rather than higher.'"

The basis for the idea that uncertainty about the stability of the U.S. government will lead people to buy more U.S. government debt seems to come from the experience in the summer of 2011 when the price of U.S. Treasury bonds soared and interest rates plummeted as we came within days of hitting the debt ceiling.

The problem with this story is that there is a more obvious explanation than people rushing to buy Treasury bonds because they were worried about the instability of the U.S. government. Italy suddenly made the list of euro zone crisis countries that week. While euro zone could have almost certainly withstood a default by Greece, a default by Italy would have almost certainly meant the end of the euro.

The very real risk of the collapse of the euro gives a perfectly plausible explanation for the plunge in world stock markets and U.S. interest rates, even if Boehner and Obama were spending their afternoons having beers together and telling jokes. In other words, the history to date suggests that there is little basis for serious concern about the hostile relationship between the parties imposing a major cost in the form of higher interest rates.

I hate to spoil the efforts at building fear and panic, but this is getting more than a bit overblown. Hitting the debt ceiling would undoubtedly be bad news, but an earth-shaking disaster is pretty unlikely. Everyone will get their money, with interest, even if it is a bit late.

The annoying part of the fear story is the implication that somehow things are okay now. We are throwing $1 trillion of potential GDP in the toilet every year because Congress and the President won't approve enough stimulus to get the economy back to full employment. And millions of lives are being ruined because people can't get jobs and earn enough money to raise their kids properly.

The media want us to get all bent out of shape because we could cross the magic line and then suddenly have to pay a risk premium of 5-20 basis points on government debt for years into the future? Sorry, for those of us who know arithmetic that doesn't come close to the disaster we are already seeing.

Comments (11)Add Comment
written by foosion, October 13, 2013 4:01
Slower growth should cause lower interest rates, all other things being equal. More risk should cause higher interest rates, all other things being equal.

It's quite possible the DC mess will do more harm to growth than it adds risk premium, resulting in lower rates.

As you say, the real story is the human disaster of high unemployment. Not to mention cuts to food stamps, head start, education, infrastructure, etc., etc.
written by Lord, October 13, 2013 4:46
Panic over availability rather than security
written by Last Mover, October 13, 2013 7:21

Think of the upside. The fear and panic of default in one direction trumps the fear and panic of hyperinflation and exploding interest rates in the other direction.

As FDR would say, we have nothing to fear and panic but fear and panic itself.
Truth but..
written by Jim, October 13, 2013 7:32
I think the more interesting debate stems from Krugman's 4 pcnt of GDP austerity shock and how that would impact yields. Alternatively, if the Dems prevailed and automatic spending cuts are reversed, would that have the opposite effect? I doubt either way 10 year yields would range much from 2.65 to 2.8, but still an interesting question.
written by winstongator, October 13, 2013 8:16
What Klein fails to mention is that if we instantaneously balanced the budget, we'd enter a recession pretty quickly. Apart from other effects, re-entering a recession would make bonds more attractive as an investment. He briefly mentions, 'where else will you put your money', but doesn't explore the logic fully. Krugman often points out that lowering yields are not a sign of strength in your economy, but of weakness.
written by watermelonpunch, October 13, 2013 9:16

The annoying part of the fear story is the implication that somehow things are okay now.

Replace "annoying" with "maddening".
A little bit late?
written by Procopius, October 14, 2013 4:14
I don't know about you, but I pretty much live from Social Security check to next Social Security check, and toward the end of the month I go to cheaper brands of cat food (not from steak to chicken like those plutocrats advocating the Great Betrayal). To me, "a little bit late" means "a little bit hungry."
written by RN, October 14, 2013 8:08
Boy are you wrong.

To lose the only safe asset in the world could do unspeakable harm, if only because no one quite knows the full impact, and in such a situation (as we saw in 08) the natural reaction is "Sell everything".

Feels like 2008
written by Jennifer, October 14, 2013 11:45
It really does feel like we have been here before. The vast majority of the population is not, at least for the very short time things are in flux, going to be affected. It seems like the threat of default is being treated like a weapon to make budget cuts that otherwise wouldn't get approved.
written by watermelonpunch, October 14, 2013 4:21

I'm with Jennifer.
Yesterday, today, tomorrow...
Day after day, is there any reason for an uptick in fear or concern? Things are not okay now.

And it just goes to show that it's kind of like how torture is ineffective at getting at the truth.
But it is effective at getting people to lie, or do or say anything to get the torture to end... even if it never ends.

And it looks like that's what's going on here.

We're being threatened, and tortured... into accepting anything, saying anything, believing anything, to get the torture to end.

But the torture tomorrow will probably be just like the torture today and yesterday.
So will the results be any different?

No, and that's the point of torture, isn't it.

It's not really an effort to get at the truth or effect any meaningful productive change.
The purpose is to get people to say & do what you want them to say & do... for whatever reason it serves for the torturers.
written by kharris, October 15, 2013 9:45
The reason to get bent out of shape about the debt ceiling is that it, too, represents a policy choice to screw up the economy. Would the debt ceiling screw-up be of similar magnitude to the austerity screw-up? I don't know. Neither do you. It is, however, well worth reporting on the debt ceiling as a potential source of wasted economic activity and welfare.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.