Investors Rebuke Feds: Get Ready For Higher Interest Rates

By: Declan McCullagh
Topics: Inflation

(AP Photo/Susan Walsh)

The plan dreamed up by the Obama administration and the Federal Reserve for an economic recovery included a big bet: that interest rates would remain extremely low. That would, they hoped, spur borrowing and lending, encourage mortgage refinancing, and even lend support to housing prices.

We're already seeing signs that this bet may not pay off. One came on Wednesday, when long-term interest rates hit a high for the year when investors forced the Treasury Department to offer higher interest rates. Another may come on Thursday afternoon if investors remain leery of the Treasury's attempt to auction 30-year bonds.

Fixed-rate mortgages are becoming more expensive. A 30-year fixed-rate mortgage is now 6.1 percent, according to financial data firm HSH Associates, up about a full percentage point from a few weeks ago. (This means far fewer people will refinance -- one estimate puts it at 50 percent fewer -- and housing prices in the most bubbly areas may fall even faster than before.)

The reason for the interest rate hikes? Increased fears that the U.S. government is borrowing so much it won't be able to pay it back without printing money. The greater the perceived political and currency risks, the higher the interest rates demanded by investors will be, and the more likely it is that any economic recovery will be stalled.

(Translated: Investors seem to be worrying that America runs the risk of becoming something of a spendthrift, debt-addicted deadbeat who can't stop running up bills she can't pay.)

The primary reason the world's wealthiest nation arrived at this state is deficit spending. The federal budget deficit leaped under presidents Reagan, Clinton, Bush and now Obama; with the exception of a few years under Clinton that coincided with high returns from capital gains during the dot-com bubble, the United States has run a budget deficit since 1970 and significant ones since 1982.

At the dawn of Bill Clinton's presidency, government debt was $4.3 trillion, and increased by only $1.4 trillion in eight years. By the end of George W. Bush's administration, government debt had increased by another $4.9 trillion. After the GM and Wall Street bailouts and the stimulus package, our current president can hardly be accused of fiscal prudence.

This leaves the U.S. Treasury in a precarious position. It needs to borrow nearly $2 trillion a year to finance its budget deficit, and is dependent on the willingness of foreigners (primarily China, Japan, and other central banks) to lend it the necessary cash.

Our creditors are, reasonably, worried that we won't be able or willing to pay back these handsome sums in full -- will congressional Democrats really be willing to slash entitlement spending or increase income taxes by, say, 50 percent? -- and fear the Federal Reserve will simply print money instead. Russia's central bank said this week that it will diversify away from U.S. Treasury bonds, and Brazil and China may follow suit; a Chinese audience recently laughed when Treasury Secretary Tim Geithner assured them their country's holdings of U.S. debt were "very safe."

No wonder that Nassim Nicholas Taleb, author of the 2007 bestseller "The Black Swan," is now betting on inflation. No wonder that Arthur Laffer, the chairman of Laffer Associates, wrote an opinion article this week saying: "We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s." No wonder that the dollar index has fallen in the last few months while gold is up for the year.

It's possible, of course, that the Federal Reserve and the Obama administration can extricate themselves from this situation without any more negative consequences. But as this week's market turmoil shows, it's becoming hard to imagine how their gamble will pay off.

Declan McCullagh is the chief political correspondent for CNET. Declan previously was a reporter for Time and the Washington bureau chief for Wired and wrote the Taking Liberties section and Other People's Money column for CBS News' Web site.
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by tazmjam June 16, 2009 11:19 PM EDT: This is not all about our debt...yes we need to get spending under control, and congress seems to have a lot of problems when it comes to trimming the fat (in fact they like to add it), but other things are at work here also. Let?s not forget that investors are hedging against inflation by speculating on oil which is contributing to the weakening value of the dollar, which in turn will create the inflation they are hedging against. Heck of a hedge when you can say I think something is going to happen...and also have the means to make sure it does. The investors don?t care about our economy, they are out to make a dollar. Congress really this is a no friggin brainer...completely close the Enron loophole, close the Foreign Market loophole, close the swap loophole, make trading fully transparent. At least yank a bit of control away from these idiots. Let us see who?s behind those curtains. What exactly are you waiting for???; Reply to this comment


by gspencer4 June 13, 2009 2:54 PM EDT: I believe that we should borrow some more of the US dollars back from the foreigners that we paid to make the things that we consumed and then throw these same dollars at the wall street financial master geniuses that created this mess. That should work!

You mean to say that this is what we are doing now?; Reply to this comment


by gspencer4 June 11, 2009 5:34 PM EDT: Economic value is created only when you grow something in the earth, extract something from the earth, or make (manufacture or construct) something that is consumable (or useful). Transportation, distribution, warehousing, taxes, sales, delivery, packaging and other similar costs are added to the value (cost) of the product that was initially created by these basic creative efforts.

Industrious nations like China grow wealthy and secure by making enough products to support their needs on their farms, factories and mines, plus earn additional currency by creating additional wealth by exporting products that they manufactured. The health of every other business depends upon these productive industries.

Borrowing US Dollars from China and other wealth generating nations to pay US citizens for raking leaves, environmental cleanup, mortgage bailout, union retirements, TARP, wars, business failures, government payrolls, and etc. to stimulate the economy just makes the existing money have less value and less buying power, but does nothing in the long run solution to the foreign trade deficit problem.

US Foreign Trade Deficit: The USA has created a situation that US gold; US currency; and title to US property and other US assets are leaving the USA in amounts of annual value that are greater than they would be if US citizens were manufacturing the things that US citizens consumed. We must change this situation or we could become a post WWI Germany economically, and this could happen overnight.

A Trade Deficit is created when the USA importing, transportation, distributing and retail sales companies such as WalMart, Home Depot, NTB and etc. pay companies and individuals in foreign countries like China with US dollars to manufacture the things that these US businesses import, distribute, and then sell to the US consumers. Manufacturers such as GM, Ford, GE, Chrysler, GE, Westinghouse and etc. manufacture vehicles, appliances, and equipment made with imported parts that they paid the companies in the foreign countries with US currency to manufacture these parts for assembly of the finished product in the USA that is then sold to US consumers. What is the dollar value percentage of USA manufactured and assembled products that are made with imported foreign manufactured parts and/or sub-assemblies?

The US Federal Reserve publicly received bids of almost 4% interest for $100 billion of freshly printed paper US Treasury securities issued in May 2009 public auctions. This was about double the rate expected by the Treasury Department. The US government will need to "borrow" at least $6 trillion more US dollars from the industrial manufacturing countries before the end of 2009 by conducting more of these same US Federal Reserve auctions. Who knows how high the interest rates will be bid at these auctions. China, and other wealth generating nations already hold a large portion of all US federal debt securities, and they are exchanging these instruments for title to US real estate, farms, agri-businesses, food supplies, dairies, forests, industries, breweries, hotels, factories, casinos, financial institutions, retail businesses, and most other assets located in the USA that they do not already own, since the US government does not redeem these dollars for gold.; Reply to this comment


by gspencer4 June 11, 2009 5:26 PM EDT: I have killed and eaten our cow, and my children are now complaining that we no longer have any milk available. I now have to borrow money to pay our neighbors for milk from his cow, and our family is running out of things to pawn or sell for money. I certainly do not want to go to work in some dirty factory and make money.

Almost everybody in the USA has bought cheaper foreign made goods when we shop. Sometimes these goods were higher quality, especially in automotive vehicles.

We must act now while we can still buy foreign made materials and equipment for the re-industrialization of the USA with the remaining purchasing power of the dollar before we have redeemed all of the exported currency for title to the remaining existing US assets for the imported goods that we consume rather than working to manufacture. The buying power of the dollar will becomes nil when there is nothing left for the foreigners to buy with the dollars that they earned making our consumer goods.

We are losing the opportunity to re-industrialize.

All of the Stimulus spending is a short term solution that will only economically benefit foreign manufacturers of industrial and consumer goods, salesmen of foreign manufactured equipment, materials, etc., and the other people working in the distribution of imported things for our consumption, but the balance of trade will still be sending US dollars and title to US assets overseas to pay foreigners for the things that we import, and this will continue to lower the value of the US dollar.; Reply to this comment


by the74blaster June 11, 2009 4:01 PM EDT: 18% interest is NOTHING! I just heard a story on the radio this morning that quoted some oil company analyst as saying that oil will quite likely be $250.00/barrel this summer!
I'm sorry, I didn't catch the name of the person making the prediction and can't vouch for his/her veracity, I'm just passing along what I heard. Hope it's wrong.
Posted by enough-already at 10:08 AM : Jun 11, 2009

It seems as though the high rollers are going to use bailout money to gamble on oil futures! We should have just left the banks go under and given the mortgage holders the right of first refusal to settle their debt for pennies on the dollar.

I cannot believe we are so stupid to sit back and let the high rollers gamble on oil futures. The esculation in prices last year caused the recession and now we are same position except that they are using TARP dollars to fund their gambling addiction.

They wanted to run on the mandate for change, but it looks the same to me. However, when the true unemployment rate hits 40%, people are getting tossed into the streets by bankers and those wealthy enough to buy up bank owned properties, homeless set up shanty towns in the bigger cities and starvation becomes an issue, watch out because we will get a change than nobody wants.

When are we going to see taxation on futures to stem the wave of speculation?; Reply to this comment


by oftencensord June 11, 2009 3:04 PM EDT: What recovery ?

the American business community is digging in, cutting back, quaking nervously not knowing what crazy scheme Obama is going to throw at them next !... how high will the taxes go ? will we be penalized and fined over health care ? Is inflation going to destroy all our savings?

If McCain/Palin had been elected we wouldn't be faced with this unfathomable deficit spending spree. We would have had tax cuts and stimulus for ALL business, we all would have gotten a big tax credit for health care ALREADY. We wouldn't have wasted a trillion dollars in give-aways and pay-offs, and bail outs for car companies !; Reply to this comment


by tomadams99 June 11, 2009 1:21 PM EDT: Seems to me I remember the Republicans warning the Democrats this was going to happen. We are on our way to Jimmy the loser Carter the second.; Reply to this comment


by enough-already June 11, 2009 1:08 PM EDT: 18% interest is NOTHING! I just heard a story on the radio this morning that quoted some oil company analyst as saying that oil will quite likely be $250.00/barrel this summer!
I'm sorry, I didn't catch the name of the person making the prediction and can't vouch for his/her veracity, I'm just passing along what I heard. Hope it's wrong.; Reply to this comment


by mljohns00 June 11, 2009 1:04 PM EDT: If only the U.S. Government hadn't kept interest rates artificially low seven years ago to hide the underlying problems caused by the unbalanced budget and war spending. If interest rates had been allowed to be where they were supposed to be, the economy would have corrected itself before it was too late.; Reply to this comment


by hologram5 June 11, 2009 11:55 AM EDT: Time to take the federal reserve out of the picture so they don't hose us. They are crooks and nothing more.; Reply to this comment