CAMBRIDGE Six months ago, I wrote that long term interest rates in the United States would rise, causing bond prices to fall by so much that an investor who owned ten year Treasury bonds would lose more from the decline in the value of the bond than he would gain from the difference between the bonds interest rate and the interest rates on short term money funds or bank deposits.

A ten year Treasury has a nominal interest rate of less than 2 . Because the inflation rate is also about 2 , this implies a negative real interest rate, which is confirmed by the interest rate of 0.6 on ten year Treasury Inflation Protected Securities (TIPS), which adjust interest and principal payments for inflation.

But those historical rates prevailed at times when fiscal deficits and federal government debt were much lower than they are today. With budget deficits that are projected to be 5 of GDP by the end of the coming decade, and a debt GDP ratio that has roughly doubled in the past five years and is continuing to grow, the real interest rate on Treasuries should be significantly higher than it was in the past.

America s Interest Rate Puzzle

China's household debt ratio is close to the United States. Is being unable to repay loan more frightening than being unable to afford a home?

Debt service coverage and bond interest

In 2005, US Federal Reserve Chair Alan Greenspan pointed to the phenomenon as an explanation for his famous conundrum interest rates on Treasury bonds were lower than market conditions appeared to warrant. His successor, Ben Bernanke, similarly pointed to purchases of US debt by foreign central banks and governments as a reason why American interest rates were so low.

Given such low yields in most of the world, investors will be eager to take advantage of the relative value opportunity offered by rising US interest rates. Add to that America s safe haven status, and the fact that any re pricing of US rates surely would reflect an economic resurgence, and the bid for US Treasuries should be exceptionally strong.

But S amp P s downgrade was a poor decision, taken at the wrong time. If America s debts had truly become less trustworthy, they would have been even more dubious before the agreement reached on August 2 by Congress and President Barack Obama to raise the government s debt ceiling.

But S P s downgrade was a poor decision, taken at the wrong time. If America s debts had truly become less trustworthy, they would have been even more dubious before the agreement reached on August 2 by Congress and President Barack Obama to raise the government s debt ceiling.

With the price level falling and the population aging, the Japanese consider the real return attractive. As long as US banks can borrow at near zero and buy government bonds without having to commit equity, and the dollar does not depreciate against the renminbi, interest rates on US government bonds may well be heading in the same direction.

The real reason why Japanese interest rates are so low is that Japan s private sector has little appetite for investing abroad and prefers ten year government bonds at 1 to cash at 0 . With the price level falling and the population aging, the Japanese consider the real return attractive.

Interest payments on the debt eventually become so burdensome that bondholders demand higher interest payments (Greek debt recently yielded over 30 ). Interest rates on US government debt remain low, so this threat is prospective, but future deficits will be far higher than government projections when rates normalize.

His estimates imply that foreign sales at a rate of 60 billion per month raise yields by ten basis points. Given that China has been at it for 2.5 months, this implies that the equivalent of a 25 basis point increase in interest rates has already been injected into the market.

Slow Growth for US Interest Rates

US Interest Rates Will Continue to Rise

The low interest rate on long term Treasury bonds has also boosted demand for other long term assets that promise higher yields, including equities, farm land, high yield corporate bonds, gold, and real estate. When interest rates rise, the prices of those assets will fall as well.

Even if the Fed ignores deflationary pressure and hikes interest rates more quickly, medium and long term rates are still likely to be anchored, given how little yield is available elsewhere in the world. Yields on German Bunds are now negative out to eight years.

12. On the occasion of previous discussions on the matter of the interest rate to be used, only non indexed United States Government Bonds were available.

With the Lebanese pound (LL) pegged to the United States dollar, the prevailing very high debt to GDP and debt to export ratios make that economy extremely vulnerable to adverse shocks.

The US government s net debt as a share of GDP has doubled in the past five years, and the ratio is projected to be higher a decade from now, even if the economy has fully recovered and interest rates are in a normal range. An aging US population will cause social benefits to rise rapidly, pushing the debt to more than 100 of GDP and accelerating its rate of increase.

So it is very likely that when the global economy has returned to a sort of normality and safe haven demand has declined, the prices of US government securities will fall and their yields will rise. As a result, China s dollar denominated foreign exchange reserves, which account for the largest share of all the foreign holdings of US government securities, will suffer interest rate losses.

It may seem appalling to expect such a highly indebted country to continue to run deficits but the world is willing to finance the US at negative real interest rates. Indeed, the main international concern has been US policymakers reluctance to raise the government s debt ceiling!

Whereas the average return on FDI in China was 33 for American firms in 2008, the average return on China s investment in US government securities was a mere 3 4 . So, why does China invest its savings so heavily in low return US government securities, rather than in high return domestic projects?

While China has attracted a large amount of foreign direct investment, it has bought an even larger amount of US government securities. Whereas the average return on FDI in China was 33 for American firms in 2008, the average return on China s investment in US government securities was a mere 3 4 .

In fact, the 30 year inflation indexed US government bond yield as of May 4 was only 0.86 , compared with more than 4 in the year 2000. Such rates are similarly low today in many countries.

The problem now is that the natural interest rate that is, the liquid safe nominal interest rate on short term US Treasury securities is less than zero. Thus, the central bank cannot push the market interest rate there.

That warning has already proved to be correct. The interest rate on ten year Treasury bonds has risen almost a full percentage point since February, to 2.72 , implying a loss of nearly 10 in the price of the bond.

Back in March 2009, the Nobel laureate Robert Lucas confidently predicted that the US economy would be back to normal within three years. A normal US economy has a short term nominal interest rate of 4 .

A normal US economy has a short term nominal interest rate of 4 . Since the ten year US Treasury bond rate tends to be one percentage point above the average of expected future short term interest rates over the next decade, even the expectation of five years of deep depression and near zero short term interest rates should not push the 10 Year Treasury rate below 3 .

It is likely to rise to more than 60 of GDP by the end of 2010, with the debt to GDP ratio continuing to increase. The resulting increase in real long term interest rates will reduce all forms of interest sensitive spending, adding further to the economy s weakness.

Annual rate of security

If foreign holders of dollar bonds become concerned that the unsustainability of America s situation will lead to higher interest rates and a weaker dollar, they will want to sell dollar bonds. If that feeling is widespread, the value of the dollar and the price of dollar bonds can both decline without any net change in the holding of these assets.

Given that the assets and liabilities of the Fund are expressed in United States dollars, it is appropriate to develop the assumptions by reference to yields available on United States long term Government Bonds.

Germany, Britain, and Japan all have similarly low long rates. And, in each of these countries, it is likely that interest rates will rise during the next few years, imposing losses on holders of long term bonds and potentially impairing the stability of financial institutions.

Global investors are apparently willing to accept these extraordinarily low rates, even though they do not appear to compensate for expected inflation. Indeed, the rate on inflation adjusted US Treasury bills (so called TIPS ) is now negative up to 15 years.

The Fund apos s bond portfolio was helped by its overweighting in United States and United Kingdom bonds and an underweight position in yen bonds.

36. Africa s external debt burden is the highest among developing countries in terms of the ratio of external debt to GDP and its debt service ratio.

Indeed, according to the OECD, by the end of this year, America s national debt GDP ratio will climb to 108.6 . Public debt in the eurozone stands at 99.1 of GDP, led by France, where the ratio is expected to reach 105.5 , and the United Kingdom, where it will reach 104.2 .

Latin American debt indicators generally indicated a sustainable debt position for the region as a whole, with a debt service ratio of 12 per cent, debt stock to exports and to GNP ratios of 103 per cent and 43 per cent respectively, and a short term debt to reserves ratio of 71 per cent.

The bonds carry market interest, but the State guarantee is equivalent to a subsidy.

NEW HAVEN The prices of long term government bonds have been running very high in recent years (that is, their yields have been very low). In the United States, the 30 year Treasury bond yield reached a record low (since the Federal Reserve series began in 1972) of 2.25 on January 30.

Indeed, the US remained the world s premier creditor nation until 1986 1987, when it became a debtor nation again. In the two decades that followed, America s debt usually was around 3 trillion, rising or falling with the exchange rate of the dollar.

Although it is difficult to know how much of this decline reflected higher demand for Treasury bonds from risk averse global investors, the Fed s policies undoubtedly deserve some of the credit. The lower long term interest rates contributed to the small 4 rise in the S amp P 500 share price index over the same period.

Although it is difficult to know how much of this decline reflected higher demand for Treasury bonds from risk averse global investors, the Fed s policies undoubtedly deserve some of the credit. The lower long term interest rates contributed to the small 4 rise in the S P 500 share price index over the same period.