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June 25, 2009

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Pretending not to be annoyed at not... wait, I missed. What did I miss?


Doug M.

Dude, I can't /tell/ you. If I did, I could no longer pretend to not be annoyed!

"You hear a lot of worring about how interest rates are going to rise from all this wild borrowing. Where will the money come from? We are doomed, doomed!! No links, because I actually like and respect many of the people doing the worrying. But they need not."

I think you're overconfident.

I see two routes to (dangerously) rising interest rates from here. You hinted at one above:

"Final demand will fall. In that situation, we might be wishing for another round of stimulus, rather than worrying about the deficit."

One of the problems with the government as borrower/consumer of last resort is that it moves credit risk from the American economy as a whole to the American government. Uncle Sam can pay rising debt service in three ways:

1. Tax rates hold steady and the economy grows = good.

2. The economy stagnates but tax rates are increased = bad.

3. Expansionary/inflationary policies = higher interest rates.

The other route is the carry trade.

Go back to scenario 2 above. If American investments are yielding bupkis, Americans will send their money abroad.* Reading between the lines of Brad Setzer's blog, that's already happening. This will add to the downward pressure on the dollar and the upward pressure on interest rates for dollar denominated investments. Including Treasury securities.

I'm not saying that interest rate problems are inevitable, but avoiding them will be harder than you say.

*I know the carry trade hasn't caused inflation in Japan. But the carry trade that was popular last year, short dollar/long oil, certainly contributed to inflation in the US.

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