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Rising Long-Term Interest Rates Will Pop the Bond Bubble.

Written by Gary North on July 4, 2013

The Federal Reserve adopted QE3 on December 12, 2012, in order to hold down long-term rates, especially mortgage rates. In a press release, it announced:

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and, in January, will resume rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

Result: the opposite. Rates have jumped.

The decision-makers at the Federal Reserve are Keynesians. They do not understand economic cause and effect. They create counterfeit money and expect this to lower long-term rates. It lowers short-term rates, but increases long-term rates. People want to hedge against rising prices.

In his 1949 book, Human Action, Ludwig von Mises described what is going on. Lenders are hedging against rising prices.

He who expects a rise in certain prices enters the loan market as a borrower and is ready to allow a higher gross rate of interest than he would allow if he were to expect a less momentous rise in prices or no rise at all. On the other hand, the lender, if he himself expects a rise in prices, grants loans only if the gross rate is higher than it would be under a state of the market in which less momentous or no upward changes in prices are anticipated. The borrower is not deterred by a higher rate if his project seems to offer such good chances that it can afford higher costs. The lender would abstain from lending and would himself enter the market as an entrepreneur and bidder for commodities and services if the gross rate of interest were not to compensate him for the profits he could reap this way. The expectation of rising prices thus has the tendency to make the gross rate of interest rise, while the expectation of dropping prices makes it drop (p. 540).

Investors think prices will rise. The economists at the Federal Reserve did not factor this into their plans.

Rising long-term rates will force down bond prices. The bond bubble will pop.

Keynesians are hampered. They do not understand economics. This puts them at a disadvantage when they devise their monetary policies.

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2 thoughts on “Rising Long-Term Interest Rates Will Pop the Bond Bubble.

  1. Texas Chris says:

    The only way Keynesian have maintained the political power over economic policy is by supporting the expansion of the nation-state, it's wars, and its welfare. When the dollar fails, we Austrians must be ready to educate, must have been already educating, against the Keynesian mutation of economic theory.

  2. Good point Chris. There's also the bankers who benefit and have a great deal of the government in their hip pockets. Taken collectively, with both politicians and bankers enamored with Keynesian policy, how could it fail to capture the economic profession?
    "Truth forever on the scaffold, lies forever on the throne"