Posted by Michael A. Kamperman on February 24, 2013
A myth can be defined as a false collective belief used to justify social policy. The idea that one day the markets will turn against the U.S. Treasury market and drive interest rates to an unsustainable level forcing drastic cuts on the U.S. budget is a false collective belief: a myth. Like all countries that are able to issue debt in their own currencies the U.S. federal government has an agency that is charged with controlling interest rates, the Federal Reserve. In Britain they have the Bank of England and in Japan they have the Bank of Japan and so on and so forth for all sovereign debt issuers. The markets do not control the direction of interest rates over any extended period of time. In the U.S. the Federal Reserve controls both short and long term interest rates. Short term interest rates have historically been kept on a very short leash. Long term interest rates are normally kept on a long leash and allowed to roam within an acceptable range. But the Federal Reserve can take control of long term interest rates when it desires to do so. Right now quantitative easing is designed to lower long term interest rates. If necessary, the Federal Reserve could purchase every Treasury Bond offered for sale to bend long term rates to its will. In the early 1980′s the Volcker led Fed took short term rates to 20% to force longer term rates higher in-order to slow down inflation. The simple point is the Federal Reserve is the ultimate arbiter of what rates will be and not the markets.
The myth that markets can take control of U.S. interest rates is the current justification for the U.S. to implement austerity policies. Despite recent evidence austerity is not working on either an economic level or a budget level calls remain to implement austerity based on this false collective belief. More and more people are coming to understand that the U.S. cannot default because it owes everyone dollars, which it can print. But almost no one is pointing out the obvious, it is the Federal Reserve that controls our interest rates and not the markets. The reason rates in Japan are even lower than rates in the U.S., despite a debt to GDP ratio approaching almost triple the U.S. debt to GDP ratio, is the Bank of Japan controls their rates and not markets.
Before the U.S. can create a political climate that will allow the federal government to enact stimulus policies to end massive understated unemployment, the false collective belief that the markets will one day punish the U.S. with sky high interest rates must be exposed for what it is: a myth. Unfortunately, the political conversation surrounding the spending cuts in the sequester are creating an environment whereby harmful cuts to the U.S. economy will not be averted. The President’s call for a “balanced approach” that includes new revenue is a good talking point to prevent additional cuts beyond the sequester. But they are terrible talking points in attempting to avoid the sequester. There is no political support amongst Republicans to raise more tax revenue and insisting tax increases be included in any deal to replace the sequester guarantees there will be no deal. The President should talk about how there is not an imminent threat to the U.S. fiscal position and that high unemployment is a much bigger threat to our nation. He should offer to drop calls for new revenue in exchange for a reduction in spending cuts. After all, the U.S. does not need additional tax revenues because the deficit and the debt are not problems. Unemployment on the other hand is a huge problem.