The research I've laid out in the past few days (here
, and here
) suggests interest rates are inevitably headed higher. But how much higher?
Over the long term, the average real rate of interest on U.S.
sovereign debt has been around 2% a year. The latest Producer Price
Index (which we believe is more reliable than the Consumer Price Index)
shows price inflation is currently 6.8% annually. Add the 2% real return
we believe investors expect, and you get 10-year Treasury bonds yielding 8.8%.
Currently, those bonds yield only about 3%.
This implies a huge collapse of bond prices – a collapse of more than 50%.
A collapse of that magnitude would completely wipe out the stock market. It would be a massacre.
No one is expecting any of this. Everyone believes something like
this could never happen. Yet this rise in interest rates would only
carry us to the average return bond investors have earned over
the last several decades. It doesn't even consider the kind of panic
selling that would ensue.
In truth, rates might go considerably higher than this for one
fundamental reason. If the bond market crashes, investors would begin
doubting America's ability to finance its debts, never mind
trying to repay them. As rates rise, the cost of maintaining our debts
would grow substantially – perhaps doubling.
Keep in mind, the U.S. Treasury currently pays only 1.4% annually
to borrow $14 trillion. Yes, 10-year Treasurys currently yield around
3%. But because the Treasury has issued so much more short-term debt
than long-term debt, U.S. borrowing costs are lower.