In an editorial yesterday ("US not in bondage") the FT editors wrote,
Shock, horror: US government bond rates are jumping. Soon, goes the story, long-term interest rates will leap, the Federal Reserve will monetise, inflation will soar and civilisation will end. Actually, no. What is happening is precisely the normalisation the Fed has sought. The government is not off the fiscal hook. But it does have at least some time.
What has happened, quite simply, is normalisation of inflation expectations
Does this mean nobody needs to worry? Certainly not. Desirable normalisation could yet become a panic over the massive prospective bond issuance. Now that the worst of the panic has passed, the administration and Congress need to agree a credible plan for elimination of the huge structural fiscal deficits. As the Congressional Budget Office’s forecasts demonstrate, President Barack Obama’s budget proposal is not such a plan: it leaves deficits of between 4 and 6 per cent of gross domestic product as far as the eye can see. This will need to change soon. But, right now, everybody needs to keep calm. Normalisation is a big success, not a danger.
In his New York Times column yesterday ("The Big Inflation Scare"), Dr. Krugman made a similar point: Inflation isn't a near-term concern, but we do
[H]ave a long-run budget problem, and we need to start laying the groundwork for a long-run solution.
Krugman also brought up the example of Japan, which has borrowed massively in recent years without driving up its interest rates or inflation. What many Americans fear -- our country losing its triple-A credit rating and having its government debt exceed 100% of its GDP -- has already happened in Japan (The CIA World Factbook says Japan's public debt exceeds 170% of its GDP). And yet, Japan's borrowing costs are significantly lower than ours. For example, according to Bloomberg, the current yield on 10-year U.S. Treasuries is 3.46%, versus 1.49% on the 10-year Japanese government bond.
I've wondered for some time about why Japan has so much lower borrowing costs than the U.S., despite having a lower sovereign debt rating and a much higher ratio of debt to GDP, but I haven't heard a convincing explanation yet. When I asked The Atlantic's Megan McCardle about this, she said the answer was Japan's Postal Savings System, but according to Wikipedia, prior to the beginning of its privatization in 2007, that system only held about 20% of Japan's government debt. Perhaps someone will leave a more convincing answer in the comment thread below.