Korva is a scroll of the internet’s best ideas.
Foreign savers kept America borrowing
The narrow yield curve
The yield curve is the spread between two-year and 10-year Treasury borrowing. Over the last 20 or so years it narrowed until borrowing for 10 years cost only 40 to 50 basis points, about half a percent, more than two-year debt on average. For some time the gap was even less. At Goldman Sachs it usually ran 80 to 100 basis points.
Foreign savings
A difference of 30 or 50 basis points sounds small. Central banks around the globe, plus China's excess savings, pulled the gap down, and that allowed the United States to lean in and borrow.
What changed
Something shifted about 40 or 50 years ago. For the first 200 or so years, capital markets and political markets were aligned so the country couldn't borrow too much. Then the broad bond markets of the world kept buying dollar assets and supporting the twin deficits, a trade deficit and a federal government deficit. Borrowing a projected $200 trillion over the next 30 years comes with a steeper yield curve and higher real interest rates, adjusted for inflation.
Why would China's savings lower US borrowing costs?
China ran large trade surpluses for years and invested much of the proceeds in US Treasury bonds. Heavy buying pushes bond prices up, and a higher price means a lower yield. Ben Bernanke, then a Federal Reserve governor, described this as a global savings glut in a March 2005 speech. He argued that high saving in Asia and oil-exporting countries was flowing into US assets.
Why do central banks hold so many dollars?
Central banks keep foreign currency reserves to steady their exchange rates and to pay for imports in a crisis. The dollar is the currency most trade and borrowing is priced in, and US Treasuries are among the easiest assets to buy or sell in size. After the Asian financial crisis of 1997 and 1998, many Asian central banks built much bigger reserves. IMF data show the dollar as the largest share of reserves held by the world's central banks.
How does the yield curve shape mortgage rates?
Banks price long-term loans off long-term yields. The 10-year Treasury yield is the benchmark most closely followed for US mortgage rates. When the 10-year yield rises relative to short-term rates, the curve steepens and long-term borrowing gets more expensive. Thirty-year fixed mortgage rates in the US track the 10-year Treasury yield closely.
More from Freakonomics Radio Network
