What falling Treasury yields are telling us

Jeff Spross

As panic spreads across both American and international markets, U.S. Treasury yields are plumbing hitherto unheard-of depths.

Yields were over 1.5 percent as recently as mid-February, but fell as the potential economic threat of the coronavirus became apparent. Last week, yields on 10-year Treasuries broke below one percent for the first time in, well, ever. When an oil price war between Saudi Arabia and Russia exploded over the weekend, they punched below 0.5 percent to briefly touch 0.318 percent. Even the long-term 30-year Treasury reached an unprecedented low of 0.702 percent. As of this writing, both had recovered slightly, but remained below the record-breaking one percent threshold.

What does that mean, though?

Most immediately, falling Treasury yields indicate a "flight to safety" by investors, as they dump riskier assets and buy up U.S. Treasuries — the safest asset there is. But the sheer depths to which Treasury yields have fallen suggest something bigger is going on: A long-standing equilibrium in the economy, and in economic policymaking, is finally reaching its end. And some things will have to fundamentally change if a new sustainable equilibrium is to be found.

Yields are not quite the same thing as interest rates. But they're a rough approximation for the interest the U.S. federal government has to pay for new borrowing — and, by extension, a rough approximation for interest rates throughout the economy. More relevant to our purposes, U.S. Treasury yields fall as prices rise for Treasuries on the financial markets. In other words, plunging yields indicate soaring market demand for Treasuries.

Of course, the way we "manufacture" more Treasuries is by having the federal government borrow more money. Falling yields are basically a market signal that demand for government deficit-spending is rising! There's an irony here, in that the biggest deficit hawks in American politics also tend to be people who talk a big game about obeying market signals. And that's something to keep in mind as President Trump's administration and Congress debate stimulus and public investment programs to combat the coronavirus' economic impacts — and, in particular, how to "pay for" that spending.

But the fall in Treasuries also long predates the coronavirus. In fact, Treasury yields have been falling more or less nonstop since 1980. The COVID-19 outbreak just sped up the final descent to zero. What does it mean that market demand for federal deficit spending has been rising almost continuously for four decades?

Here's the natural self-correcting mechanism that interest rates are supposed to serve: Some sort of panic happens, economic activity contracts, and interest rates fall as the flight to safety occurs. But lower interest rates also make it cheaper for people and firms to get loans for any number of activities — buying a house, buying a car, consumer spending via credit cards, start-up capital for a business, or expansions to an existing business. That should lead to more spending, which leads to economic recovery.

But borrowing does not occur in a vacuum: If a business is going to take out a loan, there needs to be a certain pre-existing amount of "background" spending in its market to justify the investment. If that background spending isn't there, the business isn't going to take out a loan regardless. Similarly, if job and pay opportunities are bad enough, people can't pay back their debts no matter how low interest rates fall. That interest rates have been falling steadily for decades suggests that background spending has been falling too. (Why it's been falling is beyond the scope of this column, but it's basically thanks to rising inequality, wage stagnation, and the disappearance of good jobs for most Americans.) Interest rates have had to fall ever lower to correct for that, and once they hit zero, they won't be able to correct any more.

This is where the current setup for U.S. economic policymaking becomes crucial. As I mentioned, there are a lot of deficit hawks in U.S. politics, and despite the market signals, deficit spending is not popular. Instead, we primarily rely on the Federal Reserve to manage the economy and boost us out of recessions. But the way the Fed does that is by adjusting interest rates! And the long fall in interest rates constrains the Fed's ability to do its job every bit as much as it constrains the economy's broader ability to self-correct. After each American recession since 1980, the Fed's target rate has fallen lower and lower, never able to rise to its previous height before the last crisis. As interest rates bottom out at zero, the Fed will lose the last of its room to maneuver as well.

This brings us back to how demand for government deficit-spending specifically has been rising. Interest rates boost the economy by encouraging more borrowing, but that's a tool that can only stretch so far — loans always have to be paid back by the people and firms who do the borrowing. Federal deficit spending is the one way to introduce new spending into the economy that doesn't have that downside. Federal spending on public investments, on grants, and of course on welfare state programs, all puts money into the hands of businesses and individuals — and thus increases that "background" spending — with no strings attached. Falling yields aren't just a market signal that the economy needs more money; it's a signal for more money via the route of federal spending specifically.

This has implications way beyond the coronavirus crisis, if we want to get the economy out of its long-term decline. But it matters for the response to COVID-19, too.

The government has already passed $8.3 billion in emergency spending directly related to public health needs. But Democrats are proposing things like increased unemployment benefits, a federal paid leave program, and more spending on programs like food stamps. Even Trump himself floated the idea of a payroll tax cut, which — unlike tax cuts for the wealthy and corporations — would immediately get money into the hands of average working Americans.

These are all good ways to juice the background spending that keeps the U.S. economy humming, and that provides the foundation that interest rate adjustments need to do their job. Unfortunately, the deficit hawks in Trump's administration — such as National Economic Council director Larry Kudlow — are brushing aside those ideas in favor of more limited business tax breaks. More perversely, they're insisting the Fed is best positioned to deal with the coronavirus crisis — even as officials at the central bank, aware of their deteriorating situation, try to push Congress and the White House to step in with direct fiscal stimulus.

It's anyone's guess how this will end. American policymakers have managed to happily ignore the straightforward economic implications of falling Treasury yields for decades now. But eventually, coronavirus or no, something will have to give. Because there's not much room left before zero.

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