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How high debt affects bond rates

You would think that rising government debt levels would lead to higher bond interest rates. Here’s what tends to happen instead. Higher government debt tends to lead to “diminishing returns,” or falling ratios of GDP created per dollar of debt. So, like any drug, it takes more and more to create less effect. Higher debt becomes a greater burden through rising interest and servicing costs.

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The only Phd economist I allow to speak each year at the Irrational Economic Summit is Dr. Lacy Hunt. (You can watch his presentation from this year’s conference here.) Lacy can take that complex science and still see the forest for the trees. He can still find reality from all of that great theory to real-life outcomes.

It also helps that he advises a $4 billion bond fund at Housington Management and has to get the reality of bond interest rates right or face the consequences – which he has for this entire boom!

High Debt Doesn’t Equal Higher Rates

At IES, Lacy started off breaking one natural assumption of investors in his first slide. You would think that rising government debt levels would lead to higher bond interest rates. Higher debt means higher growth. Higher growth tends to cause higher inflation, and that in turn causes higher short and longer-term rates to compensate. Oh, and to sell more debt you have to raise the rates to attract investors to absorb it all.

This chart pretty much proves these natural assumptions are false!

Rising Gov’t debt leads to lower Gov’t bond yields

This picture show a debt graph.

Here’s What Happens Instead

The U.S. accelerated debt as a percent of GDP from 2007 through 2014, and T-bond yields fell from 5% down to 2.5% into 2016 on a two-year lag. Similar for the Eurozone with bond rates falling from 4.5% to 1.0%. Japan has been goosing debt the most from 1998 into 2013 and its bond rates fell from 3.0% to o.7% by 2016 on a 3-year lag. The U.K. was the most extreme in rising debt from 2007 into 2016 with falling rates from 5% down to 0.5% currently.

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Here’s what tends to happen instead. Higher government debt tends to lead to “diminishing returns,” or falling ratios of GDP created per dollar of debt, which Lacy later shows has clearly been the case. So, like any drug, it takes more and more to create less effect. Higher debt becomes a greater burden through rising interest and servicing costs – and that slows economic growth.

It also encourages businesses and consumers to over-invest and that excess capacity lowers prices and inflation.

Voila: Another simple insight in a seemingly complex economy. And why I love Lacy!

(Featured image by Pixabay from Pexels)

DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.

Harry S. Dent Jr. studied economics in college in the 1970s, receiving his MBA from Harvard Business School, where he was a Baker Scholar and was elected to the Century Club for leadership excellence. Harry grew to find the study of economics vague and inconclusive and became so disillusioned by the state of his chosen profession that he turned his back on it. Instead, he threw himself into the burgeoning new science of finance which married economic research and market research. Identifying and studying demographic trends, business cycles, consumers’ purchasing power and many other trends empowered Harry to forecast economic and market changes. Over the last three decades, he’s spoken to executives, financial advisors and investors around the world. He’s appeared on “Good Morning America,” PBS, CNBC and CNN/FN. He’s been featured in Barron’s, Investor’s Business Daily, Entrepreneur, Fortune, Success, U.S. News and World Report, Business Week, The Wall Street Journal, American Demographics and Omni. He is a regular guest on Fox Business’s “America’s Nightly Scorecard.” Harry has also written numerous best-selling books over the years, such as The Great Boom Ahead, The Roaring 2000s, the Roaring 2000s Investors and The Demographic Cliff. In his most recent book The Sale of a Lifetime: How the Great Bubble Burst of 2017 Can Make You Rich (2016), Harry looks at the upcoming economic crisis and reveals how it could be the single greatest chance to build wealth we’ll ever see and how we can capitalize on such a unique and historical opportunity. He explains how many of the richest Americans in history have used this same kind of opportunity to quickly accumulate incredible amounts of money, in a short period of time.

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