Since 2008, the U.S. federal government has run yearly deficits in excess of $1 trillion and has expanded its debt to $16.4 trillion. Despite this borrowing binge, interest rates on U.S. debt hover at record lows. Why? To paraphrase former Wyoming Senator Alan Simpson, U.S. debt is the healthiest horse in the glue factory. That is, investors are lending to the U.S. Treasury because all other options are more risky. But it goes beyond this.
During its 100 years of operations, the Federal Reserve (Fed) never matched its current aggressive monetary expansion activity. Since December 2008, the Fed has held its short term interest rate at close to 0%. Furthermore, the Fed has launched three bond buying programs, termed quantitative easing 1, 2 and 3 (QE1, QE2 and QE3). When the Fed Launched QE1 in November 2008, the yield (market interest rate) on U.S. 10-year U.S. Treasury bonds was 3.3 percent. QE3 was inaugurated in September 2012 with the Fed currently purchasing $85 billion per month of long-dated Treasury bonds and mortgage backed securities with the result of driving the rate on U.S. Treasury bonds to 1.8 percent.
At this point in time, the Fed holds more than $3 trillion in bonds, or approximately 18 percent of total U.S. federal debt. By buying U.S. Treasury bonds and keeping interest rates artificially low, the Fed has incentivized the U.S. government to borrow and overspend. When the Fed begins to sell these bonds, which they will, interest rates will move in the opposite direction. A return to pre-QE1 interest rates would cost U.S. taxpayers as much as $240 billion per year. Who will bear this guaranteed added burden?