The value of US Treasury Bonds, (and corporate and muny bonds as well, for that matter) is inverse to the interest rate. If you own a $100,000 bond paying 5% interest, and long-term rates plunge to 2.5%, your bond will roughly double because someone can pay $200,000 for it and still get a yield of 2.5%. I say "roughly" because other factors, such as the maturity date of the bond, can come into play. On the other hand, if interest rates go up to 10%, the value of your bond would fall to roughly $50,000. (This is true if you want to SELL the bond. If you hold it to maturity, you will still get your $100,000 face value. That is why the maturity date also affects the bond price).
Investors, therefore, tend to talk in terms of bond "yields" rather than interest rates. Treasury bond yields have been declining since the 1980s, and therefore Treasury bond prices have been increasing. Presently bond yields are about 1.8%. This is extraordinarily low and as a result bond prices are extraordinarily high. In fact, of course, even the (probably understated) official inflation rate is in the 3-3.5% range. So T-bonds currently yield less than the rate of inflation. The real long-term interest rate is negative. It got that way as a result of deliberate Fed policy. Bernanke's "quantitative easing" and "operation twist" strategies have been undertaken deliberately to keep interest rates low and bond prices high? Why? Because low interest rates make it easier to finance the budget deficit but also, and more importantly, large financial institutions hold large amounts of T-bonds and if bond prices fell, they could become insolvent.
But where's the end game? That's the problem. Bond prices have to rise eventually. If we enter a recovery, interest rates will surely rise. If we "stimulate" with inflation, that might lower rates temporarily, but they will rise again very quickly due to inflationary expectations. That's how they got to be so high back in the 80's. The only other option is for things to stay just as they are which gives you a "lost decade" type of economy that has plagued Japan for the last twenty years. But that seems unlikely because the US savings rate is too low to sustain even that.
So interest rates are going to have to go up, and when they do the value of the holdings of many banks, insurance companies, hedge funds, pension funds, etc. will go down and these institutions will become insolvent.
Some are already technically insolvent. Many will go under. When banks go under, the money supply falls creating a deflationary spiral. Indeed, a significant rise in interest rates could lead the Fed itself to become technically insolvent. Not to worry, though. The Fed can print money. But even if the Fed floods the banks with liquidity, as Bernanke did in '08, it is unlikely to help the economy much since no one will wants loans with businesses failing all around them and unemployment mushrooming upward.
So the only other option for the Fed is to try to "stimulate" the economy by buying Treasury bonds directly from the Treasury Department which will create inflation. That will alleviate the problem but temporarily but at the expense of making a subsequent downturn even bigger which is what always happens when to try to rescue the economy from one bubble but creating another one.
All of this will probably happen within the next presidential term. So this election is really a booby prize because the winner is likely to be the one who will get the blame for all the hard times when the SHTF.
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