By Brad DeLong
(Bloomberg News) There is only one real law of economics: the law of supply and demand. If the quantity supplied goes up, the price goes down.
Back in the third quarter of 2008, the public held about $5.3 trillion of U.S. Treasury bills, notes and bonds. As the recession hit, tax revenue plummeted, and government spending rose, that total reached $9.4 trillion by mid-2011.
We're on target to have $10.7 trillion outstanding by mid- 2012 -- doubling the Treasury debt held by the public in just four years. Supply and demand tells us that a steep rise in Treasury borrowings should produce a commensurate fall in Treasury bond prices and thus higher interest rates -- and that increase should crowd out other forms of interest-sensitive spending, slowing productivity growth.
Yet the market has swallowed all these issues without so much as a burp. By all accounts, it's smacking its lips in anticipation of the next tranches.
In the years of the Clinton budget surpluses -- remember those? -- the U.S. government was repaying $60 billion of debt each quarter. The Bush administration worked hard to make that surplus evaporate. It succeeded.
From 2002 to 2007, the Treasury issued, on average, $70 billion of debt per quarter. Like many watching this shift, I concluded that this expanded supply would exert substantial pressure on interest rates to rise.
Treasury Demand
The demand for Treasuries was inordinately high, in part because the supply of alternatives was low. Lacking confidence, corporate executives held back investment, reducing private issues of bonds. In addition, China and other emerging economies, eager to keep their currency values low, directed dollars earned from exports into U.S. Treasury debt. Reinforcing this demand, wealthy individuals around the world purchased Treasuries as a hedge.
Thus by late 2007, the 10-year U.S. Treasury rate was exactly where it had been when the Clinton surpluses ended at the close of 2001. "How long could this go on?" we wondered. Eventually the market's appetite for Treasury bonds at high prices and low interest rates had to reach its limit, right? Supply and demand isn't just a good idea -- it's the law.