- The Washington Times - Tuesday, June 7, 2005

Nearly a year after the Federal Reserve began raising short-term interest rates, the rate on the long-term 10-year Treasury note today is unexpectedly well below the level that prevailed when the Fed began tightening. Indeed, the interest rate on the 10-year note briefly touched 3.8 percent Friday, nearly a full percentage point below the level it average last June.

A year ago, the Fed initiated the first of eight quarter-point increases in the federal funds rate — the interest rate that banks charge each other for overnight loans. Following the Fed’s “measured” pace, the federal funds rate today is 3 percent, two percentage points above its level a year ago. In congressional testimony earlier this year, Fed Chairman Alan Greenspan described the unanticipated decline in long-term rates as “a conundrum.” In a speech delivered Monday via satellite to the International Monetary Conference in Beijing, Mr. Greenspan observed that the development “is clearly without recent precedent.”

Mr. Greenspan reviewed a number of hypotheses that have been offered to explain “this remarkable worldwide environment of low long-term interest rates.” In his view, none of the hypotheses, singularly or cumulatively, adequately explained the phenomenon.

The Fed can exercise direct control over short-term U.S. interest rates by controlling the supply of reserves to the banking system, but it is the market — an increasingly globalized market — that determines long-term rates. Fed Governor Ben Bernanke, whom President Bush has nominated to be chairman of the White House Council of Economic Advisers, has argued that a global savings glut has been recycled throughout globalized financial markets, exerting downward pressure on long-term rates around the world. Because America’s own savings rate has plunged in recent years, the savings glut generated by others and recycled here has kept U.S. long-term interest rates, including mortgage rates, lower than they otherwise would be.

Mr. Bernanke’s hypothesis strikes us as a very plausible explanation. In addition to recently becoming, effectively, the sole source of financing for our record-level nominal budget deficits, these massive foreign-capital inflows to the United States have also “shown up in higher rates of home construction and in higher home prices,” which have “encouraged households to increase their consumption,” Mr. Bernanke explains. The downside, of course, is that the costs of repaying foreign debt could indeed become a greater economic burden in the future.

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