Can someone please translate this post on bonds into laymen terms..

[cbc58]

Post:

http://www.kitco.com/ind/Summers/dec142010.html

Is this a correct assumption: rates way up, economic activity way down, prices increase on some items, fall in others (what goes up and what goes down?), stock market plummets, people and governments default on debts.

Is that about right?

 

[andymillette]

When rates go up, the cost of borrowing goes up, this slows economic activity down (you are right). Rising rates can be seen as inflationairy (or that inflation is here) so prices on SOME things are high (these "things " tend to be things you need, like energy/fuel, food, etc), but prices fall on other things (these things tend to be things you DON'T need) or things that consumers have to borrow to purchase-like a new home, car, or appliances. Stock market usually goes down because the cost to borrow for businesses is higher, this hurts governments (and people) because the cost of borrowing is high-A good example of this is this: let's assume you have a loan out at 5%. Overnight, the interest rate on that loan goes to 30%. What are the chances of you paying that off?

I hope this helps.

Andy

 

[cbc58]

tks.

i wonder what the world creditors would think if somehow the fed was abolished, the dollar eliminated, a new soverign currency was created backed by gold and adopted by the U.S. would they look past the fact they got shafted for billions of dollars... or look at it as a safe place to put money.

 

[PeacePlan]

tks.

i wonder what the world creditors would think if somehow the fed was abolished, the dollar eliminated, a new soverign currency was created backed by gold and adopted by the U.S. would they look past the fact they got shafted for billions of dollars... or look at it as a safe place to put money.

At some point someone is going to get shafted no matter what is done. Most of the U.S. debt is financed by short term treasuries/bonds. When the interest rate goes up, which it will it means we will need to refinance at higher rates the U.S. debt. Just a couple of points rise will mean our debt payments will increase by hundreds of billions of dollars. No one is going to want to hold those treasuries/bonds as they fall in value as the rates increase so it puts pressure on people to sell them. Well this can and will create a viscous cycle of having to give higher rates for treasuries/bonds as many will not want something that falls in value right after you buy it. Pension funds and people who just want to collect the interest and hold on to them for maturity will buy but investors who want liquidity will not want them. The rate of return must stay above the rate of inflation or no one is likely to want them.

Just like your house payment if interest rates rise you have to pay more. As interest rates rise we will have to pay more and it takes away from what Gov can spend on other things. I think the whole thing will collapse and yes someone will be holding the bag - or maybe paid back with dollars that are worth less than the paper they are printed on.