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Even if long term interest rates are determined by the factors you mention. How does China selling bonds increase long term interest rates? Increase in expec

Even if long term interest rates are determined by the factors you mention. How does China selling bonds increase long term interest rates? Increase in expectations of growth or inflation? I could maybe see that both of those could be increased from a devalued dollar. But if that's how China is increasing long term rates it seems weird to think that inflation + economic growth would cause the US to service a higher level of debt pushing up the deficit and causing the U.S. to stifle growth and economic activity.

toast0 11y ago
> How does China selling bonds increase long term interest rates? More interest in selling with the same interest in buying drives the price down, and therefore the yield up.
yuliyp 11y ago
There is a relatively liquid market for bonds. Let's say I issue a bond today. I set the interest rate at 3% per year for 10 years. A lot of different people buy those bonds (for ease of math, assume that an individual bond is $100). If they do nothing, every year that someone owns bond they'll receive $3, then at the end of ten years they get the extra $100 back. Let's say that one day later someone wants to sell all the bonds that they bought. Naturally more sellers than buyers for a market means that the price will drop. So the bond now costs $90 to buy. However it will still pay the (new) owner $3 per year and $100 back at the end, so it's effective rate of return is now above 3.33% [The actual rate is higher since you get more money back than the $90 you put in, but this is a good lower bound for the new rate of return]. Now I come back right after this price drop occurred and realize "Oh crap, I need to issue more bonds today!" If I try and set the same terms on the new bonds, nobody will buy them, since they could just buy the ones I issued in the secondary market and make more money for the same risk. As a result, I have to increase the interest rate I pay for future bonds I issue. Thus China selling bonds increases the long term interest rates. Note that it may not increase long term interest rates in the long term, though :-)
- JamesBarney 11y ago
  So the general thinking is 10 yr treasury bonds reflect the economies consensus around what the long term interest rate is. Another general consensus in economics is that the interest rate is determined by the supply and demand for loan-able funds. Therefore if China sells so many bonds it increases the interest rate on 10yr T-Bonds. It has either shifted the long term interest rate in the U.S. by reducing the supply of loan-able funds or it created an enormous persistent arbitrage opportunity in T-Bonds.[0] Both of these seem very unlikely to me. 40 billion a month is just too small to make a difference.

toast0 11y ago

> How does China selling bonds increase long term interest rates? More interest in selling with the same interest in buying drives the price down, and therefore the yield up.

yuliyp 11y ago

There is a relatively liquid market for bonds. Let's say I issue a bond today. I set the interest rate at 3% per year for 10 years. A lot of different people buy those bonds (for ease of math, assume that an individual bond is $100). If they do nothing, every year that someone owns bond they'll receive $3, then at the end of ten years they get the extra $100 back. Let's say that one day later someone wants to sell all the bonds that they bought. Naturally more sellers than buyers for a market means that the price will drop. So the bond now costs $90 to buy. However it will still pay the (new) owner $3 per year and $100 back at the end, so it's effective rate of return is now above 3.33% [The actual rate is higher since you get more money back than the $90 you put in, but this is a good lower bound for the new rate of return]. Now I come back right after this price drop occurred and realize "Oh crap, I need to issue more bonds today!" If I try and set the same terms on the new bonds, nobody will buy them, since they could just buy the ones I issued in the secondary market and make more money for the same risk. As a result, I have to increase the interest rate I pay for future bonds I issue. Thus China selling bonds increases the long term interest rates. Note that it may not increase long term interest rates in the long term, though :-)

JamesBarney 11y ago
So the general thinking is 10 yr treasury bonds reflect the economies consensus around what the long term interest rate is. Another general consensus in economics is that the interest rate is determined by the supply and demand for loan-able funds. Therefore if China sells so many bonds it increases the interest rate on 10yr T-Bonds. It has either shifted the long term interest rate in the U.S. by reducing the supply of loan-able funds or it created an enormous persistent arbitrage opportunity in T-Bonds.[0] Both of these seem very unlikely to me. 40 billion a month is just too small to make a difference.