After closing at 0.54 percent in July 2020, the yield on the 10-year U.S. Treasury Bond settled at 4.57 percent in December 2024. Some commentators believe that the massive increase in yields is because of a strong increase in inflationary expectations.
Many assume that whenever the central bank raises the growth rate of the money supply through the buying of financial assets such as Treasuries this pushes the prices of Treasuries higher and their yields lower. This is labeled as the “monetary liquidity effect.” This effect is inversely correlated with interest rates. Furthermore, an inflationary increase in the money supply, after a time lag, strengthens economic activity, and this pushes interest rates higher. Note that we have here a positive correlation between economic activity and interest rates.
After a much longer time lag, the increase in the growth rate of money supply begins to exert an upward pressure on the prices of goods and services. Once prices begin to move higher, the inflation expectations effect emerges. Consequently, this starts to exert a further upward pressure on the market interest rates.
Time Preference and Interest Rates
Individuals must necessarily give attention to maintaining their lives—basic needs—before the consideration of more distant wants. Time is always a consideration in human action. Carl Menger wrote:
“To the extent that the maintenance of our lives depends on the satisfaction of our needs, guaranteeing the satisfaction of earlier needs must necessarily precede attention to later ones. And even where not our lives but merely our continuing well-being (above all our health) is dependent on command of a quantity of goods, the attainment of well-being in a nearer period is, as a rule, a prerequisite of well-being in a later period.”
This means that an individual assigns higher value to present goods over future goods, to present satisfaction over future satisfaction. For example, consider a case where an individual has just enough consumer goods to keep himself alive. This individual is unlikely to save those goods for later, let alone invest or lend his paltry means. The cost of doing so would be too high and might even cost him his life.
Once the individual’s consumption goods start to expand, the costs of saving, investing, or lending start to diminish. Allocating some of his goods towards saving, investment, and lending requires a sacrifice in the present. In order to invest, goods must first be produced and saved. In terms of the capital investment of the lengthening of the period of production, there must be enough saved resources to sustain one or more individuals throughout the period. This saving enables the development of tools and machinery that, if successful, can contribute to greater productivity, efficiency, and enable further saving and investment.
From this we can infer that, by restricting present consumption, individuals save in order to have more goods for the future, which can either be consumed later or invested. Furthermore, increased saving lowers the premium of the present consumption versus the future consumption (i.e., to the decline in the interest rate). Conversely, factors that undermine the expansion of saving are likely to increase the premium of the present consumption versus the future consumption (i.e., to the increase in the interest rate, all other things being equal).
Interest Rates and Inflation
When money is artificially inflated “out of thin air” and injected into the economy, this sets in motion an exchange of nothing for something. The earlier receivers of the recently-injected money can now divert to themselves consumer goods from the producers of these goods. In similarity to the counterfeiter, the printers and receivers of the inflated money can now increase the purchases of various assets, thus pushing their prices higher and their yields lower.This also has the consequence of artificially lowering the interest rate, misleading entrepreneurs about the seeming profitability of certain long-term projects. Genuine growth can also take place alongside artificial growth, but inflation has distorted the price and production structure, leading to a boom-bust cycle. However, once genuine savings start to decline, and since inflation cannot continue forever, time preferences and, consequently, the market interest rate are going to increase. This will reveal the unsound long-term projects and investments, leading to the bust of the boom-bust cycle.
A situation could emerge where the central bank attempts to counter a rising interest rate trend by means of injecting monetary “liquidity” (i.e., inflated money and credit). This will ultimately make the situation worse. This is because the increase in monetary liquidity sets in motion an exchange of nothing for something, thereby ultimately weakening production and economic stability.
We can expect an oscillation of the market interest rates along the rising trend. The oscillation emerges because the central bank, by pushing the monetary “liquidity,” temporarily lowers the market interest rates. However, the decline of genuine saving and the limits of inflationary policy push the interest rates upward, hence the oscillation of the market interest rates along the rising trend. In a free market, interest rates correspond to individual time preferences. Whenever individuals lower their time preferences, this means that they are signaling businesses to arrange a suitable capital structure in order to be ready for the increase in the demand for consumer goods in the future.
We suggest that a steep increase in long-term interest rates since July 2020 is likely in response to the sharp decline in the pool of savings brought about by reckless government and Fed policies. The fact that individuals pursue conscious, purposeful actions implies that causes in the world of economics emanate from individuals, not from various factors. Every individual assesses changes in various factors against his goals.
