While many commentators are focusing on Greece and China, the former Chairman of the Federal Reserve is warning that America’s bond market is at risk of collapsing.
Speaking with Fox Business on Friday July 10th, Greenspan said, “What people are not focusing on is we have a bond market bubble and when that decides to work its way off we’re in trouble.” (Source: Fox Business, July 10, 2015.)
Greenspan asserted that interest rates will rise in the near future, but declined to comment on the Federal Reserve’s policy. The Fed controls the federal funds rate, explained the former central banker, but not all interest rates in the economy.
The federal funds rate is the basic, risk-free price of lending between banks. Then banks can charge a slightly higher risk-free rate to borrowers, taking the spread as a de facto fee. Beyond that, the premium on interest rates is set by market forces. If lenders become skeptical about absurdly low rates, they will move them higher.
Greenspan points to the historical convergence of interest rates at five percent to prove that bond investors will not stomach low yields much longer. He argues that five percent reflects the fundamental return that lenders require from borrowers.
However, the famous central banker still believes America has significant advantages over its peers. “The United States, strangely enough, as badly as we are doing, are still the best of the worst,” Greenspan stated. “Everybody is stuck in the mud.”