Monday, November 7, 2011

Italy Nears the Brink?

There has been increasing talk recently about how 7% interest rates are an unsustainable level for European governments.  The idea is crystalized in the Wall Street Journal article: Italy Nears Brink Point as Its Bond Yields Spike which highlights the 7% level as the level that Greece, Portugal and Ireland all sought bailouts.

The fact that 7% is considered an unsustainable level is either a commentary on the sheer magnitude of sovereign debts or a commentary on how anchoring influences psychology in a low interest rate environment, because after all 7% isn't that high of an interest rate in a historical context.

The chart below is a chart of US 10 year treasury yields since 1953.  The red line is the 7% level.  As the chart shows, between 1970 and 1995 US treasury bonds spent a great deal of time (nearly 25 years) above the 7% level, and even spent some time at double that rate.  But somehow the US government didn't need a bailout during that time period.  What would happen if interest rates returned to those levels?

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