One of the consequences of overspending is the need to borrow lots of money to cover that spending. The federal government is borrowing, the state and local governments are borrowing, and the consumer is often crowded out. There’s only so much money to lend and institutions and inviduals would rather loan it to the government, for example, as opposed to small businesses. In addition, because there is a lot of borrowing and a finite amount of money to lend, interest rates often get pushed up.
An article on CNBC.com discusses the crowding out issue and its effect on interest rates.
Consumers and businesses looking to borrow and investors trying to find a way to navigate a marketplace heading toward higher interest rates will find the conditions daunting, experts say.
“Clearly the government is not the 800-pound gorilla—it’s the 8,000-pound gorilla in the credit markets nowadays,” says Mike Larson, analyst at Weiss Research in Jupiter, Fla. “These numbers are just so mind-boggling. Really what’s going on is you have intractable debt and deficit problems in the country that neither side wants to tackle in a meaningful way, so the market is doing it for them.”
I’ve added the emphasis in the quotation. It’s a good reminder that markets will not wait around for policy makers to figure out what they want to do. Markets will begin to trade on expectations of what will happen, whether those expectations turn out to be right or wrong in the long run. Markets don’t like uncertainty and they will begin to resolve uncertainties on their own by making assumptions about what might happen and pricing things in the market accordingly.
Right now the market is assuming that there is more borrowing going on than lenders are eventually going to be able to supply. Thus the yield curve is very steep and there is concern that interest rates will push higher. It could certainly work out differently, but it’s important to keep an eye on the assumptions that markets are making.
