Two Up Equals One Down

Looking through some headlines this morning I noticed a pair of important numbers moving upwards which have the potential to stall an economic recovery. This pair of numbers was the yield on the 10 year Treasury Bonds (which moved above 4%) and the price of a barrel of oil (which took a run at $87). While these levels are by no means dire their coincident upward movement is concerning, especially with a weakened national economy.

The US government has made its Keynesian approach to economic policy crystal clear. This type of strategy is dependent upon the government being able to fund massive spending projects in order to spur economic growth. In order to fund their expenditures the government has become dependent upon borrowing and issuing new Treasury debt. For the last few years this practice has been relatively cheap with historically low interest rates. The low rates took away incentive for the government to raise taxes to pay their expenses since borrowing money was so cheap.

However, with more and more debt being issued, borrowers are demanding higher rates of interest to protect against a potential fall in the value of the dollar. The movement in the 10 year bond over 4% is evidence that lenders are not going to continue to loan cheap cash to the government and that Keynesian expenditures are going to become more expensive. The interest on a $700 billion dollar stimulus package would cost $28 billion a year at 4% versus $14 billion a year at 2% (obviously not all debt is issued at the same maturity/rate). Clearly the practice of using debt to finance spending is getting more expensive.

Like interest rates on government debt, the price of a barrel of oil has also been making an upward move in recent weeks. The price was close to $87 today before settling just below $86. Another spike in the price of oil could stall an economic recovery faster than rising interest rates. I had theorized in the past that commodity price spikes can tip a healthy economy into recession as the price of a key product, like oil, has the potential to affect the prices of many other goods.

If the price of oil rises, then transportation costs rise and consumers can purchase fewer goods. A weakened consumer demand can threaten the Gross Domestic Product and force decline instead of growth. As a major factor in the determination of a recession, a fall in the GDP would stifle any recovery.

There is a great chance that the current recession will conclude in either Q1 or Q2 of 2010. However, there are factors which can endanger economic growth and tip the American economy back into recession should certain trends continue. Two of the more dangerous trends are a rise in the interest rate on Treasury obligations and a rise in the price of oil. If these trends continue too high for two long, economic growth can be seriously threatened and the economy might not emerge from recession for a lengthy period of time.