If Foreign Central Banks Were To Sell US Treasuries
Today, Federal Reserve Chairman Alan Greenspan on Wednesday played down the risk to U.S. bond markets if heavy official foreign buying dried up. Paul Kasriel (Northern Trust Company) has a thought about what would really happen if foreign demand were to fall:
"In effect, the Fed would monetize the U.S. government securities being sold by foreign central banks. Although this would prevent short-maturity interest rates from rising, it might actually lead to higher longer-maturity interest rates. Why? Because the Fed’s monetizing of debt has future inflationary implications. Rising inflation expectations would drive up the nominal interest rates on longer-maturity debt.
So, Greenspan is only partially correct about the effect of foreign central bank sales of U.S. government securities. These sales would not necessarily drive up short-term interest rates, but would probably drive up long-term interest rates."