Long-term interest rates are on an upward trend in the United States. The yield on 10-year U.S. government bonds, which stood around 3.8 percent in December, has climbed to around 4 percent. But has the U.S. economy been strong enough to trigger a rise in interest rates?

The core price index, closely watched by the Federal Reserve Board as an indicator of price trends, declined in 2002, while the latest employment statistics released Jan. 10 show the number of jobless up by 82,000 from a month earlier to 8.6 million, pushing the unemployment rate to 6 percent. Consumer sentiment is also sagging. Why, then, are interest rates rising at a time when price trends and the real state of the economy do not seem to be pushing rates up?

The biggest reason, ironically, appears to be the nearly $700 billion economic stimulus package announced by President George W. Bush. The fact that such a massive package is needed means there is little room for optimism for the real economy, but the announcement has triggered speculation that interest rates will go up because a large volume of government bonds will be issued to cover the stimulus measures. No such concerns will emerge if domestic savings in the U.S. increase and cover the additional bond issuance, but there are no signs of improvement in the savings rate. The country continues to run current account deficits — macroeconomic proof that it is experiencing a savings shortage.

So far, an inflow of nonresident funds from overseas has made up for the savings shortage in the U.S. But given the sluggish conditions of the U.S. economy and slump in share prices, one cannot expect too much from the capital inflow that once targeted lucrative investment opportunities and high returns.

Nonresident capital also flowed into the U.S. as overseas players sought a safe haven, buying the dollar in times of geopolitical uncertainty. However, no such dollar-buying binges appear to be taking place as a possible U.S. military strike on Iraq looms and a game of chicken with North Korea continues to escalate.

On the contrary, the dollar has fallen against major currencies, dipping to 1.06 euros and slipping below 120 yen. The Sept. 11 terrorist attacks have left a question mark on the safety of the U.S., and the country continues to be seen as the biggest potential target of future terrorist attacks.

Crude oil prices have surged to around $33 per barrel, and gold prices have entered the range of $360 per ounce. This not only indicates that demand for oil and gold is on the rise, but is proof that the value and purchasing power of the dollar are declining.

It is of course important to fight against terrorism and stop proliferation of weapons of mass destruction. But we also have to pay more attention to the fact that as deflation looms as a global threat, financial markets are reacting by selling the dollar, pushing up interest rates, and dropping prices of bonds and shares.

The world is closely watching the State of the Union message to be released soon by President Bush, and the current uptrend in U.S. long-term interest rates is a reflection of both the expectations and concerns over the president’s strategy.

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