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We're all doomed?

• Robert Peston
• 13 Jun 07, 06:58 AM

One of the great, global, economic forces of our age, which I’ve bored you rigid discussing in this blog, is that it has been possible to borrow long-term money at relatively low interest rates.

For the past few years, the impact of these low long-term interest rates has been visible in a surge in borrowing by individuals and companies together with the related phenomenon of rising prices of almost every kind of asset or commodity. Here are just three important manifestations:

a) UK house prices that keep going up and up – almost regardless of what the Bank of England does to short-term interest rates;

b) share prices, that have increased more-or-less in a straight line since the spring of 2003;

c) a boom in takeovers of companies, financed by borrowing, and a great wave of repurchases of shares by companies, again funded by debt.

Now, a fall in longer term interest rates is simply the corollary of a rise in the price of certain US Government bonds.

And what has kept the price of those bonds high has been two trends.

First, the accumulation of vast foreign exchange reserves by China, Japan and other (largely Asian) exporting nations, which have been invested in US government bonds.

Second, a decision taken some years ago by large insurers and pension funds to become more risk averse, and reduce their exposure to shares while increasing their holdings of bonds.

Now according to analysts, for some years long-term interest rates have been significantly lower than they should have been on the basis of their normal historical relationship with short-term interest rates and the health of the global economy.

Which is why what has been happening over the past few days is important, though largely unreported outside of : there has been a sharp fall in the price of 10-year US government bonds, known as US Treasuries, and thus a precipitate rise in the benchmark price of borrowing for ten years. Yesterday, the yield on 10-year US Treasuries rose to its highest level for more than five years (to 5.27%).

This is much more important to all of us than what the Bank of England does to short-term interest rates.

For example, the rise in these long-term market interest rates pushes up the price of borrowing for our big banks and building societies and will probably feed through to the interest rates on new fixed-rate mortgages.

Which could prick the housing-market bubble.

If those longer-term rates continued to rise, the frenzy of private-equity fuelled takeovers could fizzle – because the cost of financing takeovers would exceed the cash-flows of the relevant target companies.

So just why have longer-term rates risen? Well, one reason is that the global economy is performing too well – which means that central banks are either pushing up short-term interest rates (as they have just done in the eurozone and New Zealand, and probably will in the UK) or are not cutting them (as is the case in the US).

But that is not the significant reason, because that would not signal a return to the historically normal relationship between short-term interest rates and long-term ones.

No, the more interesting reason for the rise in long-term rates is that the Chinese are switching hundreds of billions of dollars out of bonds and into equity-related investments. And there are also signs that other important global investors are increasing their appetite for risk and equities.

That in turn means share prices are unlikely to collapse in the immediate aftermath of the fall in bond prices. They will probably be sustained by the sheer volume of cash being put into stock markets by the Chinese and others.

But there could in time be a seriously negative impact on the price of shares. Higher longer term interest rates should eventually lead to a squeeze in the profits of companies, which would make shares in those companies less valuable.

The bond-market turmoil and fall of last week may turn out to be the beginning of the end of the current upswing in in shares, property, you name it, the possible end of an all-embracing bull market.

And that would mean, to quote Private Fraser, that "we're all doomed, doomed."

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