TED spreads and US debt

The "TED spread" (short for for "T-Bill/Eurodollar spread") is a measure of the difference ("spread") in yield between the three-month US Treasury bill and the three-month London Interbank Overnight Rate (LIBOR).

The measure is useful as an indicator of the difference in confidence lenders have when choosing to loan money to the US (buying US Treasurys) or to loan money to other developed nations (in this case, nations in Europe).

When the spread is low, lenders see little difference between the two as places to put their money.

However, when general fear of economic chaos rises, the demand for short-term US Treasurys tends to rise versus the demand for the debt in other countries, causing the debt of other countries to have to pay a higher yield to attract investment. In other words, the "spread" between the world's safest asset (US Treasurys) and the asset of any other alternative increases.

Looking at the spread between US Treasurys and Europe's LIBOR is helpful, because Europe is much more economically-developed than many other parts of the world, so a jump in the TED spread shows that investors are buying US Treasurys over even a relatively advanced alternative such as European debt.

Not surprisingly, the TED spread has been climbing as the Greek debt problem unfolds, as the chart above showing the TED spread for the past month clearly indicates (investors can find charts for the TED spread at Bloomberg).

This recent increase in the TED spread is nothing compared to the record levels reached during the panic of 2008-2009, as seen in the five-year TED spread chart shown below:

However, we bring up the subject of the TED spread to highlight the point that, when things get shaky, investors still run to the perceived stability of the United States, which continues to be -- far and away -- the growth engine at the heart of the world economy.

There is a certain line of alarmist rhetoric floating around in the broad economic dialogue which argues that US debt is in danger of losing its appeal and that countries around the world which hold US Treasurys (China being the country mentioned most often) will destroy America's ability to raise capital when they "dump" all of their US debt.

We believe this discussion of the TED spread should help investors see through this fallacious thinking. Other countries (or investors) do not buy US debt out of some sense of charitable intent. They buy it because they think it is a safe place to put their money -- in fact, the safest place in the world to put it. In periods of economic crisis, their demand for that safety goes up, in direct proportion to the perceived severity of the problem.

The fear that other countries will "stop lending" to the US is overblown.

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For later posts on the same topic, see here: