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Yield Curves and Thin Ice

Of the many bits of macroeconomic esoterica I studied this semester, one that particularly caught my interest was the bond yield curve. Normally, long-term bonds pay more interest than short-term ones, because you have to lock your money up longer (this is also known as the time value of money). When you plot these prices out on a chart, you generally get a nice upward curve to the line.

However, in recent months, this hasn't been the case. The yield curve has become virtually flat. A flat yield curve means, among other things, that people believe that the economy will continue to decline.

The Big Picture goes into a great deal more detail of why this has the potential to be a problem. The piece is a bit technical but not horribly so. Here's his bottom line:

While not every inversion leads to a recession, every recession has been preceded by an inverted yield curve.

In other words, it's a sign that as 2006 fast approaches, the American economy is treading on very thin ice indeed. We may get through it unscathed, but getting back on course is going to be damn tricky.


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