Interest rates on government bonds were racing upward.

In the US, the interest rate on government bonds now rises from 1.80 at five years to 2.86 for 10 year bonds and 3.70 for 30 year bonds.

The current small difference between the real interest rate on such bonds (2.1 for 30 year bonds) and the nominal interest rate on conventional 30 year Treasury bonds (now 4.6 ) implies that the market expects only about 2.5 inflation over the next three decades.

New bonds, on which interest was back loaded, could be given the same accounting value as old ones on which interest was paid earlier.

An expectation that interest rates will be high sometime in the next decade should mean high interest rates on long term bonds today.

Domestic deflation means that the real interest rate on Japanese bonds is higher than the nominal rate.

Investors are buying long term bonds at the current low interest rates because the interest rate on short term investments is now close to zero.

NEW HAVEN Real long term interest rates that is, interest rates on inflation protected bonds have fallen to historic lows in much of the world.

But now interest rates for Italian and Spanish government bonds are on the rise again, closing in on about 6 .

Indeed, the interest rate on inflation protected bonds has now become 0.5 , even for a five year maturity!

The fundamental benchmark interest rates in modern financial markets are the so called risk free rates on government bonds.

But, because Greek euro bonds were regarded as a close substitute for other countries euro bonds, the interest rate on Greek bonds did not rise as Greece increased its borrowing until the market began to fear a possible default.

If interest rate spreads on Spanish and Italian government bonds are any guide, bondholders are no longer betting on a eurozone breakup.

The substantial surge in the interest rate on Greek bonds relative to German bonds in the past few weeks shows that the market now regards such a default as increasingly likely.

More likely would be an IMF organized restructuring of the existing debt, swapping new bonds with lower principal and interest for existing bonds.

That predictable dollar decline makes the relative return on holding dollar bonds even lower than the interest rate differential alone implies.

In 1985, the interest rate on ten year Treasury bonds was 10 , even though inflation had declined to less than 4 .

The greatest risk to bond holders is that inflation will rise again, pushing up the interest rate on long term bonds.

Investors naturally respond to unsustainable debt by selling bonds until interest rates become ridiculous.

If Greece had remained outside the eurozone and retained the drachma, the large increased supply of Greek bonds would cause the drachma to decline and the interest rate on the bonds to rise.

In this case, the price of loanable funds is the real interest rate. An expectation that interest rates will be high sometime in the next decade should mean high interest rates on long term bonds today.

Investors are buying long term bonds at the current low interest rates because the interest rate on short term investments is now close to zero. In other words, buyers are getting an additional 2 current yield in exchange for assuming the risk of holding long term bonds.

The low interest rate on long term Treasury bonds has also boosted demand for other long term assets that promise higher yields, including equities, farm land, high yield corporate bonds, gold, and real estate. When interest rates rise, the prices of those assets will fall as well.

The low interest rate on long term Treasury bonds has also boosted demand for other long term assets that promise higher yields, including equities, farm land, high yield corporate bonds, gold, and real estate.

QE2, in which the Fed bought long term government bonds, did not have a discernible effect on long term government interest rates.

And the international bond market has expressed its approval by cutting interest rates on Italy s ten year bonds to 4.8 , and on Spain s to 5.5 .

On international financial markets, the war in Georgia has rendered Russian debt and bonds toxic. Interest rates on Russia s bonds have risen by 2 3 percentage points, and many Russian creditors no longer have access to international capital markets.

Confidence would gradually return, yields on outstanding bonds would decline, banks would no longer be penalized for owning Italian government bonds, and Italy would gradually regain access to the market at more reasonable interest rates.

That s why market interest rates on privately held Greek bonds and prices for credit default swaps indicate that a massive default is coming.

The very low interest rate on long term United States Treasury bonds is a clear example of the current mispricing of financial assets.

Assume that the interest rate on ten year bonds remains unchanged for the next five years and then rises from 2 to 5 .

First, interest rates are higher on euro and British bonds than on similar US securities, making investments in those currencies more rewarding than investments in dollars.

Yields on ten year US bonds are now 2.94 , a 58 increase since the first quarter of this year, causing the interest rate gap between two and ten year bonds to widen to 248 basis points.

The ECB s announcement of a new program to purchase sovereign bonds has lowered market interest rates.

The higher interest rates would also apply to corporate bonds and bank loans, weakening business investment.

The downgrade could, moreover, force the US Treasury to raise the interest rate on new bonds, in which case China would stand to gain.

Corporations are allowed to deduct interest payments on bonds, but stock dividends are effectively taxed at the both the corporate and the individual level.

Interest rates on Russia s bonds have risen by 2 3 percentage points, and many Russian creditors no longer have access to international capital markets.

Alternatively, low interest rates could push her (or her pension fund) to buy risky long maturity bonds.

Indeed, the US stock market and many others have rebounded more than 100 since the lows of 2009 issuance of high yield junk bonds is back to its 2007 level and interest rates on such bonds are falling.

With interest rates on government bonds in the US, Japan, the United Kingdom, Germany, and Switzerland at ridiculously low levels, investors are on a global quest for yield.

They could, for example, offer an incentive in the form of a 3 4 interest rate on bonds, and even make them tax free eventually.

(Over the course of the euro s first decade, interest rate spreads between ten year government bonds nearly disappeared.)

It has no choice the seven year notes are the shortest duration Treasury bonds that now pay interest.

If that happens, China will no longer be a net buyer of US and other foreign bonds, putting upward pressure on interest rates in those countries.