Reform-related deficits are not to be feared.(Be not afraid: Social Security reform is no radical idea)

The pundits who have been predicting dangerously higher interest rates based on large U.S. deficits have some explaining to do.

Many high-profile commentators such as Robert Rubin and Pete Peterson have long been warning that long-term interest rates would rise with increases in America's trade and budget deficits. Actually, little evidence exists in economic research of a close link between deficits and interest rates. And the current reality is that U.S. long-term interest rates have been falling--from 4.8 percent in early June to 4.1 percent at year-end.

Given the awkward fact that interest rates on ten-year Treasury notes have actually gone down this year, the disaster that these pundits have been predicting for the bond market has had to be redefined as "looming" in the future. The problems are visible only to these prognosticators, apparently, and somehow are invisible to the bond market.

It's odd that U.S. deficit bemoaners have chosen to mislead the public on where interest rates are going. As a corrective, let me offer a few points on the determinants of interest rates (and how this bears on today's debate over Social Security reform).

U.S. Treasury securities are desirable places for both domestic investors and foreigners (perhaps 45 percent of the buyers) to safely store wealth. This because the U.S. is a highly stable entity with a powerful economy, potent military, and an efficient tax system, all of which make it unlikely that the government would ever have trouble servicing its debts. Our Treasury market is not only safe but highly liquid, and large. Countries and companies sometimes need to buy or sell securities in multibillion dollar lots, and no other market can accommodate transactions of such size as well. The superiority of the Treasury market as a good store of value is the primary factor accounting for our low interest rates.

Alternatives to U.S. Treasury debt exist, but they are simply not as appealing. Euro-denominated debt is an amalgam of the liabilities of the many countries with very different long-term reputations as economic stewards. Beyond that, most European governments face future retirement and health program deficits far more onerous than the costs the U.S. must deal with. The pressures on the various European governments to fund overlarge social programs means that the temptations for the European Central Bank to inflate the euro during the next decade and beyond will be intense.

The other major government bond issuer--Japan--offers dreadfully low returns. The yield on ten-year notes in Japan is about 1.3 percent, or less than a third the yield in the United States. Japanese yields are artificially depressed ...