How long can today’s record-low, major-currency interest rates persist?Ten-year interest rates in the United States,the United Kingdom, and Germanyhave all been hovering around the onceunthinkable 1.5% mark. In Japan,the ten-year rate has drifted to below 0.8%.Global investors are apparently willing to accept these extraordinarily lowrates, even though they do not appear to compensate for expected inflation.Indeed, the rate on inflation-adjusted US Treasury bills (so-called “TIPS”) isnow negative up to 15 years.

Is this extraordinary situation stable? In the very near term, certainly;indeed, interest rates could still fall further. Over the longer term, however,this situation is definitely not stable.

Three major factors underlie today’s low yields. First and foremost, thereis the “global savings glut,” an ideapopularized by current Federal Reserve Chairman Ben Bernanke in a 2005 speech.For various reasons, savers have become ascendantacross many regions. In Germanyand Japan,aging populations need to save for retirement. In China, the government holds safebonds as a hedge against a future banking crisis and, of course, as a byproduct of efforts to stabilize the exchangerate.

Similar motives dictate reserve accumulation in other emerging markets.Finally, oil exporters such as Saudi Arabia and the United Arab Emiratesseek to set aside wealth during the boomyears.

Second, in their efforts to combat the financial crisis, the major centralbanks have all brought down very short-term policy interest rates to close tozero, with no clear exit in sight. In normaltimes, any effort by a central bank to take short-term interest rates too lowfor too long will boomerang. Short-termmarket interest rates will fall, but, as investors begin to recognize theultimate inflationary consequences of very loose monetary policy, longer-terminterest rates will rise.

This has not yet happened, as central banks have been careful to repeattheir mantra of low long-term inflation.That has been sufficient to convince markets that any stimulus will bewithdrawn before significant inflationary forces gather.

But a third factor has become manifest recently. Investors areincreasingly wary of a global financialmeltdown, most likely emanating from Europe,but with the US fiscal cliff, political instability in the Middle East, and aslowdown in China all coming into play. Meltdown fears, even if remote,directly raise the premium that savers are willing to pay for bonds that theyperceive as the most reliable, much as the premium for gold rises. These samefears are also restraining businessinvestment, which has remained muted,despite extremely low interest rates for many companies.

It is the combination of all three of these factors that has created a“perfect storm” for super low interest rates. But how long can the storm last?Although highly unpredictable, it is easy to imagine how the process could bereversed.

For starters, the same forces that led to an upwardshift in the global savings curve will soon enough begin operating inthe other direction. Japan,for example, is starting to experience a huge retirement bulge, implying a sharp reduction in savings asthe elderly start to draw down lifetime reserves. Japan’s past predilection toward saving has long implied alarge trade and current-account surplus, but now these surpluses are startingto swing the other way.

Germany will soon be in the same situation. Meanwhile, newenergy-extraction technologies, combined with a softer trajectory for globalgrowth, are having a marked impact oncommodity prices, cutting deeply into the surpluses of commodity exporters fromArgentina to Saudi Arabia.

Second, many (if notnecessarily all) central banks will eventually figure out how to generatehigher inflation expectations. They will be driven to tolerate higher inflationas a means of forcing investors into real assets, to accelerate deleveraging,and as a mechanism for facilitating downward adjustment in real wages and homeprices.

It is nonsense to argue that centralbanks are impotent and completely unable to raise inflation expectations, nomatter how hard they try. In the extreme, governments can appoint central bankleaders who have a long-standing record of stating a tolerance for moderateinflation – an exact parallel to the idea of appointing “conservative” centralbankers as a means of combating high inflation.

Third, eventually the clouds over Europewill be resolved, though I admit that this does not seem likely to happenanytime soon. Indeed, things will likely getworse before they get better, and it is not at all difficult to imagine aprofound restructuring of the eurozone. Nevertheless, whicheverdirection the euro crisis takes, its ultimate resolution will end the extreme existential uncertainty that clouds the outlook today.

Ultra-low interest rates may persist for some time. Certainly Japan’s rateshave remained stable at an extraordinarily low level for a considerable period,at times falling further even as it seemed that they could only rise. Buttoday’s low interest-rate dynamic is not an entirely stable one. It could unwind remarkably quickly.