Monday, March 4, 2013

Why are interest rates so low?…don’t ask a central banker…they absolutely will not tell you...

Why are interest rates so low? I could choose to address another question as a parallel. Why are people in the US 26 pounds overweight?

Lets examine how that second question has been and can be answered. "People in the US are 26 pounds overweight because they have a high fat diet and do not exercise sufficiently." That sounds like something I could sell to a broad array of people without much argument. Or how about this: “People in the US are 26 pounds overweight because they work sedentary jobs and drink too much alcohol.” Or, “People in the US are 26 pounds overweight because they eat too much dairy and an increase in the rate of diabetes”.  Or, “People in the US are 26 pounds overweight because their diets are too high in carbohydrates and meat”.  Or, “People in the US are 26 pounds overweight because eat too much”.   Ok…I’ve put out a bunch of reasons each of which have cursory but largely distracting merit in determining why people are overweight in the US. The real reason that people are overweight by 26 pounds is actually totally different…if you would like to understand the answer you can watch this video:

Ben BURNanke is a salesman apparently trying to sell his way into a Nobel Prize for economics he does not understand. His reasons for identifying why interest rates are so low is about as relevant as any of the individual reasons that I wrote above for people in the US being fat…and entirely useless.

Below is a quote of BURNanke’s pre-Nobel Prize marketing tour/victory lap: 
Let's recap. Long-term interest rates are the sum of expected inflation, expected real short-term interest rates, and a term premium. Expected inflation has been low and stable, reflecting central bank mandates and credibility as well as considerable resource slack in the major industrial economies. Real interest rates are expected to remain low, reflecting the weakness of the recovery in advanced economies (and possibly some downgrading of longer-term growth prospects as well). This weakness, all else being equal, dictates that monetary policy must remain accommodative if it is to support the recovery and reduce disinflationary risks. Put another way, at the present time the major industrial economies apparently cannot sustain significantly higher real rates of return; in that respect, central banks--so long as they are meeting their price stability mandates--have little choice but to take actions that keep nominal long-term rates relatively low, as suggested by the similarity in the levels of the rates shown in chart 1. Finally, term premiums are low or negative, reflecting a host of factors, including central bank actions in support of economic recovery. Thus, while the current constellation of long-term rates across many advanced countries has few precedents, it is not puzzling: It follows naturally from the economic circumstances of these countries and the implications of these circumstances for the policies of their central banks. - Ben Benanke
I have never heard such baseless drivel. Lest we forget the charts I posted this weekend, Ben BURNanke is a not just marketing his Nobel Prize candidacy, he is selling something else too: CREDIT. This can clearly be seen in my charts in the previous posts…and apparently he has done a reasonably good job with his unfortunate task. The reality is that the money supply IS credit and he desperately needs people to take on credit just to even enable the settlement of previous credit without default. So, there in the end is a simple reason that governs rates…the amount that someone is willing to charge to issue credit and the rate that a credit worthy borrower is willing to avail himself of it. And there you have it…there are NO other factors. The FED is one of the participants, and as you can see, actively moves the price of credit in all sorts of ridiculous ways.

When you have very little demand for a product what happens? Its price drops. In the case of credit, price equals rate - and there is precious little demand for credit among worthy borrowers, in order to induce them to borrow you must lower the price of the product. This is certainly counter to what should be going on, as the economic risk increases globally, risk of failure, even by worthy borrowers increases. I certainly would not lend money to anyone for 2 or 3 percent in today’s environment. However, if that was my only product offering and there was such little demand, I would be forced to.

There is one more reason that rates are so low and that relates to central banks, governments and institutions who are too large to simply deposit money with a bank and expect its safe keeping and return. If you want to be sure you get your notional deposit back you need it to be in unqualified original currency - in the case of dollars, US Treasury Notes. Many, Many people are concerned with the safe keeping of large amounts of dollars and know that these dollars are NOT safe in the banking system anywhere on deposit and, therefore, must accumulate an array of government debt as a store of their currency. If you have a lot of people willing to buy notes issuing credit to the United States then rates will be very low indeed. This is why i have maintained for a long time that yields on Treasuries will actually not just calculate out to negative yield but in some cases actually go to a negative listed yield.

So, what we essentially have with Ben’s exmplanation is a salesman trying to tell us "people get fat because they get up too late, sleep on their stomachs and don’t play golf”…if you wish to believe him, do so at your own delusion.
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