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Do interest rates "have" to go up?


tede02
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I've been listening to some of Ray Dalio's stuff this week.  He talks a lot about cycles and how most people are surprised when events happen that they've never experienced in there life-time even though these events have been repeated throughout history.  This got me thinking about interest rates.  What is the historical precedent for what seems to be very low rates?

 

Looking at the ten year Treasury data on Robert Shiller's website, I found that the ten year yield dropped below 4% in February of 1880.  Rates stayed below 4% until 1911 (over 31 years). 

 

A few decades later, rates dropped again for a long period.  The ten year yield dropped below 3% in June of 1934.  Rates basically did not get above 3% again until 1956 (with the exception of two months in 1953 when rates briefly exceeded 3%).  That's essentially 22 years of rock bottom interest rates (just like we have today). 

 

Economists have been saying for over 3 years that rates have to rise, and like many, I used to just accepted the idea at face value (they have to rise because they are really low).  But history certainly seems to suggest otherwise. 

 

Lastly, Dalio's 30 minute video on "How the economy works" is worth watching.  It helped be better understand that is makes sense for rates to stay low for an extended period of time as much of the world deleverages.

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Rates were low for 20+ years after the Great Depression. Rates have been low for 20+ year in Japan. When you have a financial crisis, you generally get low rates for the next 2-3 decades. Doesn't have to happen, but seems like it generally does because the government/Fed lacks the political support to do what's necessary to change that (for better or for worse).

 

Then again, I'm biased. I'm assuming that rates will be low for a long time regardless of Fed action and I believe in Fairfax's deflationary thesis.

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Rates were low for 20+ years after the Great Depression. Rates have been low for 20+ year in Japan. When you have a financial crisis, you generally get low rates for the next 2-3 decades. Doesn't have to happen, but seems like it generally does because the government/Fed lacks the political support to do what's necessary to change that (for better or for worse).

 

Then again, I'm biased. I'm assuming that rates will be low for a long time regardless of Fed action and I believe in Fairfax's deflationary thesis.

 

Well, I'd like to point out that Japan has tried everything in the books to get rid of deflation. Without success... it's not only political support.

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I've been listening to some of Ray Dalio's stuff this week.  He talks a lot about cycles and how most people are surprised when events happen that they've never experienced in there life-time even though these events have been repeated throughout history.  This got me thinking about interest rates.  What is the historical precedent for what seems to be very low rates?

 

Looking at the ten year Treasury data on Robert Shiller's website, I found that the ten year yield dropped below 4% in February of 1880.  Rates stayed below 4% until 1911 (over 31 years).

 

 

I'm wondering if the comparison is fair.

 

Money backed by gold where the threat of devaluation came from how fast it can be mined.

 

Is that completely comparably to today's fiat system?

 

Does the threat of devaluation feed into interest rates throughout history or has it instead been the case that interest rates are completely decoupled from devaluation? 

 

I don't know, because I haven't studied it.  My initial instinct is to ask for a higher interest rate if the currency is created by fiat.  However I wonder if it is supported by history -- for example, rates are low today and the currency is created by fiat.  In fact people say you can't create inflation by fiat -- Japan has already tried, etc...

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The best take on this I've read so far is Richard Koo's theory about balance sheet recessions. What matters for what we normally regard as inflation is the demand for consumable goods and this doesn't necessarily come along with an increase in money supply. That's because there are two options for people: spending the additional money (on consumable goods) or saving it (in any kind of asset). What people are doing since 2009 is saving the money. That's why the prices of all income producing assets have been going up.  All this additional money is competing for the same finite amount of financial assets. This leads to asset price inflation but not necessarily to consumer price inflation. Rising asset prices mean lower rates. This is also part of the reason why falling oil prices didn't lead to more economic activity. People are saving the money.

 

The central banks' problem is that they haven't figured out how to get people to spend their newly "created" wealth on consumable goods. This is the decisive and final step in the QE programs that hasn't worked so far. At the moment, people want to get rid of their debts and then build up some wealth in the form of assets. This produces pressure on rates and does therefore the exact opposite of what people were expecting in the beginning when QE was announced.

 

What Dalio says is that the long term debt cycle can only turn when we finally get rid of the debt. He says that you can get rid of it by repaying it, by debt foregiveness or by inflating it away ("monetizing" the debt). He also thinks that you have to have all three of those options. Central banks are in the process of discovering that relying solely on option 3 (monetizing the debt) doesn't work. While being the politically easiest choice it has the disadvantage that you need the people to participate in it by spending the money on consumable goods and thereby creating inflation. Momentarily people don't want or cannot do this. That's why we have to come back to the other two options.

 

However, the other two options are very painful. To quote Dalio: "One man's debt is another man's asset." Therefore, getting rid of the debt means, at least to some extent, taking away another man's assets – be it in the form of tax (with which you're then able to pay back the debt) or in form of haircuts. When you think about it like this it becomes very clear that this will be a deflationary process at first, that is until people are starting to rather spend the money on consumption than having it taxed away or being haircut. This is when the whole thing can finally become inflationary. In my opinion this is why Dalio says that the process is deflationary before it will turn inflationary. The fact that this process is so painful could explain why it usually takes two or three decades until the cycle turns – you have to spread the pain over time and equally among different groups of people (i.e. debtors and creditors in their different shapes and forms – which is also what Dalio is saying).

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Well written ni-co.  That is a very good summary (at least as I perceived it) from Dalio. 

 

What this story also tells me is we're lucky that the entire world didn't experience some nasty deflation following 2009.  There definitely was some, but I'm getting the picture that it could have been far worse as was the Great Depression.  Bernanke clearly was worried about it. 

 

With respect to fiat money, I'm not sure how big a difference it makes.  I'm certainly no expert here.  If I understand Dalio correctly, interest rates stay low because people and businesses are deleveraging instead of spending (during this part of the cycle).  Therefore, demand for credit remains extremely low. 

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Well written ni-co.  That is a very good summary (at least as I perceived it) from Dalio. 

 

What this story also tells me is we're lucky that the entire world didn't experience some nasty deflation following 2009.  There definitely was some, but I'm getting the picture that it could have been far worse as was the Great Depression.  Bernanke clearly was worried about it. 

 

With respect to fiat money, I'm not sure how big a difference it makes.  I'm certainly no expert here.  If I understand Dalio correctly, interest rates stay low because people and businesses are deleveraging instead of spending (during this part of the cycle).  Therefore, demand for credit remains extremely low.

 

Thank you, tede02. I agree that the demand for credit is the more important part. Yet, there is also an oversupply of money. The world is awash with liquidity that looks for a reasonable return. People are even paying some governments and corporations for holding their money. Essentially, "everybody" wants to be the creditor and "nobody" wants to be the debtor. So there is a demand and a supply element to it. As long as these conditions remain stable it's very hard to come to a view of inflation picking up. I think the world hasn't fully recognized this as you can see from the spreads between US treasuries and European/Japanese government bonds.

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Dalio's video explaining the rise of asset prices and incomes is caused by the expansion of credit is a clear explanation of the process. Martin Armstrong's explanation the money and assets are on a see-saw is also helpful as his explanation of concentration of capital. Printing more money is already working less well because of misallocation of capital and the popping of the debt bubble in China where the greatest increase in debt occurred together with the worst mis allocation of resources. Now that the debts in China are becoming bad debts wealth is evaporating so we are in the Fisher deflation spiral with a contracting supply of credit greater than the money being created by central banks. Excess liquidity is being used to pay debts in a desperate attempt to avoid default. On the see-saw the value of money is now rising as asset values fall. Effectively interest rates are rising even though the nominal interest rate may be dropping. Currency moves are also increasing effective interest rates, mostly for holders of US denominated debts. But bond defaults are increasing as well so returns are dropping if you factor in default risk. Currencies may also be devalued so if you hold debt in the devaluing currency your return suffers as well.

 

Technological change seems to be coming to the rescue. Hopefully the governments will embark on more TE (technological easing) instead of QE and release more defence technology to the private sector and allow more new inventions to come to market. A change from coal electricity to LENR electricity, plus electric vehicles with much better batteries plus removal of tariffs on solar plus releasing the high efficiency solar based on the cone shapes from beetles (like you see in ferromagnetic fluids) plus increased automation and driverless vehicles will create massive profit making possibilities and an increased demand for debt and rising interest rates. The trend would be further accelerated if cartels are broken down such as the medical cartel, the taxi cartel, the pharmaceutical cartel, the education cartel etc..

 

As an example consider the effect of improved and cheaper solar cells plus better batteries. Real estate will have solar systems put in using debt and enjoy reduced utility costs with improved cash flow for the property owner paying the mortgage. This will expand credit starting the Dalio credit expansion with rising incomes and asset values. Now consider changing over the electric driverless cars. Lots more debt to buy these cars and the number of cars needed will plummet due to Uber solving the low car utilization inefficiency. Now consider all the people with cancer (so they spend less like older people) being able to go to Naturopaths and use the new breakthrough treatments instead of chemo and radiation. Expanded lifespan would make them more likely to be willing to take on debt to install the solar systems and buy the new electric vehicles. Taking glyphosate out of food alone would likely expand GDP growth significantly as people weren't so chronically sick, cancer ridden, fat, stupid and infertile. Think of the high growth rates during the baby boom. A few changes and we would be back to boom times and rising interest rates.

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Guest wellmont

rates could double and they would still be low by any stretch. but even that move would create lots of pain for lots of people. buffett said he would short bonds. munger said these rates in europe are a black swan. cooperman says we are in a bond bubble. icahn has a bet on that would pay off massively if rates go up. druck says these low rates are absolutely nuts given the strength of us economy. he thinks fed has jumped the shark. einhorn says we should have raised many many months ago. paul singer says fed is irresponsible, experimental, and arrogant in keeping rates abnormally low. so lots of the gray beard billionaires think they are too low right now.

 

can they stay low? yes. but even if they double, they will still be low. I would not count on them being this low for much longer.

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Looking at the ten year Treasury data on Robert Shiller's website, I found that the ten year yield dropped below 4% in February of 1880.  Rates stayed below 4% until 1911 (over 31 years). 

 

A few decades later, rates dropped again for a long period.  The ten year yield dropped below 3% in June of 1934.  Rates basically did not get above 3% again until 1956 (with the exception of two months in 1953 when rates briefly exceeded 3%).  That's essentially 22 years of rock bottom interest rates (just like we have today). 

 

Thanks for this useful info. Is there some data available how did the stock market perform during those times, preferable a graph that shows both the interest rate and stock performance, with recession periods?

 

https://research.stlouisfed.org/fred2/graph/?g=1Adu goes upto year 1954.

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rates could double and they would still be low by any stretch. but even that move would create lots of pain for lots of people. buffett said he would short bonds. munger said these rates in europe are a black swan. cooperman says we are in a bond bubble. icahn has a bet on that would pay off massively if rates go up. druck says these low rates are absolutely nuts given the strength of us economy. he thinks fed has jumped the shark. einhorn says we should have raised many many months ago. paul singer says fed is irresponsible, experimental, and arrogant in keeping rates abnormally low. so lots of the gray beard billionaires think they are too low right now.

 

can they stay low? yes. but even if they double, they will still be low. I would not count on them being this low for much longer.

 

I've heard the arguments of Druckenmiller and Singer and I don't find them particularly convincing. Are we really in an overheating economy? Sure we are at risk of generating asset bubbles. But I don't see any reason to cool the economy down. The QE programs have shown that the FED has no control whatsoever over inflation in the current environment. Too many hedge fund managers are acting or at least talking as if the FED was still in total control. I don't see how you solve the current mess by raising interest rates. The only thing they would achieve is another leg up in the dollar bull market. The BOJ tried it a few years ago and it completely failed. I expect nothing else from a FED rate hike. Then there is the ECB and the BOJ – what are they supposed to do?

 

Dalio is right: The risks are asymmetric. Meaning the FED still has the power to kill the economy by hiking rates too far but it has lost the ability to ignite it at the zero bound.

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Looking at the ten year Treasury data on Robert Shiller's website, I found that the ten year yield dropped below 4% in February of 1880.  Rates stayed below 4% until 1911 (over 31 years). 

 

A few decades later, rates dropped again for a long period.  The ten year yield dropped below 3% in June of 1934.  Rates basically did not get above 3% again until 1956 (with the exception of two months in 1953 when rates briefly exceeded 3%).  That's essentially 22 years of rock bottom interest rates (just like we have today). 

 

Thanks for this useful info. Is there some data available how did the stock market perform during those times, preferable a graph that shows both the interest rate and stock performance, with recession periods?

 

https://research.stlouisfed.org/fred2/graph/?g=1Adu goes upto year 1954.

 

Market went up a bit more than 4x during the 1936-1956 period (dividends reinvested).  Interest rates were below 3% for almost that entire time.  CAPE in 1936 was 17.  In 1956 CAPE was 18.

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Looking at the ten year Treasury data on Robert Shiller's website, I found that the ten year yield dropped below 4% in February of 1880.  Rates stayed below 4% until 1911 (over 31 years). 

 

A few decades later, rates dropped again for a long period.  The ten year yield dropped below 3% in June of 1934.  Rates basically did not get above 3% again until 1956 (with the exception of two months in 1953 when rates briefly exceeded 3%).  That's essentially 22 years of rock bottom interest rates (just like we have today). 

 

Thanks for this useful info. Is there some data available how did the stock market perform during those times, preferable a graph that shows both the interest rate and stock performance, with recession periods?

 

https://research.stlouisfed.org/fred2/graph/?g=1Adu goes upto year 1954.

 

Market went up a bit more than 4x during the 1936-1956 period (dividends reinvested).  Interest rates were below 3% for almost that entire time.  CAPE in 1936 was 17.  In 1956 CAPE was 18.

 

That was the 10 yr. Bond.  The period was into and after the Second World War when government debts were very high as well, like now.  It was very similar to today. 

 

There is no reason for rates to rise for a long time going forward.  I don't believe the fed will raise rates this year, or probably in the next few years.  Yellen has left herself lots of wiggle room.  It is the best time in decades to be an investor focused on dividends. 

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