Thursday, April 7, 2011

Low rates of interest are bad for us all

Lu Shengzhong

Lu Shengzhong © fintag

News comments:
Low interest rates have made us complacent; a big storm is just around the corner.

Interest rates are used to control inflation mostly (and currency strength too). However the spreads between inflation and interest rates for most Western economies are at historic highs because rate setters falsely believe that low rates = growth and happiness.

Governments used to be very frightened of inflation because it is a long term destroyer of countries. Look at Zimbabwe, Iraq, Yemen, Vietnam, India, Italy, Argentina, the UK, China, USSR, the list of victims is endless. In times of inflationary trouble the safe haven has been the USD (although Gold appears to be the new USD) and with the Euro trying to take over as the world currency questions are being asked - what happens if inflation destroys the USA or Europe? Well if rates were hiked up we could prevent armageddon.

But we are all like goldfish. The long forgotten Greenspan Put is why the USA is in such a financial mess (low rates for too long) but we are all too smart to learn from history. We are heading towards an economic crisis that will be the worst any of us has ever faced unless rates are hiked up pretty quickly.

We are all crack heads, it seems, where we will give up tomorrow but never do. The impact on our grandchildren will be trade wars, wars and Belgravia being full of Squatters.

There is good reason why bankers bonuses are larger than ever and we can blame the semi-god rate setters who are helping them big time.

Here are some reasons why low rates are bad for us all (unless you are a banker of course):

Low rates are no use if you cannot borrow at these low rates. Which is what is happening otherwise we would all have refinanced our debts and be living in huge mansions and driving million dollar cars on nearly interest free credit.

The psyche is this. If rates are high, people are sensible. They worry about servicing their debts and so act responsible. If rates are low, people act irrationally and go mad. And this is what is happening. People and Companies are not refinancing fast enough because they cannot. They are stuck but banks aren't calling these loans in and so are pretending everything is all right. Well pain has to come sometime.

Asset bubbles
At the moment banks have capital issues and cannot lend at the risk levels they once did but that isn't stopping them from generating and enjoying various asset bubbles such as in new areas where the collateral is deemed safe – commodities for example. And believe it or not but real estate too where cash is still pouring into the building of empty buildings.

Commodities are very volatile and as prices go up so does the capital collateral needed to trade. So the banks pour more money in because they are making money on the bubble and the bubble just keeps on growing so why not pour more into the bubble. Ask yourself why is Oil so high? Cars are becoming more efficient and solar panels are becoming cheaper. Demand is also sluggish. The middle east conflict hasn’t interrupted supply at all. Oil is a speculative boom, so make money off this while it lasts.

The Tech 2.0 bubble. Facebook and Twitter are not worth billions but with walls of cash looking for returns then yes they are worth billions and the bubble will just keep on growing whilst bankers pump and dump until we look in the mirror and realize its just another AOL debacle.

Once interest rates go up, the banks will pull their lending and put it somewhere else and these bubbles will pop. Which is good for us all.

Those who live off fixed income struggle
Pensioners suffer with low rates. Low rates means less income and if inflation is eroding the value of their income, they suffer even more. In fact the value of cash in most developed countries is eroding so fast (after taxes and inflation) you might as well spend it all and max the credit card out as it will probably be cheaper.

No wonder 1 dollar trick brothels are being found all over the country and depression is the new virus inflicting western society. (wikipedia)

Being a hippie is fine if you have a trust fund behind you otherwise it isn’t much fun.

Why bother saving?
Banks don’t need savers. Banks can borrow at near zero from each other and those freindly money printing lenders of last resort like the Fed, BoE and ECB and buy risk free govt debt with yields of 3% to 6%.

Companies who are cash rich can do the same and do. Why should they bother to lend to risky businesses when they can make these sorts of returns?

So if you are a saver then you might as well put your money in the stock markets and try and make returns that exceed inflation and be part of another asset bubble like gold and oil and tech 2.0 and other assets where the is no real reason apart from swathes of cash speculating that these assets are worth so much when their fundamentals show them to be worth a bunch of daffodils.

And of course the US Treasuries bubble. America borrows way too much but there are walls of cash form the middle east and China that want to own a piece of the American dream so they just keep on buying it. This is the next bubble for when the Fed puts up rates, bond prices will fall. With inflation pushing up, investors want a real rate of return and the existing bonds will not do it. So the US government will be forced to offer higher yields that need to be serviced and as the CRAs struggle to keep America’s AAA status these yields will move upwards and the US will become even more indebted which will cause inflation and the USA will turn Japanese where it will be caught in the trap of having to keep rates low until it can clear its debts which it will fail to do.

Real estate bad debts
Most of the world’s banks have huge real estate bad debts. The regulators know this and so do the politicians. If they were forced to foreclose, the carnage would be global (just look at the Irish banks). With banks being forced to hold more liquid debt, like government debt (so the banks are just fueling the great government debt bubble), they are making money for themselves, keeping governments propped up and not investing in new businesses.

Consumers aren’t taking advantage of this cheap debt
Why? Because consumers are already over indebted and the banks don’t want to force consumers into foreclosure so are making it hard for them to refinance. Regulators are making it more difficult for consumers to take out cheap debt too, because they were berated during the credit crunch for not controlling credit card lifestyles. Consumers are getting poor savings rates and but cannot get cheap debt to leverage their way out. No wonder consumers are feeling so depressed, unless you are a banker of course where life couldn't be more rosey.

Carry trade
Low rates is an opportunity to borrow cheap and invest elsewhere. This is the great Japanese ponzi scheme that kept much of the last boom alive. Low rate countries are used as ATMs and their currencies end up being tossed around like a rag doll on a windy night. If we are not careful the USA will be the next carry trade currency if it isn't already.

Turning Japanese
Japan has had low rates for years. It has struggled to grow internally and imports are expensive. It has survived because the Japanese love saving and this has been the cheap supply of capital that Japanese companies have relied upon but this will start running out unless it prints more money as it has done in the past and reflates and add to its huge debt / gdp imbalance (a staggering 200%). (

Older Japanese are hard workers where as the youngsters are not and are often termed Slackers. This is causing internal structural issues just as in the USA where "Entitlement" is the new Obama created socialist disease (big government). Over 90% of Japanese debt is owned by the Japanese but as the Slackers refuse to save and the pension funds dwindle the Japanese will be forced to seek external borrowers and this is where the trouble will begin. Its people are highly taxed and they spend their disposable income on Japanese government debt. This cannot last.

The Japanese Banks have got so used to low rates and above inflation Japanese govt debt yields that if rates rose the bonds would fall in value and the banks would be hit so hard there would be a banking crisis. Again.

Japan has one primary customer it sells to - the USA. The low rates in Japan have created huge car and entertainment businesses because they have had cheaper capital than the Americans. Japanese exporters have done exceptionally very well (thanks to the guilt of nuking Japan) and until the time the USA wakes up and slaps huge tariffs on Japan, it will sink completely. China has learned a lot from Japan and it laughs at the pathetic Americans who buy its cheap produce and then gives the money back to the Americans to keep the demand cycle going. It is so brilliant, China is just a huge hedge fund.

These issues are complicated but rates need to go up fast. This will clear out the bad debts, help pensioners gain a real income and focus consumers on assets instead of liabilities. They will help burst these bubbles that are causing us all pain (gas prices for example) and most importantly contain inflation.

Today's shorts:
Why the US is in a worse place than Greece (sudden debt)

UK to bail out Portugal (telegraph)

BoE spoil my day but ECB shines (reuters)

Today's longs:
So you think the USD is still the world's currency? (fintag)

Sharia compliant funds to be fall to pieces as rates rise.


BrianSJ said...

Good photo. Interesting sculpture.

Anonymous said...

Under current financial situation nobody still feels safe I guess, consumers can always find these fast pay day loans online to solve their temporary money problems, but if the whole system is in default, I do not even want to think about the consequences.