Friday, January 1, 2016

Has The Power Of Low Interest Rates Been Played Out?

It is interesting to speculate what might of happened if Paul Volcker had not nipped inflation in the bud back in 1980. By the end of the 70s inflation started to soar by taking interest rates to nose bleed levels then Fed Chairman Paul Volcker brought inflation back under control. Paul Volcker, a Democrat was appointed as Federal Reserve chairman by President Carter and reappointed by President Reagan. Volcker is widely credited with ending the stagflation crisis where inflation peaked at 13.5% in 1981. He did this by raising the fed fund rate which averaged 11.2% in 1979 to 20% in June of 1981.  This caused the prime rate to hit 21.5% and slammed the economy into a brick wall.

At Some Point Low Rates Lose Power To Stimulate
This also has had the effect of shaping the level of interest rates for decades. The dollar being the worlds reserve currency means his actions affected rates and policies across the globe. Raising interest rates in real terms far above the rate of inflation makes money or capital more valuable and tends to decrease speculation and focus the allocation of funds to where they are most needed. High rates punish borrowers and rewards savers. it also forces countries and people to live within their budget. Those who overspend and find themselves in debt pay a heavy price with their rates increasing as their credit rating drops.

The high interest rates of distant years also positioned those in power with an "ace up their sleeve" and a way to to boost or stimulate the economy at any time by loosening or lowering rates. The ace of lower interest rates has been played time and time again over the decades and it appears its power to bring consumption forward is about played out. To those of us who years ago never envisioned the super low artificial interest rates of today it is most ironic to see the concept of negative rates proposed in an effort to continue milking this effect. Sadly, when low rates are coupled with a massive expansion of new money creation, growing credit spawns debt that at some point overwhelms us and cannot be repaid. At that point this policy yields diminishing returns and has been compared to pushing on a string. This causes me to ask, has the power of low interest rates and all the benefits garnered from them been played out?

Government Debt Has Soared As Rates Fell!
While on the surface the answer might be yes, it is necessary to consider the side affects of these policies have also done considerable damage that might prove too much to bear. Unfortunately, as the experience of rising rates fostered upon us by Paul Volcker proved years ago higher interest rates bring a great deal of pain to those who have borrowed too heavily by magnifying their burden, this will likely again be the case. In the 80s high interest rates halted inflation by ending the explosion of credit expansion and new debt. However, today bankers and financiers have complicating the economic landscape by creating a slew of new games and tools by which they play and dabble in the art of procuring wealth. Derivatives, high leverage investments, and a number of carry traders have again expanded debt and become intertwined in a mass of obscure and tangled schemes that could at anytime begin to unravel.

Predicting Inflation A Difficult Task!
Interestingly the "inflation or deflation" debate that central banks often claim drives their QE policy continues. In the past I have put forth a theory that inflation could rule the day even if central banks are unable to keep the wheels on the bus and the economy collapses. This theory is partially based on and dependent, on which way the dominoes fall if a collapse does occur and how much money survives looking for a safe haven. When inflation hit Germany during the 1920s history shows the worst of the inflation hit came over a very short period. I remember pondering at the time that it was amazing how quickly inflation took root and if a similar scenario were to unfold today it would be prudent to factor in just how fast it could happen now that we live in an age of instant communication.

Today those who see inflation in our future are back on their heals and off balance as many people point to falling commodity prices as proof deflation is at our doorstep. To those in the deflation camp this removes the possibility that prices might soon soar as a result of the creation of massive amounts of newly printed money. A word of caution, in a complicated world future inflation is difficult to predict, we should not be deceived or led to believe that lower oil and commodity prides will in themselves bring about deflation. Often falling prices in both commodities and goods reflect a lack of demand or temporary supply imbalance that will correct itself. When that happens prices tend to rapidly adjust to what I will call the "new reality of the day".


  1. From my perspective the financiers are destroying the real productive economy much like a strip mining operation leaving nothing but wasteland behind. At some point this will end and not likely well. When there is nothing left to steal and the masses come to their senses someone will receive all the blame.

  2. Its weird talking to people that actually think this clown carnival is sustainable. If you take on unproductive debt to maintain a life above your means, that debt has to produce something or at some point you can't borrow anymore and austerity is forced upon you. Right now economies in places like South Africa and Brazil are imploding, and someday the contagion will destroy the core (US). Just another example of the insanity that afflicts humans from time to time.

  3. .. the inflation lift will put the Soviets to shame...