The Case for Low Rates

RSWLiving - - Department­s - BY S. AL­BERT D. HANSER S. Al­bert D. Hanser is the founder and co- chair­man of the Sani­bel Cap­tiva Trust Company, a Sani­bel- based wealth man­age­ment firm with di­vi­sions in Naples, Tampa and Chicago. Learn more at san­cap­trustco. com.

In­fla­tion or de­fla­tion? Ris­ing in­ter­est rates or fall­ing? Pun­dits con­tinue to make the case daily for both sce­nar­ios to de­velop, and the an­swers will no doubt im­pact as­set prices the next few years. Five phe­nom­ena, how­ever, tell us that the likely course for in­ter­est rates is to rise mod­estly, but to gen­er­ally stay at his­tor­i­cally low lev­els.

More De­mand than Sup­ply

It may seem coun­ter­in­tu­itive that bond in­vestors would crave U. S. Trea­suries yield­ing 0.2 to 2.5 per­cent, but there’s no doubt that their con­tin­ued ap­petite has helped push up bond prices and push rates back down in 2014. Ex­ac­er­bat­ing the de­cline in rates has been a steady im­prove­ment in the fi­nances of the fed­eral gov­ern­ment, whose yearly deficits are one- half their re­ces­sion­ary peaks— hence, there is less sup­ply of new Trea­sury bonds for yield- starved in­sti­tu­tions to bid on.

Con­tin­ued Slack in the Econ­omy

The level of in­ter­est rates pre­vail­ing in an econ­omy will, of course, cor­re­late to the rate of in­fla­tion. Those look­ing for a surge of in­fla­tion from the re­cent flood of cheap money for­get that even dur­ing the com­mod­ity boom from 2006 to 2007, when most raw ma­te­rial prices hit si­mul­ta­ne­ous peaks around the world, the con­sumer price in­dex ( CPI) in the United States was ris­ing at just 3 per­cent an­nual rates. It is un­re­al­is­tic to ex­pect 3- per­cent in­fla­tion to­day when com­mod­ity prices are far be­low 2007 peaks, wages are ris­ing at just 1 per­cent an­nual rates, Amer­i­can in­dus­tries still op­er­ate at just 78 to 79 per­cent of ca­pac­ity, and sev­eral mil­lion work­ers re­main job­less.

Beg­gar thy Neigh­bor Ex­port Pres­sures

With the U. S., Ja­panese and Eu­ro­zone economies mired in sub­par growth, cen­tral banks and pol­i­cy­mak­ers have sought to grow their na­tions back to pros­per­ity by em­pha­siz­ing ex­ports. Keep­ing cur­rency val­ues low rel­a­tive to trad­ing part­ners’ cur­ren­cies has been a means to that end and has in­cen­tivized cen­tral bankers to keep rates low to dis­cour­age for­eign in­vest­ment. We frankly see this down­ward pres­sure on cur­ren­cies con­tin­u­ing, as China, Brazil, South Korea and the Euro­pean Cen­tral Bank all re­cently have sought to push down their cur­ren­cies and in the process “ex­port de­fla­tion” to their trad­ing part­ners.

Low Turnover of Money

In clas­sic eco­nomics, the size of the econ­omy roughly equals the money sup­ply mul­ti­plied by the turnover rate of money. Start­ing in 2008, the turnover rate ( ve­loc­ity) plum­meted and con­tin­ued to plum­met into 2013— long after the re­cov­ery be­gan. Sim­ply put, all the in­jec­tions of stim­u­lus since 2008 did lit­tle to bol­ster con­sump­tion and in­vest­ment, but were used in­stead by busi­nesses, banks and in­di­vid­u­als to pay down debt and cre­ate large cash cush­ions. As long as this de­fen­sive be­hav­ior per­sists, eco­nomic growth will re­main stalled.

Gov­ern­ment Bal­ance Sheets Need More Re­pair­ing

Fi­nally, we can’t over­look the in­tense pres­sure pol­i­cy­mak­ers in Wash­ing­ton are un­der to keep rates very low for the fore­see­able fu­ture— whether that pol­icy is the cor­rect course or not. Al­low­ing rates to rise could im­peril re­bound­ing, rate­sen­si­tive in­dus­tries such as hous­ing, autos and con­struc­tion whose par­tic­i­pants have lev­ered their bal­ance sheets to low- cost funds. More omi­nous, a rise in rates by just 1 to 2 per­cent­age points would have huge im­pacts on gov­ern­ment bud­gets by swelling in­ter­est costs on debt and crowd­ing out spend­ing on po­lit­i­cally popular pro­grams. Just as wor­ri­some, ris­ing rates would im­pair the face value of some $ 22 tril­lion of fed­eral and mu­nic­i­pal gov­ern­ment bonds held on the bal­ance sheets of in­sti­tu­tions and banks around the world, caus­ing huge mark- to- mark losses that could force th­ese firms to con­tract their ac­tiv­i­ties.

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