So….Where Will Interest Rates Go Now?

My brief answer:

(1) Up Slowly…Then

(2) Down Quickly…Then

(3) Up again Quickly (after a near-zero plateau)…

Australia (for example) is still in Stage 1, whereas the USA and Europe are in Stage 2.

Here’s the discussion, if you’re interested…

Both private debt levels and sovereign (national, public) debt levels are either at or approaching all time highs – and possibly, and even likely, so high that they cannot realistically be paid back within a normally reasonable timeframe…or even at all…

With regard to the debt (and, really, exposure) of the world’s private (ie. not central) banks, an acquaintance gave me the following link:

http://www.smh.com.au/business/global-banks-face-58-trillion-rollover-20100629-zi3g.html

You don’t have to worry about all the details, except to appreciate that the numbers are HUGE…some 1/3 of the USA GDP for a year…ouch…

Before you read on, note that my perspective assumes, according to my macro-economic opinions of the underlying causes of the current “crisis”, that the causes are still present and will persist, such that the current mainly deflationary phase of this crisis that has now gripped much of the world’s economies, will continue …

The private bank debts mentioned in the Sydney Morning Herald article will “mature” and be “refinanced” according to the perceptions of several key market aspects relating to debt at the time that refinancing comes up:

a) the availability of credit
b) the liquidity of credit
c) the risk of credit

I personally predict:

– (a) to reduce by time of maturity;
– (b) to reduce by time of maturity;
– (c) to increase by time of maturity.

…of course, this does largely assume that the Central Banks (governments) of the world will not “intervene” asn distort the free-market…which they are 99% certain to, unfortunately. If this happens, credit availability and liquidity should increase in the short term after the “intervention”, but the above (a) – (c) predictions “should” materialise themselves again in the medium to long term. Hence, I consider these predictions accurate in the medium-term WITH intervention, and accurate in the shorter-term WITHOUT intervention.

To expand on those (a) – (c) points:

i) Decreased availability of credit means a smaller pool (supply) of credit/debt; hence, if demand is similar to what it is today – or especially if it increases for whatever reason – then the premiums/rates will increase to reflect a higher demand:supply ratio

ii) Decreased liquidity means that refinancing of existing debts occurs less quickly (ie. it is harder to get – think about the difference between selling shares and selling a house…speed…liquidity..ease of liquidation); ease of refinacning reduces…things stretch out; trader take premiums (ie. insurance and/or rates increases, to cover themselves somewhat, which generally ust increases the cost (rates) of debt/credit in the long run, when “it” comes around again)

iii) Risk of credit ~= risk of default or even partial default – probably the big one at the moment….things are risky in just about any (every??) market in the world at the moment (as reflected in the prices of the “i’m scared!!” categories of assets, such as (and particularly!) precious metals…again, higher risk of default (ie. can’t service debt) means traders will take premiums (higher rates) or insurance (which comes back around full circle as rates anyway!)

…BUT….

This won’t happen “quickly”……? WHY?

Well, it probably SHOULD in a truly “free-market”. Why? Well, the Western economies have for some time now mal-invested to the extreme, by over-valuing things, and consequently over-investing in them (generally through speculative, rather than productive investment)….and now everyone is either choosing to wise up, or is being forced to…

BUT…the govts of the world (just about all??) “intervene” via their central banks to “save the day” by:

a) INCREASING the availability of credit
b) INCREASING the liquidity of credit
c) REDUCING the risk of credit (or is was supposed to, at least…)

This will have the effect of “delaying the inevitable” in my opinion; delaying the consequences by “borrowing from the future” and “bringing forward demand” to pay for and delay the problems of today at the expense of the future (to use a notion from the guys at “The Daily Reckoning”).

How? Look up “quantitative easing” on the Web…aka “money printing”, though these days that is normally done by adding zeros to electronic forms and pressing a button.

Another “how”? Answer: “Stimulus”…ie. govts borrowing heaps of money from the free-market (and thus distorting it incredibly) and then giving it to private banks at really cheap prices (ie. central bank rates), thus incredibly distorting the free-market again!

Yet another “how”? No, surely not. Yep: “Bailouts”…when the free-market is trying to “correct” and rid itself of mal-investments and mal-valuations, govts, who for some reason (politics, perhaps?) cannot let GDP go “down” (ie. receed –> “recession”) – even if it is only as high as it because of unsustainable, unbeneficial broken systemics based on mal-practice! – then proceed to “bailout” those who are “too big to fail”…thus, once again, distorting the free-market incredibly.

Yep. That’s it: money printing, stimulus and bailouts; all done on incredible magnitudes, and all having incredible distortionary effects, the biggest of which is allowing entities and systems to continue to exist and continue to carry-out the very mal-practices that got the free-market system to a point of “oh no, bad!” in the first place…and thus either stick with a free-market economy, make things even worse, and then cause an almighty crash that was worse than it ever had to be; or, lose faith in the system that has been so screwed around with and distorted that no one thinks that it works any longer, and then abandon it for something else! (ie. Paradigm change, which is what i think will eventually happen..give it a few decades though…!).

Ah, but it needn’t have happened if those who wanted to live by the free-market were willing to be corrected by it earlier and more gently, rather than try to escape responsibility, accountability and consequence. Familiar? Hello human nature…

Anyhow…back to “what will happen”….

With all this govt intervention, the problems haven’t been fixed, they’re still there, and the market knows it; only now, they’re bigger, healthier, like a disease that was losing to the body’s immune system, but then the immune system was weakened or distracted, and now the disease has come back bigger, badder and more resistant that ever. The market isn’t perfect (because people aren’t perfect, and never will be in this life), but it isn’t stupid….that crap is just riskier…..price it accordingly…

Like bailing our Greece, really…they were a financial problem: they spent more that they could afford to ever pay back…then ECB bails them out….little changes, relatively speaking, and little can without collapsing the nation….so the traders say, “Thanks for the bailout, for now; but you’re still a risk becaues all the basic problems are still there; here’s a risk-premium”…then Greece is less able to pay off their debts due to higher rates…they become even riskier…and then the risk-premiums increase again, and so on…and then more bailouts, more govt borrowing, more money printing, more risk-premium increases, more chasing of the tail, etc, etc….

And that leads more to another BIG part of “what will happen”, in my opinion. With so much money being thrown at crappy financial entities, who are “free-market-sick”, and so much money being “printed”, the price of assets is falling all over the world, and the money supply – which is SUPPOSED to be tied to asset price is, but is now being printed and distributed despite falling asset prices – is INCREASING. What gives, eh?

That is, the ratio of money demand (price) to supply is decreasing, meaning that the available money EFFECTIVELY has less intrinsic value….ie. what is the value of a Euro or USD when you keep just adding more to the pool, without having more to tie the money to? The value of a unit of currency DECREASES relative to what it is supposed to be intrinsically tied to, that is, REAL assets. This is called “monetary inflation”, and the market will adjust prices upward re-balance real assets and available money.

What do govts (via central banks) do here? Ideally…they are supposed to track money, and express their desire to see their currency retain its intrinsic value by increasing interest rates – ie. the cost of their money/currency.

However, central banks these days try to do something else these days as well: save the world 😉 …via adjustment of increase rates to avoid GDP recession, almost always downwards, and definitely the case in the West today. Otherwise expressed, they adjust interest rates (ie. the inter-bank lending rates in their country) to increase the accessibility of debt/credit, and keep the “debt wheels” a-turning. Only problem is, that if the context and cause of the problem is fundamentally one of mal-valuation and mal-investment – such as the mal-investment of debt into speculative ventures on a very large scale! (familiar??) – then this just exacerbates the debt-related problems, by allowing entities to access credit and keep doing what they were doing…ie. they never had to learn…sound bad?

Anyway, decreasing interest rates is much like allowing your currency to relatively devalue, as interest rates are at least SUPPOSED to reflect your own view of the the value of your currency/money; much like how a tight pool of credit is lent at “high” interest rates, as it is intrinsically valuable to both the lender and debtor; “lower” interest rates reflect that the lender does not, in a relative sense, value their money/currency as much…such is it for central banks: they COULD just let inflation – the “normal” reason for increasing interest rates – just do its merry thing (ie. relatively devalue the currency!) OR they could react, and “fight” against this macro-systemic devaluation by expressing their perception of the currency’s value in their interest (lending) rates.

But, unfortunately, most central banks effectively “choose” to devalue their currency to allow their debt-sick economies access to more debt, and hopefully stimulate their way through the current “problem patch” (though it is not that cut-and-dried to central banks, and central banking believers, such as most Neo-classical/mainstream economists.

Hence, how does this affect what will happen with maturing debts on a global basis? With many/most assets decreasing in their relative value (deflation) and most of the govts/central banks of the world INCREASING the supply of money, we have inflation (money devaluation) on one hand, along with deflation on the other, which most central banks/govts will respond to by decreasing interest rates – even in the face of increasing inflationary pressures (which i would argue are currently being “masked” by the currently more dominant deflationary pressures; but are manifesting in some parts of the economy, and should manifest more significantly as deflation rates decrease).

And, yet, we also have private entities, particularly banks (unable to “create” money like central banks can) actually valuing what finite resources/money they have in a proper free-market fashion: risk increases, so increase lending rates to reflect that: my supply decreases, so increase rates to reflect its earning value/importance to me; and so on…

The only major free-market influence i can think of that might put some DOWNWARD pressure on lender rates might be that of a significantly and characteristically deflationary environment reducing demand for debt so greatly that lenders need to reduce their profit margins to stimulate demand for their product (ie. debt). This is not unlikely.

However, like the consolidation (aka “trimming”) that occurs when deflationary-recession grips an economy, and excess supply/production (from excessive debt/demand) is removed to match the new, reduced demand, it is likely that the private bank lending rates of those banks that have NOT been “culled” by the deflationary-correction will be higher than before the correction hit. I say this because, by the time the new supply-demand equilibrium has been established in the wake of the deflationary correction, the supply of credit/debt will be scarce, not easily lent (due to reasonable fear!) and those wishing to take hold of capital/credit/debt for the emerging recovery will have to compete for debt supplies from tentative banks.

So…

In my opinion, what will happen to private bank interest rates?

From the central banks of the world: low to very low interest rates (and for some, zero interest rates, as some already are…). This is really quite an interesting scenario, as it is effectively the death of central banks by uselessness, and the private banking sector returns to the pre-central-bank days of several hundred years ago of determining the price of money…funny that!? But it may not last for long, i surely can’t say! But moving on…

From the private banks of the world: rates that will move largely independently from those of central banks – in those countries that already have zero or near-zero central bank rates, i would predict near-continuously increasing rates; from those countries whose central bank’s rates are “significantly” far from zero (say, above 2%), i would predict a period of decreasing rates to stimulate credit access (in line with central bank moves and motives) and then a sustained period of increasing private bank lending interest rates.

Keep in mind that for that last point, I am assuming that central banks will choose to drop rates to stimulate debt-acquisition or possibly a real recovery, instead of following their “normal” and ideal mode of adjusting rates to control inflation; as i strongly believe that almost all central banks will pursue recovery over inflation control, i will not here comment on rates movements for economies whose central banks do not pursue rates-based stimulation.

SOOO…to repeat what I wrote in the excerpt to this article…

Interest rates trends for you, the reader, depend on:

i) Which country in the world you live in

ii) What the current mindset of your central bank is (if you have one), and what phase they are at in “controlling” what they are trying to control

iii) What stage of the “Correction” your economy is in.

But, generally, the corrective trend, in my opinion, will be:

Stage 1: Up (due to “debt feedback” causing consumer price inflationary pressures)

Stage 2: Down (due to national economy GDP recessionary pressures; some loss of confidence in “fiat (paper) money” to begin here (inflationary pressure), but overshadowed by large deflation)

Stage 3: Then Up again (probably very fast and high, due to monetary inflation and tight, reluctant credit conditions, exacerbated by a further, continuing loss of confidence in “fiat money”)

…with lots of “nasty” economic things happening during each phase.

For example: the USA and Europe are in Stage 2; but somewhere like Australia in still in Stage 1.

Note that the “debt feedback” comment I inserted at Stage 1 is my own specific form of what is actually a very common phenomena in real industrial processes (such as mineral processing): a quantity defined as “negative”, or at best “minimally necessary” for the balance and quality of the system, and is usually kept “minimal” and under strict control, builds up and accumulates in that process, until is gets so large and dominating in process functions that it starts to alter the nature of function of the process. It eventually “ruins” the process, in a nasty, exponential downward spiral where little more than that negative entity and lots of waste are seen coming through the “outputs”, almost regardless of the nature and quality of the inputs. Shutdown is often required…the Biblical “Jubilee” (cancellation of dents every 50 years) is the best economic equivalent I can think of. Abandonment of market-economics is the other option I can think of – extreme, but an option nonetheless.

Economically speaking, that’s generally what i think has been happening for a few years now, with the platform well-established by the 1980’s, and really gaining momentum in the 1990s: the debt got too large, and it’s altered the way the markets operated, and now it’s bringing the system down…or at least through a very large and substantial correction, IF we all decide we want to save free-market economics….else, it’s just a zombie waiting for to meet its death from a hardcore apocalypse survivor with a shotgun, movie-style, yo….

Interestingly, “debt feedback” is not a common notion in economic theory/process/system discussions – for various reasons, but mainly because (and i say this with all due respect and humility…i hope!) because many economists actually have a surprisingly bad understanding of how a free-market works. However, there are a few mentions of it on the Internet that I noticed, and those mentions have cited the exact same lack of knowledge of its existence in economic theories as I have mentioned here; I would expect that this would change in due time….but we’ll see, I guess!

Nonetheless, if this was even remotely interesting or persuasive, do yourself a favour: get out of debt, if you can; if you can’t, pay it down…this all minimises you exposure to the “nastiness” that I think is unavoidable at the moment.

Thanks for your time!

Regards,
Stewart (processdude)

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4 Responses to So….Where Will Interest Rates Go Now?

  1. processdude says:

    Hey all, processdude here.

    Hoped you enjoyed the post…but they WILL get better!

    Thumped this one out pretty quickly, but have some much more polished ones, as part of a series on the understanding the “goings on” of the financial and economic world from the point of view of the Global Financial Crisis (as it is known in Australia, Europe and many other parts of the world), or just “The Recession” as it is known in the USA.

    Enjoy!

  2. processdude says:

    Oh, and a number of smaller, current-affair-type topical posts to come as well!!

  3. Pingback: Home underwater. Inflation question - Page 2

  4. Pingback: Real-Estate Case-Studies at a Glance: Fitting the Rodrigue Bubble Curve? | Angles on Economics

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