Interest Rate Trap

This was on Drudge the other day. For it seems like forever, I have been reading stories about how the central banks are holding rates at near zero, but may be ready to raise rates at some point, but not now. I suspect most people have stopped paying attention because it just seems like the same story recycled once a quarter.

The Federal Reserve is keeping interest rates near zero and is waiting for further improvement in the labor market and inflation measures before allowing any increases, according to the latest Federal Open Market Committee (FOMC) statement.

The Committee says it will evaluate the progress of the economy, focusing on its twin goals of maximum employment and 2 percent inflation, in determining how long to maintain the current low target range for the federal funds rate.

The Committee says it will raise rates when it is “reasonably confident” that these two criteria have been met.

Fed Chair Janet Yellen signaled that the Fed may raise rates later this year when she discussed the Fed’s semiannual report to Congress on July 15.

“If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target, thereby beginning to normalize the stance of monetary policy,” said Yellen in her testimony. “Indeed, most participants in June projected that an increase in the federal funds target range would likely become appropriate before year-end.”

The Fed has held the federal funds rate near zero since December 2008.

Let that sink in for a second. We are going on seven years since the Fed lowered rates to what people thought was the floor of the possible. Now, we know central banks can and will lower rates below zero, but the US has yet to go down that road. Still, near zero for the better part of a decade is not without its consequences.

Tim Kane, an economist at the Hoover Institution, is one of these critics.

“The Fed funds rate has not been raised in nine years, and interest rates this low create an illusion that the escalating national debt is (and will remain) easy to bear,” states Kane. “With interest rates kept too low for too long, the Federal Reserve can turn a boom into a bubble.”

That’s not the half of it. Corporate and sovereign debt is now fully structured around near zero rates. Most of this debt is rolled over when it matures so a rising interest rate environment means suddenly rising interest payments. That’s what happened to Greece. Rates jumped and the operating deficit increased. That was met with more borrowing, which drove rates higher. Eventually, they could no longer borrow at rates they could pay.

In America, pension funds, which used to rely on the steady returns of bonds to remain solvent are now invested in all sorts of synthetic instruments based on equities, housing and speculation. Those pension funds are wildly underfunded and the returns are below market on their current investments. Rising rates will drive down the value of equities putting pension funds in deeper trouble. The word “catastrophe” gets throw around a lot in the pension world for a reason.

Rates will return to their natural level eventually. The question is whether it will be an orderly recession that comes with raising rates or whether it will be a chaotic depression as central banks lose control of monetary policy. Those are not great choices and they are political choices. The Fed is a political institution, which is why they keep delaying the pain. In politics, tomorrow is the best time to take the pain and tomorrow never comes.

This is a pretty good example of something Joseph Tainter described in The Collapse of Complex Societies. When the Fed first started cutting rates, they got a big return, in terms of the impact on the economy. As they kept lowering rates, the return got smaller, thus forcing them to chase the desired results by lowering rates further. As rates approached zero, returns reached zero. It appears to be a classic example of diminishing marginal returns.

At first blush it sounds like a simple thing to let rates return to normal, but that is not a cost free endeavor. At the same time, maintaining artificially low rates also has a cost. The spiraling sovereign debt is a pretty good example of the cost that comes from distorted debt markets. Some economist argue that the ultra low rates are actually hindering economic growth as evidenced by the anemic recovery.

The Fed understands this, but it is a political entity and the choices are all politically difficult. Slowly raise rates and you risk recession, which brings the political class down on the Fed. Leaving rates low means the cost of unwinding the low-rate regime keeps climbing. Worse yet, some new crisis will have to be addressed with cutting rates further, exacerbating the long term problems that come from ultra low rates.

The Romans never figured out how to make an orderly retreat from empire. They exhausted themselves financially and culturally trying to keep the empire together, eventually leading to collapse. America is not about to be invaded by Visigoths. Collapse is unlikely, but a very painful and disruptive reordering is on the horizon. The question is how painful and orderly.

9 thoughts on “Interest Rate Trap

  1. The barbarians are here, but I’m not sure of the scenarios put out by writers who claim that it will be chaos due to the ‘EBT card-Section 8 Funding-Miscellaneous Free Stuff’ being cut off. They envisage some form of Madmax, but I think that’s unlikely. We already have Mini-Madmax in the colored infested cities, but it is in slow motion.

    I think that the colored people will be catered to first, as they are catered to now. It is all of us Whites that will be thrown under the bus, because we don’t riot. We just sit and take it, with a lot of moaning and complaining and outrage, but no action.

    The PTB are very smart and seem to be following The Coudenhove-Kalergi plan. Here’s a snippet and a link to this non-conspiracy theory right from good old wikipedia, and one other. There are other sources if you care to google it.

    WIKI- from the section ‘Views on race and religion’:
    “The man of the future will be of mixed race. Today’s races and classes will gradually disappear owing to the vanishing of space, time, and prejudice. The Eurasian-Negroid race of the future, similar in its appearance to the Ancient Egyptians, will replace the diversity of peoples with a diversity of individuals.”

    Another source:

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  4. Not entirely off topic….I’ve decided to start reading my recently acquired copy of Christopher Mackay’s “The Breakdown of the Roman Republic.”

    Gee, wonder how it turns out….


    • I’m reading Steven Saylor’s “Roma Sub Rosa” series- fun stuff. I had already read Collen McCullough’s “Masters of Rome” books and quite enjoyed them. I suppose I should read some real History of the period….

      • Skip the “real history,” the real history is in good historical fiction. The spaces in between the facts are what really matter, and they’re all imagined.

  5. I think we are kinda being invaded by the Visigoths- except we’re paying them to invade us.

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