By DoctoRx
With incomprehensibly low yields on money, the U. S. has in my view definitively followed the Japanese model. Of course there are major differences. One is that the U. S. is the global big dog, alpha male, leader of the pack, etc. Ten-year Treasurys at 2.03% as I write this are lower than at any time during the 2008 crisis.
With the consumer price index running at 3.6% annually, this is a bubble yield, yet – it exists. A great deal of savings are looking for a home and not perceiving a lot of worthwhile profitable lending opportunities. A rush of funds out of Europe, out of the stock market, and out of most commodities save precious metals is bidding up Treasurys in price. At these levels, the thinking gets interesting.
Once one is reconciled to putting up $100 into a 10 year bond and ending up, gross, with $120 a decade later ($100 of the $120 being nothing more than getting your own money back), clearly one is just looking to get one’s principal back with a “thank you” of a yield. At this point, there is not a lot of difference between getting $115 back rather than $120. That’s a 1.5% yield. So yield might drop to sub-2% in a real crisis.
Again, this is not a case of price stability or mild price deflation a la Japan. The U. S. has, for now, the exorbitant privilege that comes from sweeping the table in the major conflicts of the 20th Century and dominating the world in quite an astonishing way, if one thinks about the trajectory of this nation.
So this is a good news-bad news story. The U. S. attracts risk capital, even though one of its sovereign states, Illinois, is essentially in default on hundreds of millions of dollars in obligations. We hear a lot about Greece’s problems, but almost nothing about Illinois, which has a similar population to Greece, and which sends a much higher percentage of its state’s leaders to prison for corruption than does Greece.
In any case, the flip side of lower and lower government borrowing rates while price inflation perks along is the price of gold. In 32 years of following the gold market, gold responds to negative or positive real interest rates. Currently, with even the 30-year Treasury yielding less than the CPI rate, gold’s price is doing what it did in the 1970s. Gold ignores crises when real interest rates are strongly positive. Gold has left being bling behind. Not only is it the non-dilutable “currency”, the world may be closer to peak gold than to peak oil.
Upon reflection and observation of the economic data, I have some thoughts about the recent debt limit agreement. In relation to gold, the agreement is wildly inflationary. The combination of a balanced cash
Federal budget and reasonably high interest rates through the latter Clinton years pushed down the prices of gold and oil. The current policy points in the opposite direction. My guess is that the economists and bankers were advising Congress and the White House that the economy was at stall speed. Thus my suspicion is that the deal was more or less foreordained. Following recent economic orthodoxy, “stimulus” is to be continued while money is left in circulation rather than being withdrawn from circulation. Meanwhile, each side gets to point a finger at the other, which is useful when seeking campaign contributions.
Several weeks ago, I raised the question in this blog of whether the country was already in a new recession (assuming simply for sake of discussion that the Great Recession ended in 2009). The odds are now much increased that one has begun, with one usual suspect of a cause being the massive jump in oil prices coming off their crisis lows.
Returning to interest rates and banks, then, we have come a full half circle from three decades ago. Then, disinflation was the policy chosen, and high gold and oil prices were the enemy. Relatively tight money and the tolerance of interest rates as high as needed to break the inflationary fever were the policy choices. (Note there were no tax cuts in the 1980 recession or in 1981 as that great recession got underway.)
Now we have tax cuts galore even since 2008 and rather than impossibly high interest rates, we have these ridiculously low interest rates.
Just as investors had to respect the economic cycles in the 1980-3 period while being flexible and preparing for a world of secular disinflation and a ”flight” to paper money from tangibles, so too today. The major difference could be that as in Japan, zero interest rates can be a form of flypaper or quicksand. Zombie banks and bad assets that are not expeditiously liquidated mean that capital is trapped in a sort of black hole.
Thus I interpret the Fed’s statement of ZIRP for at least two years differently from the mainstream. I look at it as a well-informed prediction that there will be a “savings glut” relative to investment opportunities for a long time. While the Fed has a highly imperfect set of opinions, it certainly knows the true state of affairs in lending institutions better than I do. I’m thus not going to fight the Fed. I’m thus taking the point of view that a sluggish level of economic activity probably lies ahead of us in the United States for some time to come. I also expect negative real interest rates to bedevil us savers and provide a tailwind of varying strength to the prices of metals and other assets that can be hoarded. In weak economic times, gold will tend to be the strongest of these; that will tend to reverse when the economic has a growth spurt.
The specific investment decisions beyond the above that flow from this view will be discussed in subsequent posts.
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