# The Federal Reserve's big experiment



## james4beach (Nov 15, 2012)

The Federal Reserve did not raise rates today. That's kind of interesting to me because the overnight Fed funds rate is currently 0.14%, so raising to a 1/4 point target only meant an effective rate increase of 0.11% ... and they chickened out of even this infinitesimally small rate increase. Can you imagine how structurally weak the market must be, if it's too fragile to handle a *tiny* 11 basis point rate increase?

I've been pointing out for a while that the Federal Reserve's current policy is a historical anomaly. This is the first time they have attempted this, so we're in uncharted territory. These people have no idea what they're doing. Doug Casey spells this out quite well:



> This is all a gigantic experiment.
> 
> Most people see the Fed as a group of genius economists who know how to steer the economy to prosperity.
> 
> ...


I think he's a bit alarmist, and I disagree that it's doomed to end in disaster, but I'm still worried about this weird experiment.


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## GoldStone (Mar 6, 2011)

Your first paragraph is wrong. The Fed sets the target range. Current range is 0 - 0.25%. If and when they hike, the target range will shift to 0.25 - 0.5%.

Other than that, carry on with your daily Fed bashing.


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## james4beach (Nov 15, 2012)

I don't see how I'm wrong. Which part of my paragraph is wrong?

The Fed sets the target rate, and the target rate is currently 0 - 0.25%. Inside that range, they currently provide a rate of 0.14%, quite close to the midpoint as one would expect.

Previous targets were not stated as a range. The range only appeared when they got to the zero bound, and that's for practical reasons of satisfying that rate in the overnight market. Previous targets were stated as, e.g. "0.25%" (not a range) or "0.50%". You can see this clearly on the Fed's own web page, where they show the old targets and the current one. The range format has only been used for the current near-zero rate.

Thus a new policy rate of 0.25% would mean the Fed overnight rate is very close to 0.25%. Calculated 0.25% - 0.14% and you get a difference of 0.11%


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## james4beach (Nov 15, 2012)

GoldStone said:


> Current range is 0 - 0.25%.


Right, that's the target _range_. The actual rate is 0.14%, and that's the current cost of (Fed funds) money.



> If and when they hike, the target range will shift to 0.25 - 0.5%.


If they hike by 1/4, the new target will be 0.25%. (Not a range)
If they hike by 1/2, the new target will be 0.50%. (Not a range).


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## andrewf (Mar 1, 2010)

Is inflation showing risks of rising above the Feds target? If not, why raise rates?

It's like complaining that your taxi driver didn't tap the brakes when you're already going below the speed limit.


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## lonewolf (Jun 12, 2012)

In the bull market the fed is looked upon as heroes by the time the bear market is over the fed will be looked upon as zeros. The fed might not last through the next bear market.


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## Eder (Feb 16, 2011)

The fed is, and has been smarter than you.


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## lonewolf (Jun 12, 2012)

Eder I m not concerned with intelligence when playing the market. A strong commitment to reason is more important to me.

In 1927 the fed lowered interest rates to help out Europe which then was in the middle of a debt crises the same as today. History repeats the fed just gave in to international pressure.


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## dogcom (May 23, 2009)

The Fed mission is to make gobs of money for member banks and use that money to gain real assets away from people who had put the time and labor into them. You get a mortgage buy a house and work 20 years to pay it off and all the bank has to do is type onto a screen and their job is done and if you can't pay they get your property. They get as many people into debt as possible and get everyone else into paper assets as possible and then bail them in. They also know all the insider information to game most any market and do so legally which we cannot.

Lonewolf they are trying to find distractions like wars and such to deflect the blame from them when it all falls apart.


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## GoldStone (Mar 6, 2011)

james4beach said:


> If they hike by 1/4, the new target will be 0.25%. (Not a range)
> If they hike by 1/2, the new target will be 0.50%. (Not a range).


Yes, you are right.

Sorry for interruption. Please carry on with your Fed bashing.


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## CPA Candidate (Dec 15, 2013)

andrewf said:


> Is inflation showing risks of rising above the Feds target? If not, why raise rates?


The relationship between interest rates and inflation seems lost on many.

I think they are determined to make a raise, but feel the time is not right at this particular moment.

Finally, all this hubbub about uncharted territory with respect to interest rates is based on the notion that things must remain as they have in the past. The nature of the economy is changing, primarily because of technology. Humanity embarks on uncharted territory everyday. As far as I'm concerned, low growth, low interest rates are just the new normal. Expectations are what needs to be changed.


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## Just a Guy (Mar 27, 2012)

The disaster will occur if rates rise because people don't understand math, or think long term. 

For example, you, the typical prospective homeowner, buys "the most house you can afford" on they typical advice of most realtors (let's say for the "average" home price of $500k (round numbers makes math easier). You put down the 0-5% minimum, after legal fees, bank charges, etc you basically have a mortgage for $500k but, working together you can make your monthly payments and are locked in for 5 years. 

Feds decide to increase rates the day after you sign, but only by the minimum .25%/year...no big deal right?

In fact, you don't even notice anything as your rate is locked in, but time passes and he rates increase every year.

5 years pass, and it's time to renew. You've managed to even get a bit of a raise, but your mortgage is probably still close to $450k, and the interest rates have gone up 1.25% since your last visit to the bank, but that's not a lot right? You've been getting a 2% raise every year. 

Then the sudden shock hits when you're monthly payment has increased by nearly $450/month!!! (Quick rule of thumb, for every 1%, you can expect almost $100 payment increase for every $100k borrowed). Imagine if the Feds raised rates .5%/year or maybe 1%.

You could, of course, sell your property. If you are amount the first wave, you may even get out relatively unscathed...but the new buyer has to be able to afford that higher payment as well, which is unlikely, so you'll have to drop your price. As time goes on, and more people hit renewal time, and the reality of that, more houses will hit the market and prices will plummet, foreclosure swill become the norm and people will be forced into bankruptcy like never before. 

Honk I exaggerate? Look at what happened in the states a few years ago. They used to have a product called a balloon mortgage where, if the interest rate was say 5%, they didn't make you pay interest for the first half of the mortgage, but they payment doubled in the second half to "average out" to the full interest payment. It was designed to make houses more affordable. The key to its success was you needed to renew before the balloon portion kicked in, which happened for years, until they lending tightened up and banks declined renewals. When faced with having to pay what was required, the house of cards collapsed.


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## HaroldCrump (Jun 10, 2009)

james4beach said:


> so raising to a 1/4 point target only meant an effective rate increase of 0.11% ... and they chickened out of even this infinitesimally small rate increase. Can you imagine how structurally weak the market must be, if it's too fragile to handle a *tiny* 11 basis point rate increase?


The number of bps to raise is not the concern - never was.
It is all about the *expectation*.

A 25 bps increase in the F/F rate is effectively a 100% increase.
Even a 12.5 bps increase would have been a 50% increase.

What that does is increase the _expectation _of future rate hikes.
You would have seen that expectation play out immediately in the long bond rates.
The 10s & 30s would have jumped several bps.

And it is the yield on those notes that serve as the benchmark for so many financial transactions across the world - from Bubba's mortgage rate on his trailer, to the expected return on complex derivatives issed by Deutsche Bank & Goldman Sachs.

The expectations also drives the gold and silver markets.

It drives forex markets.
Had the Fed hiked 25 bps, you would have immediately seen gold and pretty much every E/M currency plunge.
That, in turn, increases the real value of foreign debt that governments and corporations hold.
I believe there is about $9T of USD-denominated debt held by foreign governments and corporations.
It goes on and on....

The Fed has pinned itself into a corner by their 8 yr old ZIRP policy.
They can neither twist nor turn.
In the meantime, the global USD carry trade is continuing unabated.


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## james4beach (Nov 15, 2012)

Good point, HaroldCrump, the expectation is important. If the Fed raises, then many people will think the Fed is now on a tightening trajectory.

Yes I agree ... Fed is pinned in a corner. This is ZIRP forever, as far as I can tell. Next we'll get negative rates and/or more QE. I also personally expect that the Bank of Canada rate will get down to 0 too.


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## james4beach (Nov 15, 2012)

And just to be clear, I think zero interest rates don't help the economy (in fact I think it's harmful)

Video: Billionaire Investor Wilbur Ross and Steve Forbes talk about the Fed's decision and whether zero rates help the economy
http://video.foxbusiness.com/v/4495...to-the-fed-decision/?playlist_id=933116651001

_Ross_: If the only thing keeping the economy going is 25 basis points, and 25 basis point rise would kill, you've got nothing.
_Anchor_: Why does the Fed and central banks keep doing something that isn't working -- that isn't helping the economy?
_Forbes_: It's the definition of insanity. It hasn't worked in Japan for 25 years, zero interest rates. It hasn't worked anywhere it's been tried including the US... they don't know what else to do.


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## james4beach (Nov 15, 2012)

And on BNN: Daniel Thornton, former vice-president and *economic advisor to Federal Reserve of St. Louis*, says: Fed policies have failed

http://www.bnn.ca/Video/player.aspx?vid=705692


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## andrewf (Mar 1, 2010)

If low rates don't help, does that imply that high rates do? We should put interest rates up to 10%?


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## GoldStone (Mar 6, 2011)

james4beach said:


> And just to be clear, I think zero interest rates don't help the economy (in fact I think it's harmful)


Not that long ago, you believed that Fed policies would cause hyperinflation. You attacked them viciously for "money printing". 

How did that prediction turn out?


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## GoldStone (Mar 6, 2011)

CPA Candidate said:


> The relationship between interest rates and inflation seems lost on many.
> 
> I think they are determined to make a raise, but feel the time is not right at this particular moment.
> 
> Finally, all this hubbub about uncharted territory with respect to interest rates is based on the notion that things must remain as they have in the past. The nature of the economy is changing, primarily because of technology. Humanity embarks on uncharted territory everyday. As far as I'm concerned, low growth, low interest rates are just the new normal. Expectations are what needs to be changed.


Great post. I agree completely.


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## andrewf (Mar 1, 2010)

I'm not sure that low interest rates and low inflation are 'permanent'. It seems like it may be driven in part by a glut of global savings. It doesn't seem like productivity is rising fast enough to explain the disinflation.

It could be that central banks will need to shift to NGDP level path targeting rather than inflation targeting as a way of credibly delivering low, positive inflation. I'm just not sure about having a reliable, politically independent way of measuring GDP to implement such a policy.


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## james4beach (Nov 15, 2012)

GoldStone said:


> You attacked them viciously for "money printing".
> 
> How did that prediction turn out?


I _still criticize_ them for printing money. ZIRP and QE is money printing activity. And I do criticize them for the result: inflated asset prices (stocks & bonds).

I was wrong about hyperinflation (for now). What we now know is that their aggressive money printing has not caused hyperinflation, and it also hasn't caused economic growth. It's only caused yet another asset bubble, which is the only thing the Fed seems to ever accomplish.


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## GoldStone (Mar 6, 2011)

james4beach said:


> I _still criticize_ them for printing money. ZIRP and QE is money printing activity.


No. This is a myth perpetuated by ignorant zero hedgers.

*The Fed is not "printing money"*

Quote:
"The idea that the Fed is "printing money" with abandon, and that this is seriously debasing the U.S. dollar, is a fiction borne of ignorance of how monetary policy actually works."


*Where Does “Money” Come From?*

Quote: 
"I never stop seeing the term “money printing” all over the place. It has to be the most abused term in all of economics and finance. The madness must end!"


Both articles are written by professional economists who actually understand how monetary system works. Google "money printing myth". You will find dozens of similar articles.


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## GoldStone (Mar 6, 2011)

james4beach said:


> What we now know is that their aggressive money printing has not caused hyperinflation, and it also hasn't caused economic growth.


It's not the job of the Fed to drive economic growth. It's not part of their mandate.

FAQ: What are the Federal Reserve's objectives in conducting monetary policy?



> The Congress established the statutory objectives for monetary policy--maximum employment, stable prices, and moderate long-term interest rates--in the Federal Reserve Act.


- maximum employment
- stable prices
- moderate long-term interest rates

This is known as triple mandate. Or dual mandate if you omit the last point. There is no mention of economic growth.

That said, you are dead wrong about growth:


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## Eder (Feb 16, 2011)

james4beach said:


> I _still criticize_ them for printing money. ZIRP and QE is money printing activity. And I do criticize them for the result: inflated asset prices (stocks & bonds).
> 
> I was wrong about hyperinflation (for now). What we now know is that their aggressive money printing has not caused hyperinflation, and it also hasn't caused economic growth. It's only caused yet another asset bubble, which is the only thing the Fed seems to ever accomplish.


Well they did accomplish avoiding another great depression, but I guess that doesn't count...


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## Just a Guy (Mar 27, 2012)

Delaying may not be the same thing as avoiding...personally, I don't see many "rosy" days on the horizon. If oil doesn't recover, that Great Depression may still be on the horizon. Already had drought on the prairies, next year is predicted to be similar...another dust bowl?


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## james4beach (Nov 15, 2012)

Well seems pretty obvious then, by your logic we can get a perpetual bull market, perpetual GDP growth, and never _ever_ any recessions or depressions in the future... they should just keep doing this non-money-printing as you call it.

If that really is how economics works, it should be our new global model for everything. Screw business cycles, we can just use central bank magic to guarantee perpetual growth with no consequences.

Come on guys, this is silly. They expanded their balance sheet by $4 to $5 trillion. There _are_ consequences to this, it just hasn't hit yet. It's kicking the can down the road and you know it. Problem is, at age 30-something, I'm going to have to live with those consequences.


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## andrewf (Mar 1, 2010)

You can guarantee nominal growth, real growth is another matter.


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## GoldStone (Mar 6, 2011)

james4beach said:


> Problem is, at age 30-something, I'm going to have to live with those consequences.


You already do.

You got a six-digits paying job in the US. I bet that job wouldn't be there for you if not for the Fed's aggressive policies. You should be eternally grateful to Ben Bernanke.


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## james4beach (Nov 15, 2012)

GoldStone said:


> You got a six-digits paying job in the US. I bet that job wouldn't be there for you if not for the Fed's aggressive policies. You should be eternally grateful to Ben Bernanke.


That's very short term thinking. My job is also tied to US government spending... so there are many ways I am benefiting from both US government deficit spending, and Federal Reserve policies.

Sure, this job may not have existed if the Fed wasn't so aggressive (and if US didn't run trillion dollar deficits). However I am much more interested in what happens over the 30 years ahead. If the Fed is trapping us in a zero growth environment, that doesn't do me much good. Similarly if the US government is bankrupting itself, that also doesn't do me any good.

All the cheering about the Federal Reserve is about short term benefits. There is no reason to think there is any long term benefit to what they are doing. And I worry it's going to be long-term harm, Japan-style.


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## londoncalling (Sep 17, 2011)

james4beach said:


> That's very short term thinking. My job is also tied to US government spending... so there are many ways I am benefiting from both US government deficit spending, and Federal Reserve policies.
> 
> Sure, this job may not have existed if the Fed wasn't so aggressive (and if US didn't run trillion dollar deficits). However I am much more interested in what happens over the 30 years ahead. If the Fed is trapping us in a zero growth environment, that doesn't do me much good. Similarly if the US government is bankrupting itself, that also doesn't do me any good.
> 
> All the cheering about the Federal Reserve is about short term benefits. There is no reason to think there is any long term benefit to what they are doing. And I worry it's going to be long-term harm, Japan-style.


Pretty sure most of us make more from our human capital than our investment returns. I would trade a career of income for zero growth any day. We have been kicking the can for quite some time. Some of us have made out well because of it. I've been putting in money and locking in profits for quite some time now. Could the party stop at some point. Definitely. That is what is risk tolerance is all about.

Cheers


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## namelessone (Sep 28, 2012)

The fed's action is just to help the borrowers to have lower burden of servicing their debt and avoid massive national wide default (Transfer of wealth from saver to borrower) and keep the economy functioning.As long as the nation's leverage ratio doesn't go down to a healthy level, the interest rate will stay low.


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## james4beach (Nov 15, 2012)

londoncalling said:


> Pretty sure most of us make more from our human capital than our investment returns. I would trade a career of income for zero growth any day. We have been kicking the can for quite some time. Some of us have made out well because of it. I've been putting in money and locking in profits for quite some time now. Could the party stop at some point. Definitely. That is what is risk tolerance is all about.


There's another extension of this. QE and ZIRP has been particularly good for upper wage earners. The disparity between rich and poor has widened during the ZIRP years, and this is bad for society in my opinion.

More than anyone else, ZIRP & QE has been amazing for investment banking. This part is a no-brainer ... these policies are ridiculously good for banks.

The data I saw earlier said that lower wage earners have not seen any benefit at all during this "recovery". The wealthy, on the other hand, have seen a huge increase in their incomes.

If this is a consequence of ZIRP, I think it's a really bad effect. This is not good for democracy and society. This kind of wide disparity is a destabilizing force. Personally, I would rather suffer the pain of reversion to the mean / price discovery / recession. I'm not sure those are the two choices we have, but I don't like the growing income disparity.

And yes, I've come out ahead as a result. I know that.


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## andrewf (Mar 1, 2010)

Deflation, on the other hand, is quite regressive, since those with low incomes tend to be borrowers. Why are you advocating for deflationary monetary policy?


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## GoldStone (Mar 6, 2011)

James, you are obsessed about the Fed. But you never mention the politicians. Why is that? Tea Party dimwits stalled the recovery big time. They forced the austerity at precisely the wrong moment in the cycle. The Fed was left alone to fight the deepest recession since the Great Depression. Federal and state governments did nothing to stimulate the economy. Worse, they went on some serious belt tightening. Do you have any choice words for the politicians? If not, why not?


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## james4beach (Nov 15, 2012)

Why are *you* advocating for regressive policy? Income disparity has widened under ZIRP and QE.

Let's look back at income disparity over time. It really started getting worse in the 1990s, which is when Greenspan came and brought his radical change to cheap money/credit for everyone. It looks like low interest rates and cheap money feed this unhealthy trend and growing income disparity.

And your answer to this is, I suppose, let's have even _lower_ interest rates?


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## GoldStone (Mar 6, 2011)

I guess you love double-digits unemployment rate. It does wonders to address income inequality.

Give you head a shake.


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## dogcom (May 23, 2009)

In the US they already have double digit unemployment. You are only seeing the numbers by the way they count it but a lot is left out.

You must also notice we have a big bond bubble, which is the last bubble I believe they can blow. Each bubble is bigger and bigger and the aftermath will be far worse then if we had just let it come apart in 2008.


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## GoldStone (Mar 6, 2011)

The tin foil crowd is out in full force.


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## Just a Guy (Mar 27, 2012)

Realistically, the fed just provides a tool for the general public to use. How people use, or misuse a tool isn't the fault of the toolmaker.

Personally, I used the low interest rates to make a lot of money and increase my net worth. Other people took the same tool and bought lots of toys and racked up debt. 

I did nothing that others couldn't have done themselves, but you can't legislate stupidity away. Some people are poor because of the choices they made or make, should I be punished, now that I'm considered wealthy, because I failed to make bad choices? I didn't start off rich, I made my money, I chose not to buy the toys and be frugal when I started yet, being rich, I'm now expected to pay for the people who made bad choices...

Again, there are exceptions, not every poor person has the same opportunities but I know many who've squandered opportunities to change their fate. They'd rather have short term satisfaction over long term benefits.


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## james4beach (Nov 15, 2012)

GoldStone said:


> I guess you love double-digits unemployment rate. It does wonders to address income inequality.
> 
> Give you head a shake.


As I understand it, you're implying that if central banks raise interest rates at all, then unemployment will increase a lot. Am I reading that right?

What if -- in the process of keeping ZIRP and feeding new asset bubbles -- they feed another destructive bubble that then bursts and causes economic turmoil? This is exactly what happened with US housing and to a lesser extent the tech bubble, which was also fuelled by cheap money.

You seem to see normal interest rates leading to economic destruction.

_I see_ prolonged ZIRP as feeding new bubbles, which in turn burst and cause destruction. The post-Volcker Fed has already established a history of feeding asset bubbles; the last two have been awfully harmful. How can you be so confident that this time nothing bad will happen? It's setting up the some way. Plentiful and cheap liquidity fuels a dramatic run-up in prices and a temporary state of euphoria.


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## dogcom (May 23, 2009)

Goldstone is correct I believe on interest rates because the Fed is boxed in. If they start raising the deficit will balloon, mortgages will jump, US dollar will rise to much killing exports and massive derivative bets will unwind.


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## GoldStone (Mar 6, 2011)

james4beach said:


> As I understand it, you're implying that if central banks raise interest rates at all, then unemployment will increase a lot. Am I reading that right?


No. Take a look at the unemployment chart in my post #28. Without QE and ZIRP, we would be still stuck close to the bottom. 

Unemployment did touch double digits in 2009. Now it's around 5%. Thank Ben Bernanke for that.


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## GoldStone (Mar 6, 2011)

james4beach said:


> You seem to see normal interest rates leading to economic destruction.


You seem to think that "normal interest rates" is a number set in stone. What was normal in the second half of the 20th century must be normal forever. Demographics doesn't matter. Technological progress doesn't matter. Globalization doesn't matter. Supply and demand of capital doesn't matter. Supply and demand of labour doesn't matter. None of that matters, right James?


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## Just a Guy (Mar 27, 2012)

Historically speaking, no economic or political system has ever lasted for very long (relatively speaking), they've all broken down eventually. When I was in school, I predicted the collapse of the Soviet Union and the United States in my lifetime, so far I'm 50% correct. I don't think it's rocket science to say that we are in a decline compared to the height of the system. They are running out of ways to stem the tide of inevitability. 

That being said, it can take a long time to truly die...maybe read up on Rome.


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## GoldStone (Mar 6, 2011)

Reading my morning news:

Target is planning to test robot workers

James, did we have robot workers in Target stores when interest rates were "normal"? 

Are robot workers inflationary or deflationary?


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## sags (May 15, 2010)

Bond guru Bill Gross explains the damage that low interest policy is doing and why the Fed must raise rates now.

_“Zero destroys existing business models such as life insurance company balance sheets and pension funds, which in turn are expected to use the proceeds to pay benefits for an aging boomer society,” Gross said. “These assumed liabilities were based on the assumption that a balanced portfolio of stocks and bonds would return 7-8 per cent over the long term.”

But with corporate bonds now at 2-3 per cent, Gross said it was obvious that to pay for future health, retirement and insurance related benefits, stocks must appreciate by 10 per cent a year to meet the targeted assumption. “That, of course, is a stretch of some accountant’s or actuary’s imagination,” he said.

“Do central bankers not observe that Detroit, Puerto Rico, and soon Chicago, Illinois cannot meet their promised liabilities?” said Gross, the co-founder of bond giant Pimco who now runs the $1.4-billion (U.S.) Janus Global Unconstrained Bond Fund .

“Do they simply chalk it up to bad management and inept governance and then return to their Phillips Curves for policy guidance? Do they not know that if zero were to become the long-term norm, that any economic participant that couldn’t print its own money (like they can), would soon ‘run on empty’ as Blackstone’s (co-founder) Pete Peterson once expressed it in describing our likely future scenario?”

The developed world is beginning to “run on empty” because investments discounted at near zero over the intermediate future cannot provide cash flow or necessary capital gains to pay for past promises in an aging society, Gross said.
_
http://www.bnn.ca/News/2015/9/23/Bill-Gross-urges-Fed-to-get-off-zero-now-on-rates.aspx


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## james4beach (Nov 15, 2012)

GoldStone said:


> James, did we have robot workers in Target stores when interest rates were "normal"?
> 
> Are robot workers inflationary or deflationary?


Deflationary. So I think you're saying: a lot of things in the modern world exert a downward pressure on prices. We will have structurally higher unemployment and wages that never go up.

That sounds realistic to me. And that's a terrible environment in which to buy stocks... so I hope you don't have too much invested in the stock market.

My heavy fixed income exposure is a very appropriate deflationary positioning.


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## Value (Jul 31, 2015)

GoldStone said:


> You seem to think that "normal interest rates" is a number set in stone. What was normal in the second half of the 20th century must be normal forever. Demographics doesn't matter. Technological progress doesn't matter. Globalization doesn't matter. Supply and demand of capital doesn't matter. Supply and demand of labour doesn't matter. None of that matters, right James?


Supply and demand of capital doesn't matter??

Whatever MARKET DYNAMIC was in place in the end of the 20th century, is the SAME DYNAMIC in place today! And whatever that DYNAMIC could be, it would NEVER set, NATURALLY, an interest rate of 0% on capital...

Whatever the situation might be for demography, technology, globalization, supply and demand of labour that in turn would influence interest rates, all that matters today is there is no such free market that sets an interest rate, because that number is manipulated by central banks!

You can argue that the price of capital would be of very low interest rates compared to the end of the 20th century, but you can NEVER argue that it would naturally be at 0%... The markets have been tampered with for years and years creating distortions that will end badly! 

Yes, the fed is cornered and CAN NOT raise rates without deflating their ridiculous economy and markets that THEY have inflated artificially. But the sooner they deflated at and return to NORMALITY, meaning FREE MARKET DYNAMIC, the better it will be for all!~


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## GoldStone (Mar 6, 2011)

Supply and demand of capital doesn't matter.... that was sarcasm.

The rest of your post is a bunch of nonsense. Not going to respond.


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## james4beach (Nov 15, 2012)

Value's post makes sense, I think it's accurate. He's right about the distortions and GoldStone's dismissiveness just shows that he has a bias about all of this (see no evil, hear no evil)

By flooding the system with money, the central banks have created an unnatural market and suppressed free market forces. This is not a free market -- it is heavily manipulated to force an artificial cost of money (cash rate) and interest rate (bond price). It *has* become a ridiculous economy, chugging along under ridiculous operating conditions that have been forced into place.


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## HaroldCrump (Jun 10, 2009)

If we agree that money is no different than any other commodity or "thing" i.e. has demand and supply, has a cost, has a return, has risk, etc. and follows the same laws, then interest rate is the "cost" of money.
When the cost of something is zero (at least for some sub-section of consumers), it creates irrational behavior.

Cost of money is clearly not 0 for everyone, just some.
This is known as interest rate Apartheid.

Irrational behavior leads to malinvestment and misallocation of capital.
In the public sector, it leads to wasteful public works projects (bridges to nowhere), China's "ghost" cities, etc.
In the private sector, it draws investment into fundamentally inefficient projects, financial engineering (LBOs, buybacks, etc.)
Also leads to over-investment into sectors that otherwise would not have been profitable (shale drilling, Arctic drilling, real estate, etc.).

While, large sections of the population are not able to make ends meet, struggle with falling real wages, or simply get disenfranchised and marginalized from the mainstream economy.


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## andrewf (Mar 1, 2010)

For goods that can't be stored, then zero or even negative prices are not unusual. See electricity markets. Time value of money (interest) can't be stored. It is a use it or lose it commodity. When more people want a promise of money in the future than there are people who are willing to make that promise (retirees looking for income in their dotage vs future workers), then the time value of money can fall to nearly zero.


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## james4beach (Nov 15, 2012)

andrewf yes, zero or negative prices on things is a possibility. So you're right that these kinds of "prices" (zero interest rate on cash) are possible. But the difference here is that the central bank (Fed, ECB, BoJ) _manipulates_ that price. And as if it weren't enough that they are already manipulating the price on cash, they also started -- with QE -- manipulating the price on treasury bonds.

So both cash and bonds are two critical things in the market whose rates are artificially set by central banks. It's not the market who set the rate of cash to zero. The central bank is sitting in that system, pushing out an endless supply of cash to force that rate to zero. It is a complete warping of market forces.

I think many of us are disturbed by that level of involvement and price control. True, the central banks have done this for a long time but I'd argue that there's a really big difference between a central bank holding cash rates to say the past average 5%, versus holding cash rates to 0% and pumping up treasury bond prices too. It's way too much interference.

To put it another way, their past "target prices" of cash rates like 5% were much closer to what the market would probably value money at, if left alone. So the interference was somewhat gentle and 5% still reflects that demand is generally higher than supply. However today's central bank target rates are WAY out of whack with what the market would set on its own.


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## james4beach (Nov 15, 2012)

Let's also talk about how narrow that scope of the 0% rates are. The central banks adjust the price of money (by increasing supply in the overnight rate) but this only happens in the inter-bank market. Those rates are only available to the large commercial banks.

I have cash in my wallet. I might want some more cash. Yet, when I ... or my business ... wants to do a cash transaction, we idiots still have to use a market-determined cash rate. What a bunch of suckers we are, using market-determined cash rates when all the big banks get free money at 0%.

So not only are 0% and QE greatly modifying the prices of cash & bonds away from their natural levels, but it's also doing it with huge asymmetry: it's only large banks that get the direct benefit. Which is why (obviously) banks have done incredibly well since 2009.

I cannot respect a system that (a) warps market prices so badly and (b) specifically benefits only a select group of companies. This is just an extension of the bail-out mentality... because it basically is an ongoing bank bailout. I ran a small business and had to shut down in 2008. Why did I not get a bail out? Why do only large banks ever benefit from the free money? Ridiculous


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## andrewf (Mar 1, 2010)

james4beach said:


> To put it another way, their past "target prices" of cash rates like 5% were much closer to what the market would probably value money at, if left alone. So the interference was somewhat gentle and 5% still reflects that demand is generally higher than supply. However today's central bank target rates are WAY out of whack with what the market would set on its own.


Sure, but the market left to its own devices would resolve the current situation by inducing a huge deflationary event. Millions of individuals and firms would become insolvent and default on debts (so much for the safety of your fixed income holdings). Perhaps even some governments as well. There would be mass unemployment, destruction of capital, and long-lasting damage to the credibility of the financial system (think of people scarred by the Great Depression).

I think that, on balance, QE is the obvious choice (even if half-hearted QE that leads to Japan-esque lost decades) is preferable to allowing a deep deflationary spiral to take place.


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## andrewf (Mar 1, 2010)

Banks are always able to borrow at preferential rates. Are you trying to suggest that rates as a whole did not move down as a result of QE? 5 year bond yield charts tell a different story.


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## james4beach (Nov 15, 2012)

> True that banks always have preferential rates but ZIRP and QE takes this to its _extreme_. Banks used to * not * get money for free. Now they literally do.


I agree that interest rates on all kinds of credit has gone down in the last 5 years. Sure, the central banks have reduced the cost of credit for everyone. This was a primary goal and they have achieved it, at least in the short term.

It's just that we if we look at the benefits provided by QE and ZIRP, it's outlandishly weighted towards the banks. True it seems to have helped the global economy (in the short term) but not uniformly.

And my belief is that there is a cost and a consequence of all of this market intervention. I think that cost -- instability, misallocated capital, and future inflation -- is going to be felt across everyone. So we're getting a short term benefit to a SELECT group (big banks), and the consequences are going to be felt by everyone. That's a horrible deal and is the same ethical problem as the bail-outs.


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## james4beach (Nov 15, 2012)

andrewf said:


> Sure, but the market left to its own devices would resolve the current situation by inducing a huge deflationary event. Millions of individuals and firms would become insolvent and default on debts (so much for the safety of your fixed income holdings). Perhaps even some governments as well. There would be mass unemployment, destruction of capital, and long-lasting damage to the credibility of the financial system (think of people scarred by the Great Depression).


This is going to happen anyway. All they're doing is delaying the inevitable. Or do you think the Fed will grow their balance sheet to $100 trillion?

There is no exit plan from this situation. That's the problem. It's temporary and it will unravel, eventually. By intervening to this degree, they have put the financial markets into a state where they cannot recover on their own. You guys illustrate here in this very thread; if they were to just raise rates by a tiny 0.5%, the entire global economy would collapse.


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## bmoney (Jun 22, 2013)

For anyone interested in a less conspiratorial foray into the history of central banking, Lords of Finance is a good read. I think Harold summed it up well that the present value of money is deeply influenced by interest rates which is creating unique distortions of investment in a back-drop of low inflation. That's a great explanation of the symptom but I don't believe it's the root cause, let's stop dancing around the issue and get to the core of the problem.

The Fed cannot unilateraly raise rates without hurting US allies, and possibly US interests in the process. We went through this already after the world wars, any increase in US rates now would increase the competitiveness of the USD (purchasing power), and decrease US labour competitiveness (domestic problem), and the cost to service USD debt (domestic and international problem). We can already observe the effect of a higher USD on commodity prices and the pressure being exerted on export economies receiving fewer USD in trade. The Fed can't move off near zero until either their allies in Europe or Japan are in a stronger position, or it no longer serves US interests to maintain a low interest rate policy. The periphery will be screwed one way or another.

Deeper to the core of the problem is a lack of structural demand due to unemployment, under-employment and fewer good paying jobs. There is a deep structural reform happening due to technological advancement that is creating a winner-take-all type of business environment. The problem is multi-faceted, but outsourcing, free flowing movement of capital and disruptive companies/business models are some of the obvious issues. I was floored when I took a 45min Uber ride to LAX and it cost me $14 all in. That tells me one thing, the new job created by Uber is not a good paying job, and the taxi driver (a higher paying job) is idle at 3x the fare. If labour had bargaining power (and I don't mean more unions) due to economic expansion and new "good paying" jobs being created, we wouldn't be discussing Fed fund rates. 

It's inappropriate to lay blame solely on the Fed, they are playing the hand that was dealt and did an exceptional job at staving off a great depression which is a worse out-come than even 3 decades of little or no growth. There is fundamental lack of political leadership and coordination to come up with viable solutions, it's easier to use monetary policy and let the market figure it out - typically more disastrous consequences.


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## bmoney (Jun 22, 2013)

james if all you're after is higher rates, that is not difficult to accomplish provided it were coordinated with other central banks. They haven't got to that point yet because some economies have catching up to do. The US has no good reason to go at it alone, lots of incentives to stay put.


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## james4beach (Nov 15, 2012)

> james if all you're after is higher rates


That's not all I'm after. What I'm _fundamentally_ after is a healthy economy, not short-term patch solutions that generate long-term instability (and that's what I think ZIRP and QE are). I don't like experiencing one bubble after the next, which is all the Federal Reserve has done since the mid 1990s.

I also want something closer to free markets, rather than what we have now which is a central bank-dictated market in both stocks and bonds. I want this because I think that free markets go hand in hand with capitalism and create the opportunities to generate real wealth. I don't like that the Federal Reserve, Bank of Japan, ECB etc have strayed so far from this notion.

Right now we have all kinds of warped incentives and risk/reward is out of whack. This is a bad environment for me to grow my career, run a business, and make good investments in.


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## lonewolf (Jun 12, 2012)

james4beach said:


> I don't like experiencing one bubble after the next, which is all the Federal Reserve has done since the mid 1990s.
> 
> 
> 
> .


 Without bubbles where would technology be today? The tech bubble advanced technology.


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## HaroldCrump (Jun 10, 2009)

bmoney said:


> For anyone interested in a less conspiratorial foray into the history of central banking, Lords of Finance is a good read.


That is an excellent book.
Two other good books on central banking are as follows:



















These are _not_ dry, academic tomes - these are very well written, interesting books.
_The Alchemists_ is 400 pages+, but it flows like a Jack Higgins or Frederick Forsyth crime thriller novel.



> Deeper to the core of the problem is a lack of structural demand due to unemployment, under-employment and fewer good paying jobs. There is a deep structural reform happening due to technological advancement that is creating a winner-take-all type of business environment. The problem is multi-faceted, but outsourcing, free flowing movement of capital and disruptive companies/business models are some of the obvious issues.


I agree completely !
The problems we are seeing here are mostly structural.
These are not business cycle problems that monetary policy can solve.
These are not liquidity or credit availability problems that monetary policy tools can solve - even sophisticated tools like QE, LSAP, NIRP etc.

Globalization and capital flows are also contributing to the issues, rendering independent monetary policy by NCBs ineffective.
I am not saying globalization and free capital flows are bad, but it is making independent monetary policy ineffective.

Institutions like the IMF, World Bank, G20, etc. have basically become paper pushing tigers now - they are not able to solve the problems facing global capitalism.


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## james4beach (Nov 15, 2012)

Harold, good points and I agree ... I do not believe the central banks can solve these significant issues.

The central banks actually have a very limited scope. I'm not sure how "sophisticated" all of these policy instruments are. They can only really do two things:
1. Print money
2. Buy securities and put them on their own balance sheet

Everything they've done amounts to more or less the same. They either provide cheap money overnight, or buy treasury bonds, or buy corporate bonds, or distressed debt securities, etc. These all fall into one of these two categories.

And somehow people have gotten accustomed to this idea that such things can accomplish grand results in the economy. I don't know how everyone has developed so much faith in these kinds of policies. For instance we've had zero rates since 2008, yet it looks like the global economy is still teetering on the brink of collapse.


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## Pluto (Sep 12, 2013)

In the past the economy and the stock market have been cyclical. I expect the cycles to continue in the future regardless of what the fed or any other banks do. The premise that the nature of the economy is changing is flawed: that's a variation of the "its different this time" delusion. The economy is not essentially different. Has the law of supply and demand suddenly evaporated? Nope. Has the norm that debts must be paid evaporated? Nope. Has the norm that one needs enough income to meet liabilities evaporated? Nope. has the norm that companies need to make money in order to have value changed? nope. 
What the heck is essentially different this time? The only differences are peripheral. The essence is the same. 

As far as stocks go, if earnings don't go up, stock prices are not going up. When we reach the peak of a cycle, it doesn't matter what the fed does, it can not prevent the end of a cycle. Savvy stock investors know that. Google for auto sales for example: Annual sales are as high as they have been since before the last recession and predicted to go higher next year. But what are the auto stocks doing? not too much. ford and GM stock topped out a long time ago. Why? Because savvy investors know the music will stop no matter what the fed does. The excess demand for stuff gets satisfied. Then sales drop. Then earnings drop. that means stock values drop. managements then look to cost cutting which usually means some layoffs. Savvy investors see that coming. That's why the stock prices peak out *before* the actual economic cycle ends. 

There is nothing any central bank or any group of central banks can do to stop the end of a cycle. They can't force people via low interest rates to buy stuff that they already just bought. So the cycle ends. The fed can't force businesses via low interest rates to borrow to expand. Business will only borrow if they think they can profit, not just because rates are low. 

Unfortunately new stock investors get taken in by all the baloney and start putting their life savings in stocks just as they are poised to weaken, flop around a bit, then tank. Many of them never trust the market again. But it isn't the market that fooled them, its the baloney of 'new normals", and "the feds got our back", and so on. "New normals' on interest rates are just distractions from the essence. The essence is the economy and the stock market are cyclical, and it looks like stocks are telling us savvy investors see an end.


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## james4beach (Nov 15, 2012)

I agree, pluto.

I think we're now entering the bear phase of the cycle.


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