How to make a mess in the era of low demand.
This is the transcript from my podcast last Sunday, THE WOLF STREET REPORT:
Now the plot thickens: I’ve got a former Secretary of the Treasury backing me up. We’ve already seen, including in my last podcast, how negative interest rates screw up the economy. Negative interest rates are so absurd that just thinking about them gives me a headache.
In the era of negative interest rates, owning financial assets such as government bonds, or savings in the bank, or corporate bonds, and increasingly European junk bonds, no longer produces income but a financial burden – because you have to pay the negative interest in one form or another. And so these quote unquote “assets” are not only a financial burden on you that you would want to get rid of normally, but by extension, they’re burden on the economy as a whole.
Look how economies and stocks have fared in countries with negative interest rates – such as Japan and the countries of the Eurozone: Their stocks have gotten crushed. Their bank stocks have gotten annihilated. Japanese bank stocks are down 92% from the peak 30 years ago, and European bank stocks are down 76% from 12 years ago. European bank stocks are now back where they’d first been in 1993.
The European and Japanese economies have been mired in microscopic growth interspersed with declines. In Japan, this has been going on for over two decades. In Europe it’s been a dozen years.
But it’s not just negative interest rates that will whack the real economy. It’s “low” interest rates too – meaning “low” as the rates in the United States now.
Treasury yields are between about 1.5% and 2% currently. They’re below the rate of inflation across the curve; and the “real” interest rates are negative.
So now we will see how low interest rates put downward pressure on demand, when demand is already the fundamental problem. And cutting rates further would be a massive policy error.
Low interest rates are supposed to support part of the economy that benefits from debt funding, such as capital-intensive production of durable goods. This would be cars or furniture or computers. Lower interest rates would make it cheaper for companies that produce durable goods to borrow money to build factories and expand their production.
Low interest rates would also make it cheaper for companies and consumers to buy or lease these goods, the theory goes, and this would stimulate demand for these goods.
Construction would benefit from low rates because it would be cheaper to fund projects, and businesses and consumers would be incentivized to buy those buildings or lease them because it would be slightly cheaper to do so.
But those benefits, assuming they exist and function at all, are minimal when interest rates are already low and are reduced from low to even lower.
And what if the real problem isn’t the cost of funding projects and the cost of borrowing to buy things. What it the real problem is low demand?
And if the real problem is low demand, how do you increase demand when interest rates are already low?
Or conversely, what can a wrongheaded central bank do to crush this low demand even further than it has already been crushed?
Any time a central bank makes a move, such as lowering or raising interest rates or buying assets, it is thought to benefit one part of the economic participants at the expense of the remaining economic participants. This is a well-known but pernicious effect, called in harmless-sounding central-bank speak, the “distributive effects of monetary policy.”
These “distributive effects of monetary policy” take income and wealth away from one part of the people and give it to others. This is how monetary policy works. And it is accepted. The reason why this is done is because it is thought that through this shift of wealth and income, the overall economy would somehow benefit. The wealth and income of some people are sacrificed for the benefit of the overall economy, and other people get rich in the process.
So central bank policies, by definition, redistribute wealth and income.
Interest rate repression has this effect. The idea is to induce businesses to borrow and invest via low interest rates, and to induce consumers to borrow and spend, and the hope is that all this would crank up the overall economy as measured by, you guessed it, GDP.
And then there is the other side of those distributive effects: The people directly or indirectly deriving income from those interest-bearing assets.
Those people are not just a few savers: In total, there are around $40 trillion with a T in US Treasuries, banks savings products, investment-grade corporate bonds, municipal bonds, and asset-backed securities. People who hold these $40 trillion in assets, directly or indirectly, obtain or will obtain income from these investments.
When interest rates get cut, these people, directly or indirectly, see their disposable income go to heck. And guess what, they spend less, which crushes demand.
This is what has been happening in Japan for over 20 years. This is what has been happening in Europe. And it is what has been happing in the US.
When central banks, in this environment of already lacking demand, cut interest rates further they will make the demand problem worse.
At the same time, because interest rates are already so low, lowering them further has few and fading benefits for industrial production and other capital-intensive sectors.
In other words, these “distributive effects” no longer benefit the real economy, but they crush demand further. And central banks that lower rates in this environment make the problem worse.
Now I’ve got some serious backing from Larry Summers, who was Secretary of the Treasury from 1999 to 2001. With his article published just before the Fed’s annual Jackson Hole shindig this weekend, he addressed all central bankers out there. And he put his finger where it hurts.
In this type of environment that he calls “secular stagnation,” where demand is the problem despite very low or negative interest rates, lowering interest rates further is a massive policy error.
“Interest-rate reductions beyond a certain point may constrain rather than increase demand,” he says.
Central banks, in this environment of lacking demand despite already low interest rates, are powerless to fix the problem, he says, and they shouldn’t make the problem worse by repressing interest rates further:
“Europe and Japan are currently caught in what might be called a monetary black hole – a liquidity trap in which there is minimal scope for expansionary monetary policy. The United States is one recession away from a similar fate.”
Growth in the US is slow, and in Europe and Japan dismally slow, despite years or decades of low interest rates or even negative interest rates, and despite massive bouts of QE that had the effect of repressing long-term interest rates even on risky assets such as junk bonds.
This slow-growth or no-growth picture means that there is “some set of forces operating to reduce aggregate demand,” Summers says and adds:
“There are strong reasons to believe that the capacity of lower interest rates to stimulate the economy has been attenuated — or even gone into reverse.”
One of the reasons why rate cuts won’t do much good is because, as Summers says, and as we have known for two decades, “The share of interest-sensitive durable-goods sectors in GDP has decreased.” Which is of course part of the result of offshoring production.
But “the negative effect of reductions in interest rates on disposable income has increased as government debts have risen,” he points out.
In the US, these debts of the Federal Government alone have risen to $22.4 trillion. Total fixed-income assets, including savings products, amount to nearly twice as much. This $40 trillion in assets is spread over a lot of people. And that income is getting smashed by lower interest rates. And these people’s disposable income declines, and they have to cut their spending – and thus demand declines.
A 2% reduction in interest rates on the $40 trillion in assets means a reduction of $800 billion in income per year, every year, for these people. That’s a lot of money that cannot be spent. And much of it goes to people that would spend all of it.
An $800 billion reduction in spending would reduce GDP by 3.5%. That would be a blisteringly steep recession – just what everyone has been clamoring for.
Summers also points out, as I’ve done previously, that declining interest rates in the current environment hurt the real economy via the banks that form the financial infrastructure. Declining interest rates undermines the banks’ income and capital, which reduces their capacity to lend, makes them more unstable, and induces them to engage in risky activities that can blow up the bank.
And even if interest-rate cuts increase demand, “there are substantial grounds for concern if this effect is weak,” Summers says. “It may be that any short-run demand benefit is offset by the adverse effects of lower rates on subsequent performance.”
These adverse effects are that low interest rates “promote leverage and asset bubbles,” he says, and that they encourage investors “to reach for yield,” which is where they take ever more risks to get a little yield, thereby driving up prices and reducing yields further. And these inflated prices of risky assets are then used as collateral and are leveraged to the hilt.
“Almost every account of the 2008 financial crisis assigns at least some role to the consequences of the very low interest rates that prevailed in the early 2000s,” Summers points out. Bubbles thrive on easy money and lots of liquidity. And bubbles blow up.
“There is something unhealthy about an economy in which corporations can profitably borrow and invest even if the project in question pays a zero return,” he says.
This is precisely one of the many absurdities of low interest rates – they create zombie companies that wouldn’t be around at normal interest rates, but that are putting downward pressure on prices in their industries.
In an environment where the problem is a fundamental lack of aggregate demand, he says, “reducing interest rates may not be merely insufficient, but actually counterproductive, as a response to secular stagnation.”
And in this environment of secular stagnation, cutting rates, he says, “is exactly what is not needed.”
“What is needed are admissions of impotence” by central banks, he says, “in order to spur efforts by governments to promote demand through fiscal policies and other means.”
So here you have it. Central banks, including the Fed, have cut rates too low, and are now cutting rates further, to make the fundamental problem they have caused with their low rates, namely a lack of aggregate demand, even worse.
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Summers is very late with his understanding but he is finally making progress. He argues monetary policy is futile, which is true, but he then says fiscal policy and more government spending is the answer.
The demand void he refers to is simply the result of massive wealth inequality. To fix the problem, you don’t pile on more government debt that only further increases inequality. You fix the problem by restoring progressive tax rates. Since the 1980’s tax rate progressivity has drastically reduced. This is when our problems started.
The capital gains rate reduction should be the first to go. Capital gains of a passive nature (stock and bond holdings) should be taxed like any other income. The tax preference should be provided only for active investments in people, equipment, and intellectual property development.
Mr. Bobber is correct in my opinion. Monetary policy alone does not increase demand in the economy. More money in the hands of average folks would send the economy moving upwards (i.e. higher wages). Get the infrastructure investments moving. I know that the 1 percent could not care less about roads, bridges, and so on when they fly in private jets but sooner or later the wealth they are hoarding will evapourate.
Agreed.
Another related problem is wage repression. For the 70% of employed Americans classified as ‘production/ nonsupervisory’, real wages are up 15% over 60 years. Just to match labor productivity over the last 30 years, they would have seen a further 50% increase. These are people who spend, and who could be paying a lot more in taxex and saving for retirement.
What is the growth fetish? Seriously, you do not have to borrow money on the USA credit card and give it to people to spur growth. Similarly, globalization and improved technology have increased competition. Sure companies are moving offshore to cheaper labor sources and are able to outsource things like Xray readings, engineering, etc.
What the USA needs is a return to thrift including letting others police the world. The outcome of this era in history will be frugality and thrift and not more gubbermint borrowing and giveaways. The MIC, banking industry, etc., control the gubbermint. The Fed bailed out their banks by inflating asset prices. That’s it. The whole premise that The Bernank was trying to save the USA economy is rubbish. Any knock-on benefits of FOMC policies were ancillary.
The answer is not more power to the Fed on more gubbermint action. It never was.
Growth fetish?
Think that through.
Think about what a recession looks like. People are scared to lose their jobs so they stop spending.
If they stop spending then demand falls for goods and services so companies cut jobs and we get less spending etc. Eventually the economy collapses
Fortunately central banks don’t see growth as a fetish, and when recessions strike, they act, to restart growth – and STOP COLLAPSE.
And now we are about to see the limits to the central banks power to restart growth.
The growth ‘fetish’ is coming to an end.
I guarantee that when it does, you will reconsider your thoughts
“letting others police the world”
you mean letting others rule the world. those army bases are there for the benefit of the usa not for the natives.
Without zombie corps currently providing employment for possibly millions of Americans right now, even if it is an economic aberration, I can’t imagine how much poorer and more screwed up the U.S. economy and labor markets would be. There would have been no recovery at all instead of this weak one. Technology is slowly curbing demand for labor, hence the lack of wage growth despite the fed trying its hardest to juice inflation. Businesses complain about lack of demand… Well we’re rapidly headed into a world where money is failing to serve it’s original purpose. It’s going to call into question what the whole point of an economy is.
Larry Summers had no idea what was going on in 2008 and he still doesn’t.
He only wants access to whatever money grab will be forthcoming.
BTW, tax preference for people, equipment, and IP already exists, it’s called expensing.
Petunia,
I always appreciate your comments.
I don’t think Summers has a philosophical problem with the chasm of wealth inequality in the US.
The rest of the world should take note; and like some have suggested, create an alternate currency – or more accurately, a basket of currencies, including the Renminbi – to combat Dollar hegemony, which is clearly distorting the global economy.
Nicko2,
The Governor of the BOE, has recently been advocating for such an idea!
He calls it “ SHC”! ( synthetic hegemonic currency)!!
In my opinion some sort of shooting down of the role of the USD will happen sooner or later.
The problem/s always start in the transitioning period from a system to another. If this is to be achieved peacefully without shooting wars I will retain a mild faith in human nature!!
History however shows that any such moves is always almost certainly accompanied by violence.
The real shift will happen, all old powers have to be broken.
Further to the point of this article, while I understand Wolf’s content and happiness about Summer’s speech, I feel underwhelmed by his over excitement!!!
I have No respect for anyone criticizing a system once they’re comfortably outside it , after perpetuating the FED and it’s important role in the Economy ( characters like summers) should not be elevated to any kind of sainthood status!
Where I reserve my respect is for people who criticize the system when they’re part of it and from within! PUBLICLY.
Long story short, the Central Banks are becoming irrelevant and should be relegated to the dust bins of Economic history.
To achieve peace and prosperity for everyone, world powers have to invest in the most valuable commodity they have ( THEIR HUMAN RESOURCES).
or they could always go the easy way!
By killing more of these, the blue print for this route are WW1, WW2.
If the capital gains are simply the result of inflation, which is very often the case, the real return is 0%. In other cases, the real returns are actually negative. So any tax is confiscation of the principle, i.e. like NIRP.
So maybe tax the negative interest income as well?
The point is to reward actual work being performed as opposed to passive investing. It’s not only a moral position but also serves to help distribute capital to production.
Maybe a flat tax is the best answer. After all it is all income.
> … $800 billion in income per year, every year, for these people. That’s a lot of money that cannot be spent. And much of it goes to people that would spend all of it.
Curious — what data backs this up?
Math: 2% of $40 trillion
I should have been clearer — I was looking for data that backs up this part — “… much of it goes to people that would spend all of it.”
The key question in my view is how many people benefiting from this 40 trillion USD. Are they a significant number in order to stimulate demand. As far as I guess the most (potential) consumers which could stimulate demand are indebted already and so are not able to stimulate demand anymore – only when you allow them to make even more debt and write off their old debt the game would continue to run. In this case you would create a new currency called “access to debt”.
wakarimasen,
There are some consumers that are indebted, and there are other consumers with lots of assets, including money in the bank. Consumers own about $10 trillion in savings products (CDs, savings accounts, etc.). They own trillions of Treasuries, directly and indirectly. They own their homes outright without mortgages (about one-third). They own trillions in stocks. Don’t let the averages mislead you. There is a lot of wealth in the US, but it is very unevenly divided.
No matter what statistics are produced by government or non-governmental agencies, zirp, or very low interest rates are an admission that we are in a no-growth economy. The fact that we are on a finite planet guaranteed that this day would arrive and no more aggregate growth would be possible. We need to adjust or economies and economic thinking to this inevitable reality.
Nirp and zirp are a tacit admission that demand, for credit, is not there.
TPTB have tried hard to generate inflation, inflation being a rise in the price of goods and services. If demand for goods or services is there, prices can increase. If demand is not there or is very weak, inflation is absent.
TPTB threw liquidity in to the banking system, but this liquidity failed to be transmitted in to the real economy generally. Instead this liquidity went into sections of society such as the financial markets cut off rest of the economy.
I argued back then instead of creating the loop between bond purchases and central banks, TPTB would have been better off putting g the liquidity directly into the bank accounts of each citizen and letting them spend it. That would great demand/economic activities.
Finite planet? We’ve barley scratched the surface of this planet.
Global populations will increase by more than 2 billion people over the next twenty years; That’s 100 million new consumers every year for the next generation. That means Asian and African economies will experience sustained growth for the foreseeable future.
And rising per-capita poverty?
That depends on whether the Asian and African economies can overcome the usual civil wars, kleptocracies, massive corruption, oligarchic bottlenecks, and usual Muslim/Hindu/Other religious extremism that have consistently set back these countries into the Third World.
If they overcome these obstacles, they will grow and prosper, and their population growth will stop, like it has in ALL industrialized countries.
If not, the usual Malthusian Four Horsemen, will take care of the overpopulation in these countries
Probably time to review demographics. Only Africa has rising population with young consumers, but they have the poorest economic buying power. Rest of world it’s the 55 and over population that is growing and the older you get the less available dollars to spend so world demand in aggregate is declining.
I am going to strongly disagree with that, it’s just a matter of where the growth is coming from.
Yes Senecas, I believe this is a major factor going forward in western economies – population growth flattening then going negative. Economists talk about the need for 2% population growth to keep demand increasing. But what if we are now in a paradigm shift where that 2% growth in population is over ? Isn’t this part of the “systemic” problem that Summers mentions ? “What it the real problem is low demand?”
Wolf, the obvious answer is Andrew Yang’s Universal Basic Income and taxing the heck out of companies like Amazon and billionaires (no MMT allowed), and cranking interest rates back up to 4-6%.
This will crash the stock market for sure, but will put money into the hands of every American to spend in the economy instead of locking it up in the vaults and tax havens of banks and billionaires.
Strange as they seem, Yang’s ideas actually make a lot of sense in this era of NIRP and tax cuts for corporations and billionaires. The Trickle Up Economy
I actually like Yang. I realize his support of universal basic income is not politically viable and most people will dismiss it out of hand, but I like his reasoning behind it.
The government should actively think about how to keep ordinary people working and part of the economy as more and more of our jobs are automated. Too many boomers subscribe to a Milton Friedman style belief that new jobs will materialize out of thin air … these jobs didn’t in time come for those displaced by the industrial revolution, and the rate of job displacement today is even faster.
Leaving too many behind as productivity swells causes massive unrest and political problems … We risk ever crazier solutions the longer this problem is ignored.
The MSM seems to be ruthlessly trying to ignore and bury Yang, but if you dig deep into Yang’s detailed explanations for his ideas, they are remarkably cogent and rational, far better thought out than anybody else running for President in either party at addressing many of the economic issues raised here and elsewhere
Disclosure: Recently donated $24 to Yang’s campaign- picked that number because Yang had said that was the average amount of his donations (“our donors are cheaper than Bernie’s!”)
Yang will never get anywhere. You look at what he says carefully enough and he starts to seem like an advocate for responsibility. And in an age of gimmes, responsibility is a dirty word.
The fundamental reason behind tightening the lending standard was because loose standards caused the last financial crisis. Now, to stimulate lending, people go with low interest rate. How ridiculous. It’s like forgetting the lessons of the housing bubble. Just loosen the standards and raise the rates. It has the same effect. At least that way, the destruction is predictable.
It took an economic meltdown near Great Depression levels to elect the first black man to the Presidency. I never thought that would happen in my lifetime
All it would take to elect Yang would be another massive debt bomb explosion and economic meltdown. How often has this possibility been raised here?
Think about it. Would the American people go for another Wall Street bailout? Another multi-trillion dollar Stimulus Package? Another bailout of GM (now with majority profits in China)? More Fed zero interest rates?
Hell no. It took years for any signs of economic recovery to show up in the pockets of the American people doing things that way. The financiers who caused the debt bomb mostly got off scot free. Everybody except ordinary people got rich from the asset inflation caused by the Fed’s zero interest estes
That would be the perfect time for a candidate like Yang to say, hey, let’s not bail these people out, let’s make them pay taxes and give YOU the money directly instead to stimulate the economy
And it does make a lot of sense
“Would the American people stand for another …….”. The American public as a whole is so brain dead listening to MSM, reading people mag and watching NFL, and demo debates so scripted to not allow any real discussion. Yes they will rise up and demand as told by CNN, etc. than Russia is responsible for next recession. Truth and snark.
UBI is USELESS without accompanying controlle of rent’s land ownership and prices.
Without control of the above issues, the small room in a poor part of town rent rate, simply rises to the total of UBI plus a small %.
Facts on the ground from a country that has a low UBI by a differnet name.
Low or NIRP interest rates destroy growth. This is a no brainer from lots of examples just since the end of WWII. What drives strong growth is the change of a major technological paradigm. We certainly saw this from the change from the agrarian age to the industrial age, then into the information age. We are between paradigms right now. I am sure there will be a game changer – perhaps energy source. We shall see, but we are not there yet and interest rates changes are unlikely to do anything but further complicate and slow down things.
Alternative energy, biotech, robotics/AI. Those are sure bets.
“Low or NIRP interest rates destroy growth.”
Agreed, but it’s a positive feedback loop ie a self reinforcing mechanism is in place. Z(N)IRP is a (non) solution to the growth ‘problem’ (infinite growth was never an option), which is caused by flat productivity, which is caused by slow technological and scientific progress. Real growth has been negative in the US since 2000 (except a few blips). The slowdown is structural, probably because society has reached point of diminishing returns with increase in complexity, ie human minds can barely manage what we’ve already built. A paradigm shift is necessary, but it’s nowhere in sight.
Incidentally, the only times historically when regular people (working class/poor) have increased standard of living was in periods of fast technological progress, which meant fast productivity growth, which meant all boats were lifted. Stagnation means return to Feudal ages, as wealth and power tends to accumulate in the hands of the few, until some major disruption happens.. like the four horsemen.
You are, of course, correct, but since our government has been effectively captured by corporate interests and the wealthy this logical and obvious solution will never happen. Remember: “Government IS the problem.”
Government is NOT the problem. Human nature is. The mass is being employed by the corporations. Government says, give me power, vote for me and I will help you deal with corporations. The mass happily handle the power to the .gov. Corporation then feel the power of the .gov and they start to money shower the politicians. The mass gets angry. .Gov says “give me more power and I will help you deal with corporations”. The mass see
the hope and MOAR power to the .gov!
.Gov is the problem?
You wonder if Powell and his admiration for Yellen would lead him to normalize when others call for rate cuts. If the market sags between now and the next Fed meeting and it becomes clear that a rate cut isn’t going to do it, will he follow the markets? He spent a lot of time taking notes during the hearing, whatever you say about this guy, he has his eye on main street. He has also spent a lot of time (well spent probably) distancing himself from the president. Add it all up he may turn out to be the peoples Fed chief.
The same Yellen that kept rates zero bound for her entire term? He admires her so he does the opposite? Could you explain please.
Yellen raised rates and ended QE and wanted to do more, Powell commends her handling of 2016. I think that global monetary flotsam saved the markets from another crash. It might be she should have raised rates sooner but Bernanke was drawing foreshadowing parallels to 37′. He is pretty much following her pattern of non-incremental rate policy. She ended QE, he is drawing down the balance sheet. Trump fired Yellen and now he has Powell providing continuity to her policy. Powell has gone rogue on important issues and is a clear danger to Trump in a crisis. At that point we can all kiss our donkeys goodbye.
Stock buybacks in the US are the ONLY net source of buying for stocks. Buybacks became legal only since the 1980s
Stock buybacks in the US now exceed CAPEX.
Corporations make decisions on NEW CAPEX( that which exceeds the amount needed for depreciation) based on their expected future returns.Even if the cost of money is very low,if expected returns are too low, then corporations will NOT invest. This is the situation that Europe finds itself in. Little to no NEW CAPEX means no new jobs. Actually it means a reduction in jobs because money spent on old CAPEX (depreciation)will result in more automation and FEWER jobs. No new jobs or a reduction in jobs creates the potential for SOCIAL UNREST.
Combining social unrest with a continuing resentment against the European immigration policies is a recipe for turmoil and the disintegration of the Eurozone
People are working today for assets that have a negative real return or simply a negative absolute return. Other than cash flow needs for daily living, there is no reason/incentive to labor or invest …. unless you think the bubble in some assets can continue to expand. It can’t indefinitely.
Same with companies. Why should a company expand today to produce profits aka assets that have poor or negative return prospects? And companies have indeed slowed investment.
So everyone is basically pissing into a fan …and they will stop doing that (which is even worse than doing it) Incentives for production have been turned into disincentives. The incentive to produce is the only thing that separates modern humans from people living in caves.
For now, the US is one of the few remaining developed countries with positive rates across the curve, while the rest of world pursues the insanity. But it must not be insane from the vantage point of some people, which is truly disturbing.
And we have a former Fed vice chair Dudley saying the Fed should try to influence the next election, i.e. create a recession. He has ripped the mask off. Wow.
“People are working today for assets that have a negative real return or simply a negative absolute return. Other than cash flow needs for daily living, there is no reason/incentive to labor or invest …. unless you think the bubble in some assets can continue to expand. It can’t indefinitely.”
I’m coming to the same conclusion. Whatever surplus one may have accumulated will be stolen by the central bank via ZIRP and inflation, grifted by the financial market insiders, and outright taken through ever-increasing taxation of various kinds.
For an individual these days, once all debts are paid off and all necessities accumulated, it makes more sense to slow down and enjoy living rather than staying in the yoke till he drops.
@ a reader,
regarding: “For an individual these days, once all debts are paid off and all necessities accumulated, it makes more sense to slow down and enjoy living rather than staying in the yoke till he drops.”
Nicely said.
I just spent a few days camping and I am somewhat ashamed to say it was/is hard for me to force myself to relax and just be. If you are a project person and like working, it is pretty easy to stay in harness. I know many folks who love to work and keep at it. The people I feel sorry for are those who would love to slow down, and are chained up out of economic necessity.
Choice is everything. I retired quite young, but still work everyday…just at what I choose to do. Working is enjoyable for many.
Anyway, you made a great observation, imho.
Working is what keeps you young into old age. To learn new things, to exercise, to volunteer, to build things, to learn new skills and so forth.
Decoupling generates all sorts of problems especially for those that rely on what is being invoked on everyone.
Today has a wonderful example of: Student Invoked Fees as a necessity.
Student councils and other organizations that were imposed on students to pay…now they have the choice.
Student councils are freaking out and trying to get students to reverse this new policy.
And of course the inflation rate depends on whether or not you believe the government. The government has immense reasons to lie, both political and budgetary. If they report the real inflation rate, they have to do what the government hates which is to pay more money out to people in indexed payments, and thus have less to spend on killing people (which is what the government loves to do)
Lets take a simple reality check. A 2% inflation rate on a $2 gallon of milk should raise the price by $0.04 a year. Thus, that gallon of milk that used to cost $1.99 should rise only to $2.03. Yet of course, us non-billionaires who do our own shopping know that this is not the case.
The government plays a lot of games with the inflation rate. One is that they simply say that when something gets expensive they substituted into the sample market basket a cheaper good. So, when nobody can afford beef any more, they claim that prices have not risen because now people can still afford to buy chicken. Then there is the bizarro bankers measure which complete excludes food and fuel, neither of which a person can do without in this society, and claims they simply don’t count at all when computing banker defined inflation. So, if you simply don’t eat, just sit in your slum dwelling, and don’t get anything delivered to you, then you are living in what the bankers call inflation.
Perspecuity,
I get your theory. But look, it’s nonsense to cite a cherry-picked example to prove your point: “a simple reality check. A 2% inflation rate on a $2 gallon of milk should raise the price by $0.04 a year. Thus, that gallon of milk that used to cost $1.99 should rise only to $2.03.”
There are many examples of goods and services that have gotten BETTER AND CHEAPER, including my broadband service. It’s now over 50 times faster than a decade ago and costs less. Also check the price of gasoline, which is cheaper now than it was a decade ago.
When you give me a cherry-picked example to prove your point, all I have to do is give you one cherry-picked example to crush your evidence.
So I suggest you read some of the articles I write about inflation because I explain this stuff — and I also point out the difference between inflation (same good or service costs more) and rising cost of living, which is a mix of inflation and the costs of quality improvements, such as the same goods or services costing more because they got better, such as consumer electronics or cars.
Much like recapitalizing the banks by paying interest on reserves, maybe the Fed should recapitalize Main Street by paying interest on savings.
Maybe I just have to accept the fact, that I am totally ignorant of anything in the stock markets and any economies. However, the following link: https://www.barrons.com/articles/federal-reserve-could-rethink-stock-buyback-data-thanks-to-two-analysts-51567097489?mod=hp_LATEST
means to me that with the total capitulation of any level of meaningful integrity and factual analysis of transaction activities, by a supposed top “economist”, as reflected and indicated by stock market reports, publication, stock exchanges, central banks documentation etc.- who needs to give a hoot about anything screwing up the economy, least of all any meaning and significance to any interest rates, positive or negative.
And we also now have the information that the Fed contemplates their decisions making process on partisan politics.
Yes, no surprise at all there. Except, he actually ripped the mask off …which appears quite stupid … and yet he is certainly not stupid. So he was willing to sacrifice the Fed’s facade in order to establish his bonafides for post-trump.
Now, how is anyone, who would openly advocate creating a recession/economic hardship for main street for political expediency, a friend of main street?
When was that ever not true? The thought has always been there. What’s changed is that someone said it out loud.
My view is that Wolf Richter has nailed this one spot on. That said, I do not look for anything to change in the foreseeable future. A lot of the issue is perceived short term gain versus a possible low probability painful event in the distant future.
The short term include things like low interest rates driving stock and bond prices higher creating a general feeling of euphoria. Grossly underfunded pension and retirement plans are buoyed, kicking that disaster down the road. The interest cost of government debt is held down. People are able to borrow and spend for current consumption – and encouraged to feel good about it. A tiny sliver of the population leverages all this into enormous wealth (and they “invest” some of their gains into politicians and other government officials – it pays good dividends). The elite ruling class feels good about being perceived as “doing something”. They also have strong incentive to not let it end “on my watch”.
So, yes low interest rates reduce disposable income for a large number of people. But, it also encourages borrow and spend for current consumption. Of course, this time it is different because very smart people are running the show – what could possibly go wrong. However, it will end, we just do not know when, why or how. I believe that the next “recession” will look very different from past ones. Mostly because money printing is so addictive.
@Eferg
What money printing? only roughly 8% of all the money in the world is printed on paper as cash. The rest is just brought into existence on computer screens and hard drives. Which is why money no longer is real or has any value its all fantasy and one big ponzi scheme until the music eventually stops and then all bets are off.
Marc:
I have not researched it, but I suspect you are right about the share of money physically printed. The financial literature I read uses “money printing” generically regardless of physical form. The money created electronically is just as real and fungible as paper money. It is potentially more dangerous as it can be created much faster and in unlimited quantities. I think we are basically aligned on this point.
The key point remains that it can be seductively addictive. Some years ago I was dumbfounded by an article I read that interviewed two architects of past hyperinflations. These interviews were conducted after the hyperinflation. The first was about the Weimar Republic in the 1920’s. The person interviewed was in charge of issuing the currency. He noted the huge logistics problems involved and was super proud of his performance enabling the hyperinflation. The second was Zimbabwe in 2008. This guy was apparently one of its chief architects and maintained how important and necessary the inflation was. That seems preposterous and defies all logic. But, it does show how irrational intelligent people can be in the “heat of the battle” – and they may continue to cling to their self justification.
I think there is a general feeling that we are too smart and sophisticated for that to happen to us. I do not share that confidence. History shows that the fallibility of people has few limits. Mankind has not evolved to a higher state in the last few decades.
Jay Carney recently said that keeping rates too low for too long is dangerous, and historically leads to wars and financial crises.
When interest rates are too low for too long, more debt is taken on, making it that much more difficult to raise rates to the point where the economy is healthy and productive.
I sense Powell is doing his best to get us out of that trap, but he isn’t getting much help.
Correction: Mark Carney of the Bank of England. Not Jay Carney!
“but he isn’t getting much help.”
Powells biggest problems control the PBOC and ECB.
He has to find a way of preventing their covert QE from inflating the US $ and driving down US T note rates and Yields.
In this he will not get help from P 45.
More and more proof is appearing that the US and other + % rate nations interest rate issue have serous outside forces driving them mainly in the PBOC and ECB.
Two comments:
1) Rate changes do not immediately impact interest earnings from previously-issued debt.
2) Total interest payouts (across the economy) are a function of both the rate and the quantity of debt. Lower rates increase quantity, so the total interest payout doesn’t decline as much as the yields suggest. The interest on $1T of debt in, say,1990 at 10% coupons was $100B/year; the interest on $10T at 1% coupons today would still be $100B/year.
3) Point 2 goes out the window when yields become negative.
4) Points 1 and 2 together imply a paper-wealth effect for investors during times of falling yields. This reverses when yields rise (and debt outstanding must fall), which is why it’s so hard to get out of the black hole of debt.
Anyone notice the 3 month T-bill is currently only 1 (one) basis point under the 30 year?
Whoops, now both currently at the yield of 1.98%.
3 month now 2 points higher!
Could the Treasury’s current practice on short term issues be having a defecating (pun intended) effect on short term demand?
…. and maybe why significant increases have come in the Fed’s 7 to 10 year bond holdings.
Regarding the affects of low/negative rates, I’m seeing headlines on that-site-which-must-not-be-named, that the $100 dollar bill is now the most widely circulated, because folks that can are fleeing Negative Rate Land.
Seems this has implications for the size of the Fed’s balance sheet. A larger one will be needed to accommodate growing foreign holders of USD cash.
No wonder the Fed decided it need a larger balance sheet. Would’a been nice had they told the reason why a bit more concisely and connected a few dots.
I am more and more using $50 and $100 bills to pay for my submarine sandwichs at the Anthony’s North End in Western Ma as it has a minimum required to use plastic. Which is easy for me because my tenant pays rent in cash almost $100 and sometimes $50 bills.
Their Reuben sandwich is to die for!!!
timbers,
“Seems this has implications for the size of the Fed’s balance sheet. A larger one will be needed to accommodate growing foreign holders of USD cash.”
That’s not the implication. Cash in circulation has been rising steadily and at a pretty good clip – whether $100 bills or $20 bills makes no differences. Much of it is overseas. The implication is that excess reserves decline as cash in circulation rises (both are liabilities on the Fed’s balance sheet), and that the balance sheet therefore stays flat — and that’s the Fed’s stated new plan.
Oh Wolf, you know that they stopped QT and held the balance sheet at a higher level than it would otherwise be at this point.
So it did have implications for the size of the balance sheet; it’s larger than it would have been without the overseas demand for circulating cash.
And we can be grateful because so long as those $100 bills are out there, and the Germans and Japanese continue to love cash economies, NIRP is held at bay.
So when Turkey’s central bank needs to make an interest payment on their dollar denominated bonds do they go around to the shopkeepers tapping the till? Not to be facetious but physical cash and digital payments are like the moon and the stars.
So funny ?. I have been saying that inflation is moribund for years, because real wages stink.
This latest collapse is utterly Japanese. So, sell it hard baaaabeee.
This comment of mine has been consistent since 2008. We had bubbles in commodity which collapsed, now following housing again.
Yet nothing has changed.
Someday this war’s gonna end…
Gail Tverberg at her Our Finite World blog has a lot to say about this ‘secular stagnation’ but she puts the blame on the lack of low cost energy. This both constrains wages for ‘non elite’ workers and the prices commodity producers can obtain. Thus high energy prices crush demand for energy and low wages restricts demand for energy at prices producers can supply in a circular process.
Worse still, we’ve added complexity and technology as work arounds to this dilemma. In her ominous analogy she compares it to climing a ladder in which the rungs below you disappea as you ascend. That is you cannot climb back down to a less complex technological world because the skills that created it no longer exist.
Thanks unit472, I now have 3 good reasons not to worry about Tverberg’s opinions.
1) Primary energy costs adjusted for inflation are quite low historically. NatGas is about at its lowest for the past 20 years and Crude Oil is in the lower quarter of its range. Furthermore, energy is priced globally and China has had no trouble with growth at these prices.
2) Secular stagnation IS due to constrained wages, but is measurable in the historically high share of GDP going to corporate profits rather than wages. This is thoroughly documented in the Federal Reserve’s database. The cure for industrial overcapacity and low commodity prices is to increase market competition, which reduces profitability for incumbent firms but has the beneficial side effect of lowering consumer prices and increasing competition for labor (raising wages). Naturally the Federal Reserve cannot see the value of this.
3) Humanity absolutely can climb back to a lower-tech world. Human skills have to be regenerated with every generation; there’s nothing permanent about high-tech skills. And the skills needed to recreate a lower-tech world (or better, to create a new lower-tech world) are easier to learn (and even easier to relearn) than the ones needed to sustain a high-tech world. And many of today’s technologies are already simpler and less resource-hungry than those of the past.
You’d think with the flat yield curve significantly below the interest rate MBS pay that the Fed Balance sheet would be free of that mess thanks to eager yield chasers. Not yet.
I support Low and even NIRP until that MBS mess is cleaned up even if it means the implosion of the banks that created the mess to begin with.
It doesn’t matter if “Negative Yields” are “Not Required”! The reality is that they are needed.
And they are needed because if you want to keep issuing DEBT in order to “make payroll and pay vendors”, and buy stuff you don’t need, pay interest on DEBT itself and so on, which is what we are presently doing – estimates of global debt are around $240+ trillion – there is no other way to keep paying the Owners of this DEBT unless some of the new debt issued to pay the old one as a negative yield attached to it.
Simple math! The funniest part is that this ponzi scheme is destroying the very fabric of the MONETARY SYSTEM!
@CoCo destroying the monetary system appears to be the goal! Read some of what the IMF intelligencia is writing.
Fiscal policy also creates a certain and ever increasing demand for dollars. This always increasing demand, driven by inflation and servicing of interest ensures a deflation of game credits over time.
This only works if you are trapped in the game.
Starve the bankers, use cash.,
Sorry Wolf, duplicate comments. This one and the last one. Wish I could edit for one minute.
Please delete my first two comments when you get back from HH. I edited the third comment to include the first two.
I’m an idiot savant. Please forgive me. I’m a dumbass who means well and is trying to figure out what all this means.
The only way NIRP lasts beyond the everything bubble is if the financial system becomes an absolute control system with no cash and no escape.
Think of it like a video game. You pay for credits and the machine that took your quarter can dispense or remove credits at will or skill, automatically, according to the programming of the machine, whose owners also have the ability to make unlimited credits at will, and who has the ability to punish or reward you. Covert and overt Fed actions are the core programming of the game.
Fiscal policy also creates a certain and ever increasing demand for dollars. This always increasing demand, driven by inflation, and the servicing of a interest, ensures a deflation of game credits over time.
This is MMT and MMT is the current reality, not a theory.
Cue social credit scores and micropenalties linked to your phone, gps, and the internet traces of your life like purchases and your online statements filtered by the Ai of these supranationals and that’s about all the machine needs to force you to pay for the use of money. You pay the game owner for the use of game credits that can be redeemed for prizes!
The only remaining value in a digital dollar is in its transactional value. The Idea of fiat money being a store of value died long ago to anyone paying attention.
What I’m saying here is the transactional value of the dollar is the only value left. You can’t play a video game without buying credits, like shoving quarters into that machine, doesn’t matter if they are sovereign quarters, the machine only accepts quarter. Could be any division of a quarter’s value.
The US is a big economy and if any supranational corporation wants to play here it must purchase credits in our video game machine which we call the US Dollar.
Quantitatively, this dollar demand by corporations to keep playing the game will always grow as corps align with the creators of game credits This transactional value is huge and not to be underestimated. The petrodollar, or oil standard, requires a certain large demand for dollars as well, adding to the effect.
It’s about control. Money is control. These things I just said were realized a long time ago by helicopter banksters.
This scenario only works if you are trapped in the game, and you are.
Starve the bankers, use cash.,
Transactional value is all the value left of a digital dollar, true. And store of value is all the value left of physical gold. So when transacting, use digital dollars. When saving, use physical gold. Both fit they’re roles perfectly.
Are we to the point that lower rates no longer
stimulate the economy but are in fact deflationary ? If loans are just being rolled
over at lower rates and fewer dollars being loaned into existence, isn’t that stagnation ?
There is a secret sauce to a wealthy society. Very few countries have found it. It’s definitely not a central bank as Zimbabwe has one and so does Argentina. It’s basically a government and society that believes in free enterprise and punishes corription. Funny money doesn’t help except to buy a little time for you to get the above two things going again.
Great article. Thank you Wolf! A couple of more things maybe worth considering:
– the low demand might also be triggered because of large amount of borrowing from the future that has already happened: e.g. there are only so many SUVs buyers can buy on credit. At some point they become saturated. Plus the capacity to borrow becomes smaller and smaller.
– once people see the Fed getting on a path of lowering interest rates, even those that can still borrow and are not yet saturated might think about waiting until rates get even lower. So the initial phases of the rates lowering cycle could lead to decreased demand for this reason too.
Sandu,
Concerning your #1 point: Yes, most definitely. This “borrowing from the future” is a well-established effect.
Btw, that phrase was just used by a Fed governor as one of her reasons why she might not be in for another rake hike next time.
2nd week in a row, the Fed is buying Treasuries: Chris Hamilton, Economica.
Hasn’t happened since October 2014. Never mind. I’m sure its nothing.
“A 2% reduction in interest rates on the $40 trillion in assets means a reduction of $800 billion in income per year, every year, for these people. That’s a lot of money that cannot be spent. And much of it goes to people that would spend all of it.”
That is loss in income that would not be spent or invested. Add the amount that these people will not spend to shore up this loss. That is the total investment that the economy loses due to the inane policy of the central bankers.
“So here you have it. Central banks, including the Fed, have cut rates too low, and are now cutting rates further, to make the fundamental problem they have caused with their low rates, namely a lack of aggregate demand, even worse.”
Try telling that to Bernanke of “wealth effect” fame.
When one tries to pull forward demand today one forgets that there could be a vacuum in demand tomorrow. This would not cross their minds.
The only way for any economy is to increase the ability of people to spend (through increase in income) that would spur demand naturally instead of thinking that these central bankers can conjure magic.
This is the end result of the experimentation with the interest rate by the central bankers, starting with Greenspan. Powell is left holding the bag. Guinea pigs – We the people.
One year ago, the Fed was rethinking recession spreads and their very own model said they should have just backed-off rate hikes, instead of raising them into December. Now, a year later, with trump tweets weaponizing and manipulating markets, the Fed doesn’t have a model and no clue as to what to do.
“Participants also discussed a staff presentation of an indicator of the likelihood of recession based on the spread between the current level of the federal funds rate and the expected federal funds rate several quarters ahead derived from futures market prices. The staff noted that this measure may be less affected by many of the factors that have contributed to the flattening of the yield curve, such as depressed term premiums at longer horizons.”
In my first business class it was said that 80% of all business fail in the first 5 years. by ten years only one out of two are remaining. Should have changed my major right then….
With that said I can see why people would rather be investors as compared to the rough and tumble of enterprise risk taking being so difficult. Diversification investing helps investors beat the ugly reality just described. Or should I say “use to anyway”
My take on this “new” reality is that you, the investor, will now have to jump in and put YOUR ASS on the line, just like the rest of us, and I think that is a good thing so you will be FORCED to invest and EAT WHAT YOU KILL…. or DIE, Just like the rest of us out here fighting on the economic battle field.
In short, I am saying that by shrinking the “investor” class living on “interest” it is a good thing for those here to get in the fight instead of talking about what should be done to maintain a class of people who ride on the coat tails of risk-taking warriors. Or, should it be said what will all here do when you cannot get alpha any more??? Yes, Then What?
This cat makes sense.
When the likes of Summers and also Carney start questioning current policy do not jump to the conclusion they are coming round to your point of view or indeed common sense. It is a prelude to a change which is very unlikely to be in our favour. They are snakes.
Quite correct: Carney’s musings were merely about how to keep the racket going, as far as one could see.
And also directed against US economic nationalism.
Pure speculative globalism, through and through.
Negative interest rates don’t work because we now live in an ageing society where people are living longer outside of America with a falling birthrate worldwide. Negative interest rates are harming more people than they help. As seniors become a higher percentage of the population they’ll go broke faster and faster which also means no wealth transfer of any type to the next generation making an endless worldwide depression a reality.
Wolf, your analysis of the effects of low interest rates is cogent and sound. Don’t sully it with validation by a former Treasury Secretary, especially Larry Summers! ?
What I haven’t heard here on the board is recognition of the incredible amount of investment by China in practically every corner of the globe. Such projects as the Belt & Road & New Silk roads initiatives will revolutionize trade throughout the Euro-Asia landmass. The high speed transportation build out connecting Beijing to Europe will take commerce between the affected nations to a whole new level. The huge land mass of Eastern Russia & Northern China are veritable goldmines of vital natural resources and rare precious metals. The transportation routes will facilitate a cost effective environment enabling mining and extraction and bringing to market these resources. Along the same routes, natural gas pipelines have been developed and these will be utilized to supply these resources throughout the entire Euro-Asia landmass. The New Silk Road initiative will integrate the Southern portion of the landmass (following the ancient Marco Polo route).
The Chinese are also making significant inroads for similar development in South America (both Columbia & Venezuela so political ideology is irrelevant). Not to mention the significant investment on the African continent.
Over here in Berkeley CA big condo projects are going forward on sites that have been vacant land since at least 1983 when I first to the Bay Area. I’m talking prime real estate locations. These are for students attending Berkeley. Anyone want to guess the nationalities of the people who will living in these?
I work for a company that develops solar farms throughout the US. We were brought out by a Chinese firm 4 years ago and are aggressively pursuing just about every opportunity that arises. American companies (backed by VCs) now seem to be on the back end of these deals buying the energy streams after we have built them out, almost always profitably. PS: Goldman Sachs is now becoming a major player in buying these.
This is way too long already but just a couple of points.
First, these are investments directed by the Chinese government. They are unconcerned about collecting on debts for failed projects. They are just written down.
Second, while the US has squandered literally trillions of dollars on wars and regime change operations throughout the world, China has been investing in these projects making themselves a far more attractive partner to almost every nation on the planet.
Third, the US is being isolated and increasingly made irrelevant to the world at large. Unless a major zeitgeist informs the public to urgent action this will be our fate. Sooner than anyone can imagine.
If cost of producing money is less than what it can buy then there’s an incentive to forge it.
It makes perfect sense to have negative nominal rates if the inflation rate is negative (deflation) resulting in positive real rates. If inflation is -2% and nominal rates are -1% then real rates are +1%.
While prices for many things go up, the value you get is going up even faster. Especially in manufacturing and anything connected to transistors/software or subject to network effects. Even things like real estate have value increase as amenities increase, telecommuting increases etc and enable more value for hikes in geographies previously considered unattractive. Thus inflation goes down.
Second, the time value of money is turning positive meaning money in the future is more valuable than money now. Anyone saving for retirement, running a pension fund or and endowment understands this. That’s a lot of assets.
Finally, in a world of rising productivity, less money is required for a given level of output. Thus there is less demand for money and lower nominal rates.
So it makes perfect sense to me that we see a world wide trend in advanced economies toward low or negative nominal rates.
Didn’t NIRP used to mean near zero interest rates? And now it means negative interest rates. I think that about says it all.
NIRP = Negative Interest Rate Policy. ZIRP = Zero Interest Rate Policy
“Negative interest rates are so absurd that just thinking about them gives me a headache.”
Yeah, just borrow your way into prosperity like the United States does.
“Look how economies and stocks have fared in countries with negative interest rates – such as Japan and the countries of the Eurozone: Their stocks have gotten crushed.”
US stocks are doing great as long as you can keep it up. And by the way, people in Europe and Japan aren’t starving.
“Japanese bank stocks are down 92% from the peak 30 years ago, and European bank stocks are down 76% from 12 years ago.”
Oh that’s bad? We must borrow and spend more so that stocks can rise and banks can make bigger profits?
It is either blowing up the economy or deflating and deleveraging it. And there is more in life than just profits and rising stock values.
With respect to growth, financing is secondary to great ideas. We need another development like the personal computer, the Internet, the cell phone, or the smart phone. Without some growth catalyst, free money just goes to inflate asset prices.
Employment is high but people can only buy so many salad shooters and chicken sandwiches.
C’mon self-driving cars!
I am not one to usually jump in the same boat as Larry Summers. But I think he is right. And right in all the ways that spells doom. I’ve never been scared before in this market with my skin in it since late 2009. I am now.
Kind Regards and good luck to all,
mB