Bring them on. Financial Repression has a huge cost.
By Wolf Richter for WOLF STREET.
Yields have been rising in anticipation of a tightening cycle, and they will rise further when the Fed actually raises rates and engages in quantitative tightening (QT). Rising yields reduce bond prices for investors who sell those bonds. Investors that hold bonds to maturity earn the yield at which they purchased the security, and at maturity they get paid face value. A few hedge funds might blow up along the way because their highly leveraged bets went awry. So for current bondholders, a tightening cycle is not pretty.
But for future bond buyers and for savers, a whole new world opens up: a world with more income. And this higher income will throw off more tax revenues for governments. So how much money are we talking about here? $67 trillion in assets that will generate higher incomes.
There has been a lot of talk how the Fed can never raise interest rates because of x,y, and z, and how the Fed can never do QT because of x,y, and z. And one of the reasons often cited is that the US government wouldn’t be able to afford the higher interest payments. But that’s a red herring.
First, the US government issues its own currency and can always pay for anything with the Fed’s newly created money. The Federal Reserve Board of Governors, of which Powell is Chair Pro Tempore, is an agency of the US government. So the US won’t ever run out of money, but the dollar might run out of purchasing power – the trade-off that is now particularly ugly.
Second, only newly-issued Treasury securities would carry the higher coupon interest rate, and the still outstanding Treasury securities would continue to pay the same coupon interest as before. The higher rates would only show up when securities mature and are replaced by new securities, and as deficit spending is funded with new securities. So higher interest rates would only gradually filter into actual interest expenses for the government.
Third, and this is the topic here because no one ever mentions it: higher interest rates generate higher income across the entire Fixed Income spectrum, and higher income generates higher tax revenues.
Total “Fixed Income” Spectrum: $67 trillion.
There were nearly $54 trillion in US-issued bonds that were publicly traded at the end of 2021. This does not include bank loans, and it does not include the Treasury securities that are held by US government pension funds and by the Social Security Trust Fund (source of data: Sifma, US Treasury Dept.).
| US issued publicly traded bonds | Trillion $ |
| Treasury Securities, portion held by the public | 23.1 |
| Mortgage-backed securities | 12.0 |
| Corporate bonds | 10.0 |
| Municipal securities | 4.0 |
| Federal Agency securities | 2.0 |
| Asset-backed securities | 1.5 |
| Money Market | 1.1 |
| Total publicly traded bonds | 53.7 |
And deposits… There are about $18 trillion in deposits at commercial banks and credit unions. About $5 trillion are demand deposits, such as checking accounts. But around $13 trillion are deposits that in normal times carry interest, such as savings accounts and CDs.
Combined, the $53.7 trillion in publicly traded bonds and the $13 trillion in savings products make up the spectrum of “Fixed Income.” But that “fixed income” – the cash flow from regular interest payments – has gotten brutally crushed and sacrificed by the Fed on the altar of asset price inflation, as that whole range of investors, from life insurers to retirees and savers can attest to.
So about $67 trillion total investments would gradually begin to generate higher interest income as interest rates rise. And that income would generate income taxes for the federal government.
In other words, if some day in the future, the Federal government had to pay an interest rate that is 3 percentage points higher on average on its public debt, the entire and much larger fixed income spectrum would pay out about 3 percentage points higher interest rates, and recipients pay taxes on this additional income.
In addition, there are the secondary effects: Fixed income investors have gotten crushed when the cash flows from their investments went to near-zero. Many of them cut back their spending in response. Higher interest incomes across the Fixed Income spectrum would fuel more spending by the recipients – many of whom, such as retirees, would spend every dime they get – and this economic activity would generate more income, and more tax revenues.
Crushing the huge Fixed Income spectrum through the Fed’s financial repression was a really, really bad idea for numerous reasons – including the consequences on real economic activity. This started during the Financial Crisis with QE, and except for a feeble respite in 2018 and 2019, continues through today.
Obviously, when interest rates rise beyond a certain level, they begin to impact the economy in the other direction more strongly than higher interest income boosts spending and supports the economy – and the cooling-down process that the Fed is now planning begins.
When we look at the interest expense of the government, we should look at tax revenues triggered by the whole Fixed Income spectrum. That’s not how budget analysis works, but that’s how reality works. In other words: bring on those higher interest rates!
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Yup. I figured this out soon after 2008 when interest stopped. I felt like spending when I knew that my savings would make up for the spending. After the savings stopped earning, I slowed down my spending.
Buying stuff is a true ‘wealth effect’, for the economy and for taxes. I’ve never gambled in either the Vegas casino or the Wall Street casino, so those ‘wealth effects’ were totally irrelevant for people like me.
Ditto for me. I spend safely. I can’t wait for the comments on this barn burner.
It is nice to spend. While they still take you money. Seen it all before.
I think Fed is going to have to extricate itself from the minus 5% – 7% real rate quickly or they are going to break the financial system. It will cause a stampede to gold, silver, crypto and possibly stocks as anything would pencil out better than losing 7% annually on your money.
the Fed, IMO, has proven themselves a tool of the wealthy. The muscle of the American economy, the everyday guy, is the last thing they consider.
An aristocracy has overthrown America with the Fed as the spear head. The Fed policy over the last 15 years has created an uninthamenable inequality for anyone whos hope is hinged on democracy.
Since the Supreme Court of the US overthrew the prohibitions against monetary corruption, we have had monetary corruption in the US. And it is corporate america dominating every issue by sponsoring the representatives of our government with money, the least valuable commodity in the America we all need.
Which brings me back to the corruption of the Fed who considers the criminal banks as they’re clients.
They just dumped 4.5 T into the bank accounts of about 60 billionaires free of charge. The greatest criminal heist since the Fed bank bailout in 2008 thru the present.
The government is in a situation like a snake living by eating its tail: it prints money to pay retirees, etc., and may get back 10 to 30% of that money in taxes, fees, etc. However, the 70% of new money, for example, creates inflation.
That increased inflation will defeat the raises of interest rates by the “Fed” (whose district banks own it and are owned by the banksters that own the stock of those “Fed” district banks) to tame inflation as more and more money is printed to cover raises in interest rates. Any one else think we are going in the same direction as Weimar Germany or worse, Zimbabwe?
Can we ignore the over $211 TRILLION in entitlements that we will have to pay soon? The “Fed” is now in a situation like the coyote that chased Bugs Bunny in an old cartoon my child just saw: it is trying to walk on air unless taxes are raised, so the US’s governmental debts are paid with real assets, namely the assets/income of the ultra rich.
Yup… We need to see 7% on mortgage rates…
Anything less will just be kicking the can so to speak.
Maybe then will see what the actual value of a home is.
That can has been kicked for bloody ages
Must be almost worn out
No, it’s re’cycle’able!
Is 7% some magical number for true value?
7% enables the bankers to afford their mansions.
Not necessarily…. I can remember 7% mortgage rates. Money Markets we’re at 6% ..Etc etc..
Things just seemed more “Balanced” …
Oh, and business was booming also…
At least that was my world….
I got a 9.5% mortgage and was like “under 10 baby” beat that!!! And the 6% CD’s, yawn…..no big deal….
I remember playing “Payday” board game with my Aunt made in the 1950’s. I saw savings and CDs paid out in 6-10%. She told me it was, at that time, savers that covered auto loans and mortgages. The bank decided on the interest rate to charge borrows, based on the ROIs of savers. Then they added a % to cover management of account plus capital income. That is why interest rates were high. The problem is the crash of the 1930s killed this business model. Banks now back everything with the government insurance. Apparently, this model is off of the Christmas movie “It’s a Wonderful Life!”. To bad Potter purchased government officials and won.
I’m 40 and I worry that my kids’ generation will become used to this financial repression. Unless we teach them differently, they won’t know. This should not become their new normal. I do believe the Fed will raise rates and end QE over the next few months. But, how long until they feel the need to restart QE?
Regarding money markets, the best I could find recently was 3% on the first $2,500, then 2% up to $5k, then 1% after that. Disappointing to say the least.
I borrow on my stock and pay cash for rental property.
I think that is what a lot of buyers do here. They sure don’t seem to mind paying 110% of listing price as soon as a house comes on the market, then closing in 30 days. Most houses [almost all] get multiple offers and bidding wars.
That has been a very effective financial model for a friend of mine.
He says at these rates being mortgaged ‘up to the hilt’ to buy rental properties is a good move. The cash flow from the rents cover the mortgage payments. His whole family is involved as they do the maintenance on the properties. And … he lives very frugally.
I know this because he wants to buy our house – with no work on our part – at a very fair price. So he told me.
Sure he’s wealthy … but he and his family work their collective butts off.
Much gutsier than I am.
But good on him! 👍
If the stock market drops 20%, so now you have four buyers lined bidding for a house instead of ten buyers, how will that affect the RE market? You still have more buyers than sellers. You only need rwo buyers per house for a biding war.
I can see the marker slowing down, I can see the Fed rescuing the asset class [again] but I just don’t see the RE market collapsing the way so many hope it will.
I could be wrong, we shall see.
And if the stock market crashes….
I remember way back O, must ‘ave been about Two years or so. The stuck market was at about 17k and I was concerned that if the Fed couldn’t rescue the situation then we really were finally entering the post-normaL prepper apocalypse we all know is coming. Thankfully they had another bullet in the chamber then. Do ya feel lucky, Wolf?
If the stockmarket crashes nervous people will be flocking to other forms of investment and capital retention. One of these will be houses.
But when was the last time we saw 7% mortgage rates? 20+ yrs ago?
If mortgage rates go to 7%.
What roughly would the investment rates be at?
Prescient article, given my recent griping over Robert Reich’s Guardian Opinion piece.
There will be winners and losers to any decision. As someone who saves his money and has been thought of as a loser for not being in the stoxk market, I say f***king bring it on too. I’ll be the ant to all these damn grasshoppers without remorse.
Exactly!! Savers have been loosing for quite some time…
I too am ready…And when it happens, I promise not to brag..
I am a saver but I have given up on ever getting a decent interest rate on my cash again. I fully expect the FED to be behind inflation forever. If a CD is paying 7%, I expect inflation will be double digits.
DC
I suspect we are of the same generation, and we learned throughout our lives that
Never a debtor or lender be
Saving is prudent
Once you are in a good saving position you can look to investing
It is good to save for that which you wish to purchase
All this was tossed in 2009 by a decisions by an unelected body who chose to serve one group at the expense of another.
I would love to hear Powell answer this question…
“Did you ever save your money? Did your parents? And if so, were you punished by whimsical Fed policies?”
For saving has been the American way to get on your financial feet….for generations! Then, it was decided, that saving was not good, it will be punished, and the Federal Reserve would not stand to their post and do their duties, but instead serve another master.
As and aside, in 2007, when the stock market made its then all time high of 14K (Dow), fed funds were 4%.
In 2018, Fed Funds were 2% and inflation was 2%, the closest we ever came to normalcy in 12 years. No recession, but stocks didnt like it…..but stocks are NOT the economy…they are a choice in a game.
Always appreciate your perspective, historicus.
Never a borrower or lender be? Please recognize, Historicus, that your savings in a bank account are really being lent to the bank providing you the account. Your “savings” are a liability on the bank’s balance sheet. You are the bank’s creditor, and it is your debtor.
If wage gains are further behind inflation than CD rates are then you’re in the positive not negative. As long as you do better than the wage earners that should be your real priority.
I have been a mostly a saver the last five years. Now I understand I have helped facilitate an even larger asset bubble. I should have saved in gold and silver so the savings could not have been used to leverage asset prices higher.
Just read Fed still retains right to confiscate gold in national crisis. Might be good to not hold in ETF form. Also read central banks only hold about 17% of world’s gold. That leaves a lot for governments to list after.
When I said Fed I meant US government.
Interesting perspective, thanks for sharing. While higher rates on all that debt will boost taxable income, isn’t there also some offset by the payers of that interest? Higher interest paid will reduce taxable income for those borrowers and thus reduce tax revenue earned by the government from the issuer. Is the higher rates still a net increase in tax revenue for government?
There is no offset for issuing government entities ($30 trillion in the table). There is no offset for companies that lose money — which is nearly all high-yield plus a gazillion of other companies. There is no offset for MBS where the underlying mortgages face caps on interest deductions. Plus, the max corporate tax rate (21%) is lower than the max personal income tax rate (37%).
Wolf said: “Plus, the max corporate tax rate (21%) is lower than the max personal income tax rate (37%).”
_____________________________________
A collective is allowed to accumulate savings faster than an individual. And we wonder why we are owned.
Income from public companies get taxed twice. Once at the corporate income level and then at the share holders level. Works out to about the same as individual income tax level.
@ Old School –
That is the price paid by stockholders for receiving limited liability …. which may be bad practice in itself. It seems anti-rugged individualism to let a promoter with a bunch of people and their limited liability pool their money to compete against individuals. I will contend it is bad practice to have a collective pay a lower tax rate than an individual.
@ Old School –
and that doesn’t negate the ability of the corp to accumulate funds faster than an individual. not to mention also the lobbyist provided tax loopholes. Anti-individual. Collectivist favoratism, and then surprise at people who lean to socialism
The dilemma is that we don’t “owe it to ourselves”. That’s the most frequent rationalization I read.
The USG can “print” endless currency but no one else owing USD can. There is a drastic imbalance between those who owe the debt and those who own it.
Those who owe it are frequently a combination of either broke or zombie debtors.
The corporation’s ability to service their debts is based upon inflated cash flows from a fake economy. The consumers (even those with “prime” credit scores) are also disproportionately dependent upon the fake economy for their job but if not, definitely for their pay level.
I’d expect any credit stress to show up in corporates first.
It’s not possible to predict in advance how much of an increase will trigger a problem as it isn’t a mechanical process. There won’t be a problem as long as creditors continue to roll over maturing debts and grant new credit.
That’s a psychological condition. Look at a chart of outstanding debt and you will see that during the GFC, it barely decreased yet the credit markets “froze” up.
Our grandkids “own” the debt.
Unfortunately, without low rates the entire economy collapses. Corporate debt that can’t be paid with new low interest loans will be defaulted upon causing a tsunami of bankruptcies. I don’t like it any more than you do, but that’s where the FED and boomers have led us. A decade of growth has been pulled forward. Buy me a hamburger today and I’ll gladly pay you tomorrow. But maybe it’s for the best. Bankrupt the bloated gov pensions, wash away the debt, start anew with 80% less government and zero debt.
When I started working, projects had to make at least 7% to clear the “hurdle” rate. Anything else was considered a waste of effort/resources.
I look forward to a world like that again. No more food delivery services losing money on every customer. No more money losing fracking, fast food on every corner, or half empty malls. The whole economy is useless junk that doesn’t have to make a profit.
One negative is 10s of millions will be laid off when all these marginal businesses go under. Times will be tough for many.
OK, but there is a hazard on the other side, and 20th century history quickly shows it. The sacrifices on the altar of “principle” in favor of a gold standard drove economies into deep lasting recessions (Churchill and Montagu Norman did it for England 1919-1932; across the pond, our Fed tried loose credit that invited the great Crash) and banking crises that led to world war 2. And that was before the dreaded boomers were even a gleam in their parents’ eye. Examples of the hazards on either side go back to ancient times. So “let it burn” is nice bluster but the reality HAS been reality-tested and it is very un-pretty and it goes back to economic dynamics not go back to one moment’s particular villains, as much as some think. It goes to a dicey process hard to navigate for anyone.
Phleep-
Not sure what point you’re making.
If its that we should be prepared for pain and disruption as rates rise, that makes sense. Volatility of rates and economy were ever present in 1800’s and 1900’s, to be sure.
If your point is to make an argument that perhaps we want the authorities to “stabilize” or offset that pain through policy methods (monetary of fiscal), I’d argue that would be a return to can-kicking.
My comment is to be more question than criticism…
If money consumers had a choice, they would act to protect its value, whatever form it took. If they did that, “tight” credit conditions (of some sort) would be the norm. Currency holders in the aggregate would never choose to have anyone perpetually plunder them. That’s what institutionalized inflation under modern central banking represents.
This is what existed under the gold standard, more or less. Negative interest rates might exist temporarily but never as we have seen since 2008. That this is supposedly “necessary” only proves that a lot of debt needs to be written-off and too many uneconomical investments are being made.
The problem with writing off a lot of debt is that it’s someone else’s asset. And contrary to what many seem to believe, I doubt it’s mostly owned by the rich, at least not the elites. They don’t have most of their wealth in pensions, mutual funds, bank accounts or insurance policies.
That’s the middle class and some of the affluent.
The “rich” seem to have most of their wealth in corporate stocks, real estate, or private businesses. They owe debt on some of these assets to benefit from currency debasement and asset appreciation, at the expense of someone else.
Read the profiles of the (supposedly) super rich and “The Millionaire Next Door”.
Not suggesting, but asking ………… how about writing off that portion held by the FED. Their practices have already introduced inflation and debased the currency. Why squeeze more from the taxpayer to pay them back, assuming they could ever be paid back at all.
probably a bad idea ……………..
Selective “Default.” That’s what that’s called. The US Treasury debt rating could be cut to D for default. The financial fireworks would be enormous. And there is no reason to do it.
@ Wolf –
actually it seems like it would improve the US credit rating. more clear runway to re-print, tax and pay.
That’s not how it works. You cannot default on your debts, selectively or otherwise, without huge consequences.
@ Wolf –
So the US government pays the FED nothing ………..
for nothing received (unless you want to count digitzed dollars conjured from thin air)
sounds like an exchange of nothing for nothing (except for the theft from savers and the rewards provided to bailout recipients,,,,, which can’t be undone)
seems better that sucking real dollars from taxpayers to pay the funny money debt
The Fed receives the interest from nearly $9 trillion in assets. That’s a lot. After all expenses and dividends paid, it made $108 billion in 2021 in net income and sent most of it to the US Treasury:
https://wolfstreet.com/2022/01/15/the-fed-released-its-preliminary-financial-statement-for-2021/
Wolf said: “The Fed receives the interest from nearly $9 trillion in assets. That’s a lot. After all expenses and dividends paid, it made $108 billion in 2021 in net income and sent most of it to the US Treasury:”
————————————–
What a great institution ……………….
You conjure dollars from nothing …………….
diluting the value of existing dollars and savings, diminishing the standard of living for many ……………..
buy “assets”, suppressing interest rates, rewarding vendors and insiders, and floating financial markets ………………
earn interest which you reward yourself and the treasury with, spreading influence for your practices along the way ………
provide opportunities for advantaged trading ……
and you get to pretend you benefit the country because you share some of the spoils with your benefactors
Churchill’s error, which he admitted, was not tying the pound to gold per se but in valuing the pound to gold at far too high a rate, ignoring the diminished value of the pound post WWI.
He sometimes said this was his biggest mistake but this may have been to deflect history from the Gallipoli disaster.
JM
2018
2% Fed Funds
No recession.
I live in Canada and I’ve watched the penniless Pakistani’s and Punjabs completely lie about their income to get a mortgage only to see home prices go to the moon. Something is seriously wrong when someone from the third world becomes a millionaire starting with nothing and living on welfare cheques. Zero interest rates and corrupt banks that hadn’t been exposed like Laurentian Bank were behind all this. This is why things need to change and interest rates need to be raised.
Where is the “due diligence” by the banks? Sounds like the average Canadian got screwed out of a house by the banks because he DIDN’T lie like a rug on his loan application, and that is a real shame.
I hate to see honesty punished and dishonesty rewarded. Not a good sign for society.
Here in the UK this type of mortgage fraud was shown on national TV 20 odd years ago and nothing was done about.
JM You are one of the few that realizes there is no sustainable economy. without free money every thing starts to unravel.
Exactly. The Fed Can’t raise rates. So many zombies out
Unfortunately pop up ads keep covering up where I’m typing
Can,t get rid of them to see what I m doing.
the USA is in an economic war.
If they deem low rates are a systemic threat and that they need to get off them to avoid losing this war, they will throw highly leveraged speculators under the bus without a second thought. Cannon fodder.
Now do they want to do this? That’s the question. If we agree they do, I think they will.
You can only live in make believe land for so long. You can’t live in a world forever where utility stocks pay 3.8% dividend and inflation is 7% and expect to have electricity when you flip the switch.
@OS – the attitude is “I don’t need it to last forever. I only need it until I’m dead.”
JM,
True. I will give an example of how this worked.
Tanger REIT stock went down to $5 during the big lockdown. They had a lot of debt, but had a pretty sound balance sheet. As government pumped money into economy their stock went to $20. They sold new shares into the booming market at $19 and used proceeds to pay down debt. Having improved their balance sheet they were able to refinance much of their debt at 2.9% for the long term.
Depreciation expense pays the interest rate and they now can generate high levels of free cash flow and pay a healthy dividend even though they report no gap earnings.
They are locked in an average 3.1% interest for next six years. So even if rates temporarily rise they have a six year window of life ahead. I suspect a lot of companies are in that situation.
Your last statement is correct. It’s very common. I have reviewed a non-representative sample of many corporate balance sheets.
Disproportionately, their balance sheets are what I would describe as weak or cr*p, but due to artificially low interest rates, extended maturities, and inflated cash flows from a fake economy, even with mediocre to low credit ratings, their interest coverage ratio is adequate or high.
One example is Oracle Corp. $100B in debt with a high coverage ratio. It has about zero equity (large negative tangible equity) and a market cap of over $200B. I wouldn’t buy the stock or its debt now, but the debt is probably safe for the foreseeable future.
Its cash flow is relatively stable from what seems to be a substantially captive customer base and good pricing power.
JM. There is no economic need of a corporation that can’t pay for its debt. It needs to be liquidated. Welfare is for food for hungry people not corporations that need free money from a transfer due to Financial Repression of savers. Bankruptcy is the cure.
JM,
I’ll just repeat it here:
People always forget to see the benefits of higher rates. In 2018, we got higher rates, and the economy was cranking along just fine. GDP grew at 2.9% in 2018, the highest since 2005.
But asset prices were taking a hit. Low asset prices is the reason for the resistance against higher rates. But the real economy will be better off, as we have seen in 2018.
A federal funds rate of 3% won’t trigger a recession. Rates would have to go far higher to trigger a recession in this inflationary environment. Short-term rates below the rate of inflation are stimulative. CPI inflation = 7%. So you do the math about what rates might trigger a recession.
But if the Fed didn’t have the balls to endure a 20% equities decline in late 2018 (triggered by 3% Treasuries), why do you think the Fed has the balls to endure a 40% equities fall in 2022 election year (3% Treasuries soon to be labelled by desperate Dems as “white supremacy”…Reich at Berkeley has already started rolling this ball of baloney…)
Inflation of course…but the G has a long, long, long history of pinning inflation murder raps on anybody/everybody else besides that Man Behind the Printing Press (Pay no attention to him!)
@JM: “Unfortunately, without low rates the entire economy collapses.”
No, it doesn’t “collapse”. It has a recession and then gets going again. There’s centuries of history supporting this. To say “the economy collapses” is too hyperbolic.
“Corporate debt that can’t be paid with new low interest loans will be defaulted upon causing a tsunami of bankruptcies.”
About time – this is long overdue. Companies that cannot afford to repay their debts out of cashflow need to be restructured anyway. Bankruptcy doesn’t shut down most businesses, it just allows the bad management to be fired (“decapitation”) and punishes the shareholders for not doing their job – overseeing the management.
Bankruptcy transfers ownership to the former bondholders as the new shareholders. Those bondholders are powerfully motivated to get some return on their loans, so usually they rework the business and get it moving again. In the cases when the business does shut down, it’s because the new owners cannot find a path to a profit – and in those cases it’s better for all to get those workers doing something profitable for someone else.
Kill the Zombies – Decapitatate and Recapitalize!
Once you have held interest rates down for 12 years,you own it. You can’t take your hands off now because investing decisions were made at suppressed rates. Fed has to manage socialism from now to kingdom come. If they fail. When they fail heads are going to roll.
Re “You can’t take your hands off now because investing decisions were made at suppressed rates.”
Sure they can. It’s just a question of which eggs they choose to break to make the new omelet.
I agree that losses are baked in – the question is who will eat them. Inflation has a way of changing people’s minds, and fairness is rarely the prevailing consideration when the hard decisions get made.
No mention of housing and what impact higher rates have on home values. High rates = less purchasing power and declining home prices. You may get a few % more on your CD but your home will be worth 50% less amongst the tidalwave of foreclosures when a few million highly mortgaged homes are negative equity and banks are taking losses in the tens of billions, just like 2007-09. Come one man, think it through.
Declining home prices? Noooo, please, anything but that!
Had they left rates up after the housing bust, we wouldn’t have to worry about this…. We never really did let the market balance itself naturally…..
Now we have the same problem as before, maybe worse..
Will we kick the can again or let the markets balance themselves….
Best of all: millions of unemployed real estate brokers and mortgage loan officers, along with more affordable dwellings for everyone. Bring it on!
Years ago, when I lived in California, I used to say “when the housing market tanks, the real estate agents go back to the tennis courts”.
Mortgage rates were about 7.5% in 1971 and peaked above 16% in 1981. The price of a home rose during this time. There was the Vietnam War, the Cold War and the 1973 Arab oil embargo. Nixon resigned after his role in the Watergate coverup became known. The minimum wage was $1.60/hour in 1971 and $3.35/hr in 1981. Workers got raises. They bought homes. It costs more to maintain a large home than a small home.
Were house prices at the peak of the biggest housing bubble in history in 1971? Didn’t think so. There is absolutely no correlation whatsoever.
No, there isn’t. There wasn’t a fake economy then inflating incomes either.
Housing prices may seem high. Look at your charts. In the past 5 yrs the Federal debt has grown about $10 T, or 50%, if memory serves correct. Some thought the dollar might collapse before the housing market and bought property.
The German 10 yr bund surged from negative to positive yields this year. How many years before it exceeds inflation? Do you have that chart. I would like to know these things.
DH, et al, Wolf?-any observations about the massive expansion of U.S. consumer credit and a concurrent linkage in this time period and going forward?
may we all find a better day.
@David – I agree with you .
House prices tend to go up when rates are rising….why…because rates might be rising as CBs are trying to tame inflation.
In an inflationary environment…hard assets go up in prices as the local currency is being devalued. Usually wages are going up in this environment too…..which they are. I know so many people who quit their job to take a higher salary over the past year.
Demand for housing is not going to go down. The population in the U.S. is growing 2 to 3 million a year.
During HB1, there was in my opinion, about 5 million excess homes built but right now we are still at a deficit regarding inventory. I read this number is about 500k. Luckily housing starts are increasing as Wolf has show plenty of charts on this growth. Will the builders overshoot with excess inventory, probably.
Maybe there is shadow inventory of vacant homes but I am not sure if there is enough to cause a crash right now.
Somebody pointed out as long as interest rates are below the rate of inflation, Wall Street will be interest in buying real estate.
I know real estate is regional and also depends on the local economy. Austin is hot because Tech companies are moving there. San Fran may be cold because companies are looking for lower cost alternatives.
But, I will say the lower 50% of the income demographics in the U.S. are getting priced out of Single Family Homes. Their wages are not keeping up with the price of homes. I think this is the new normal as more industries become monopolies and most of the money goes to Amazon, Walmart, Home Depot and the mom and pops stores owned by former middle class disappear.
The government needs to stimulate mom and pop ownership. Such as no sales tax like they did to help Amazon grow into the huge company it is now.
ru82-very well-said. too bad the idea contained in your last paragraph wasn’t floated/incorporated for mom ‘n pops’ over that time period-the state sales tax collection/accounting that they couldn’t honestly avoid or offset (prox.8%+in CA) was the proverbial straw that broke (and is still breaking) many of them during the rise of online commerce…
may we all find a better day.
@ JM –
So what if houses are worth 50% less? They are just places to live. Low house prices are good. It frees up productive earnings to be spent on goods and services. Any move away from a rentier, rent seeking economy is good, especially good for workers.
Come on man, think it through. It shouldn’t take long.
JM,
Declining home prices would be one of the best things that could happen to the real economy. High housing costs are cannibalizing the real economy.
High rates = lower home prices = higher purchasing power of labor and of the dollar. This is exactly what this economy needs. Labor has gotten crushed over the past few decades, in part due to these artificially low interest rates.
I would be DELIGHTED to see my home price (SF Bay Area) decline if it means my kids and their generation have a chance to eventually be able to afford homeownership without it overwhelming them financially.
I bought my home to live in not speculate with. If my house drops 50% in value that’s a Damn Good Thing. Even Chi-Com Chairman Xi gets it. He said that houses are for living in and not for speculating. Commies and Capitalists need a home. Bloated local governments need to be cleaned out and a housing bust is a good start.Bring it on as Wolf said in his intro.
I don’t see home prices going down til stock market goes down til Fed raises rates off zero bound. What’s to keep investor from turning a fantasy priced stock certificate in a real sticks and bricks?
You are only kidding yourself. Home price are coming down. To much inflation.
Declining house prices
Never gonna happen. With construction costs going up and rental income going up, two up the drivers of house price inflation there is no way you are going to see any decline in housing prices across the board. Maybe in some selected areas if you are lucky, but not in places where people want to live, and where the jobs are. Those who are waiting for a decline are just dreaming. Forget it!
The main drivers of house price inflation is money creation, interest rate suppression and government/FED/Banker/Wallstreet loan subsidization. Get rid of those things and prices will fall.
This still doesn’t mean that existing home prices won’t decline. People can only pay what they can pay or usually, the loan size they qualify.
The market does not care what it cost to build a structure on a property, just like it does not care what you paid for your stock.
I dont understand the overwhelming desire by so many commenters to see one of the major engines of our economy, real estate, crushed. Yes, 50% would crush much more than real estate.
Let’s assume we get higher interest rates that choke off the real estate industry. Now it’s THE BANKS that are cannibalizing the economy. What do they produce compared to the construction and sale of a home? Not much
Meanwhile over 50 professions and trades (maybe more) that actually produce products and provide services will be decimated and now all the cash goes to banks and VC shadow lenders. Not the best scenario in my opinion.
Are home prices too high relative to incomes? Absolutely. But the solution isn’t to kill the goose. Beef prices are too high, in my opinion, but I don’t think the solution is to put ranchers and feedlots out of business. Who is going to pay unemployment to all the plumbers, framers, concrete workers, roofers, drivers, etc. Think about how much less lawyers, title experts, insurance agents realtors, accountants, plus all the above tradesmen will be spending on cars, meals, clothes, food, toys etc. This will result in a very ugly economic downturn that will have all the commenters screaming about interest rates being too high and killing the main street economy.
DISCLAIMER – I’m a RE broker, builder & investor
In 2018, with the highest interest rates since before the Financial Crisis, and with stock prices tanking, and home prices starting to trend lower, the US economy grew at 2.9%, the highest growth rate since 2005!!
In 2018, higher interest rates were good for the economy, but not good for asset prices. In prior years, and since then, lower interest rates were good only for asset prices.
High home prices cannibalize the real economy. And high asset prices divert economic energy into sheer speculation — and now there is more sheer speculation than ever before.
As you know, lower home prices will keep the RE industry running just fine. Homes will be sold, commissions will be paid, homes will be financed, etc. The RE industry will be just fine with higher rates.
You probably shouldn’t worry. The not to distant future will probably bring zero interest rates and expanded QE. Good for you but not for me and many others.
CCCB said: “What do they produce compared to the construction and sale of a home?”
—————————————————-
Who is asking for less construction and sales? Lower prices is the clarion call. Good value is healthy. Paying a disproportionate share of ones income for shelter is an anchor.
CCCB said: “Are home prices too high relative to incomes? Absolutely. But the solution isn’t to kill the goose.”
————————————————-
What is the solution?
“Declining home prices would be one of the best things that could happen to the real economy”
Are you the real Wolf?! Or you completely forgot about 2008/2009 deflating House price and stock market?
USA economy is now very much asset dependent. Higher asset price allow extraction of equities for spending, and optimism of asset price embolden the suckers to spend more.
The new workforce entrants are poor anyway, so they do not count much if any at all to the economy.
Powell could care less of Inflation. Any whiff of deflating asset price would have him start printing immensely again. Next round he would follow BoJ to directly buy Stock Market and own houses.
Every CB policy will have it’s winners and losers. In rate hikes homeowners are one of the losers in short time span. However, many homeowners have children which will in 10 or so years want to be the homeowners themselves, and it is in interest of those very children and a lot of members of young generation for home prices to go down. It is time to stop draining future of young people so that we could live lavish lives today.
@JM – A policy of artificially raising home prices constitutes generational theft and servitude to banks who conjure the money they lend. Your gain on a house is necessarily someone else’s loss; it’s zero-sum.
Housing dropping => less people speculating and they turn to adding value to make money => genuine growth
Housing being high is a bad thing. Would you like your grocery bill to be higher? Cars to cost more? Why is housing different?
> because it’s an asset
Wake up and think for yourself if that’s your answer, for most it’s a cost.
Jerome Weimar Boy Bowel isn’t getting any help any time soon from the supply chains he’s been blaming for inflation. Ford just announced they are shutting down production of numerous vehicle lines which includes their best selling F150 and Bronco because of semiconductor chip shortages. A recession has never been so badly needed. If these idiots hadn’t gone on this money-printing orgy, things would be much better right now.
DC
“the supply chains he’s been blaming for inflation”
That tact of Powell could be defused with two or three simple questions asked in public.
““Obviously the pandemic disrupted the economy and contributed to inflationary pressures, but U.S. production is higher today, and U.S. ports are moving 27% more goods than before the pandemic. Inflation, driven by excess demand, always faces supply-chain problems as production struggles to keep up. But supply-chain problems increasingly are the result of inflation rather than its cause.” WSJ Jan 13 …Gramm and Solon
Inflation is causing the supply chain slowdowns not the other way around. Excess demand from future expectations of prices is causing the supply chain slowdowns. Powell would dream up any excuse. If there was deflation there would be nothing wrong with the supply chains everything would flow like before Covid-19.
I tend to agree with Marc Faber that history shows money printing always ends bad for society. The Fed has stepped it up since GFC and doubled down with the Pandemic. It usually follows current path of inflation of assets first and then inflation in goods and services like we have now. Next will be price and capital controls if history is any guide. High taxes on crypto and gold transactions will let you know they are desperate.
The reason money printing ends badly is because there is never something for nothing.
It’s always at the expense of someone else, either now or later.
The current money “printing” is no different. I read comments here claiming or implying that “it’s different this time” but it isn’t.
I’ll also take the “under” that all money “printing” theft has been fully paid for by stealing from the past and present.
The day of reckoning still lies ahead, in the form of (noticeably) lower median living standards.
I would differ on that the median living standard will be (noticeable) lower or have to be lower. That is politics. It is feasible to organize society in such a way that the average living standard go way down, the median a little and the mode does not shift at all.
Giving the wealth disparity, if everyone in the USA get housing, food as healthy as they like and necessary health care the median living standard is not down even if the upper 10% are down to one house and one holiday residence and overall consumption down a lot.
AF/Sams-“…one man’s ceiling is another man’s floor…”
-Paul Simon
DC
Good
Ford deserves to go bankrupt, building cars that nobody wants or can afford. Good riddance.
But who will make F150s? /s
Exactly right that’s where imports got their start and took over the car market. You can thank greed and stupidity of the American car manufacture. Look how long it took it took before the USA car manufacture woke up, they are still trying and may not.
MC-sidebar (check me on this, Wolf), a key component of the Japanese (or German, with VW ‘Beetle’) rise in the U.S. auto market was a CHOICE-LIMITED in terms of options (ordering an individually ‘optioned’ vehicle and waiting for it was much more common then than finding and driving one off the dealer’s lot), but relative HIGH QUALITY build in terms of available product (a different form of ‘efficiency’ in obtaining market share).
may we all find a better day.
GM shouldn’t even exist today but Uncle Sam loves to subsidize failure. Must keep those pesky innovators from gaining a foothold! For some reason.
Gov wanted the Union voters. They were spared and the bond holders decimated. Gov took stock in the “new” GM and made money on it when they sold it.
Swamp Creature,
Based on your comment, might I assume you won’t buying the dip in Ford’s stock (F)?
I thought I read last month Ford had a market cap of $100 billion dollars. Sounded like fantasy to me. Ford, GM and Tesla probably one severe recession away from bankruptcy/ bailout
You read correctly.
The difference between Ford versus GM and Chrysler in 2008 is that the Ford family presumably did everything they could to avoid losing voting control, from their class B shares.
They may not be so fortunate next time.
CEO Alan Mulally came to Ford from Boeing on 5 September 2006.
Just as he was about to be announced as the new President & CEO, he made the comment that his Lexus LS430 was, “the finest car in the world.” however, he did switch to a Ford when named to be the Head Honcho.
His first move was to borrow $23.5 billion. This was secured by all of Ford’s assets — intellectual property and the company’s blue oval logo included.
His viewpoint was that declaring bankruptcy would be fatal for a car company. But he did testify before Congress that General Motors and Chrysler should get government loans for the sake of the economy in general.
The Boeing 777 was developed under Mulally’s tenure.
Strongly suggesting they will raise funds rate from 0 to 0.25 was enough to pop ARKK and BTC by 50% and push mortgage rates up by 50%.
If that’s how strong the fed is – I have to take the contrarian view to Wolf and most of the readers here. A few hikes seems like it’ll stop inflation (and therefore upward rate pressure) pretty quick given what we have seen thus far.
I say stagflation
No growth and high inflation due to government screwing up real economy with high energy costs and mess they have made dancing with communist regime in China.
There’s likely years of pretty strong growth coming, just from on-shoring effects, as companies bring production back to North America.
That may come at the cost of higher inflation for longer (because it costs a bit more to produce here, even with increased automation), but it probably won’t result in stagnation.
Reshoring will not happen in a meaningful way. American workers are simply far too expensive compared to the alternatives.
Maybe a momentary blip, but it won’t last unless our standard of living drops enough to compete with the shipping costs and supply chain risks involved with overseas production.
random guy 62
Now, what make the American worker expensive?
Their wage and other benefits?
Or a ridiculous compensation of all executives in the company?
Combined with over inflated real estate and an insurance/healthcare system that place heavy taxes on the US workforce? Topped of with a lot of rentier activity that also skim whatever surplus and a little more?
Small, cheap, simple items will likely continue to be offshored. Nobody wants to manufacture plastic forks in the West.
Heavy, expensive, complex items are already moving back. If not to the US, then broadly to North America and Europe.
Not only does it simplify matters, there also seems to be a broad political consensus that this is strategically important.
Economy is already slowing ,no more free government money ,except welfare and section 8 housing, how much stuff is too much
It’s not only the tax on interest income that helps the Treasury. If the Fed embarked on a convincing interest rate hike cycle, and had the resolve to let asset prices adjust, people would sell stocks and RE, and recognize taxable capital gains. But, if they don’t believe the Fed has resolve, they will not sell.
The Fed needs to stick to the rate hike plan this time and not reverse course early like in 2018. But thats wishful thinking. We’ve seen them cowtow to Wall Street too many times.
Why doesn’t anyone talk about congress = they are the real problem
Flea:
+1000
Powell has his feet under the table for four long years. Plenty of time to get something big done.
I believe he won’t get confirmation,ride off into sunset and forgotten,
Wolf said: “The Federal Reserve Board of Governors, of which Powell is Chair Pro Tempore, is an agency of the US government.”
—————————————————
Is the Federal Reserve System an agency of the government?
Is it owned by the government?
it’s federalreserve.GOV
the internet certainly thinks so.
cb,
Please re-read what I said and what you yourself quoted: “Federal Reserve Board of Governors” is an agency of the US government. The “Federal Reserve System” includes the Board of Governors (US agency) plus the 12 regional Federal Reserve Banks (private organizations).
Re: Fed ownership
I always thought of the FRS as a sort of a cooperative. Wasn’t it originally steered by the bankers, especially by the powerful NYFed? Later, the Board of Governors wrested power from the bankers.
Also, originally the purpose of the Fed was to stabilize the Banks, but evolved into an organ designed to stabilize the U.S. Economy, especially employment.
Talk about an unholy alliance!
John H.:
“House of Morgan”
An oldie but a goodie. (Book)
I caught exactly what you said, and with a quick search I found the FED says itself, in 2017, that the “Federal Reserve Board of Governors” is an agency of the US government. The FED also claims, in a 2017 writing, that the FED is regularly audited. I can not yet find who pays the FED board of governors.
Considering how forthright the FED is not, I suspect a lot of smoke and mirrors and mis-direction. I asked my specific question to point out that in reality things may not be as they seem to be on the surface.
Stipulating that the FED Reserve Board of Governors is an agency of the government, I submit that they are captured by the banking interests (as is the senate and perhaps the president) and do the bidding of the banks.
“I can not yet find who pays the FED board of governors.”
Every one of the 7 members of the Board of Governors, and all the many employees of the Board of Governors are employees of the US government, get government salaries with COLAs, government pensions, and government healthcare. Every one of the seven members of the Board of Governors is nominated by the President and confirmed by the Senate. This includes Powell, who is head of this federal agency.
And yes, there is a revolving door at the Board of Governors just like there is at other federal agencies.
Wolf said: “And yes, there is a revolving door at the Board of Governors just like there is at other federal agencies.”
_____________________________
with 14 year appointments?
“While the salaries of federal employees are subject to transparency, the Federal Reserve – otherwise known as the Fed – is claiming that it has a right to keep 98.4-percent of its salaries secret.” source – Forbes Magazine October 26, 2021
They quit. Like Yellen. She quit after she wasn’t reappointed for the Chair and went to some university, and then became Treasury Secretary. Quarles just quit. Others did too.
You can put the conspiracy theory babbligook away at anytime.
Is the USPS part of the “government?”
Is the CDC part of the “government?”
But while we’re wondering what the “government” actually is, ask yourself if the “government” is merely the “State” acting on behalf of the public, or the series of other private institutions making decisions that govern your life?
When Facebook can control public discourse, and bury or promote businesses at their whim, when do they become a practical part of the “government?”
They’ve even created their own supreme court and often talk about the important of “corporate governance.”
This kind of fallacy is either called equivocation or reification.
We are to believe it is not an agency due to its makeup, but it is tied at the hip with the Treasury Dept, and engages in “agency creep” (climate change, inclusive employment, etc.)
The operational indications that it is indeed an outside entity is that
*in a government that boasts of “checks and balances”, there IS NO “check” on the Federal Reserve,
* they expand the money supply in giant increments at their whim (though minting is a Congressional power that cannot be delegated)
*they lay an inflation TAX on the US population (though only Congress can tax and that power cannot be delegated)
Very much like their very own government, without accountability to voters. For who would vote for a tax on dollars (inflation) that the Fed openly promotes?
+100. We should end the Fed.
LOL, it looks to me like we are all owned by the Fed. What is more powerful than money control?
I must have heard wrong in civics class about only three branches of the federal government. The fourth is a cartel of unelected rich bankers who make policy that affects every aspect of our life more than the other three ever could.
The Federal Reserve was created by an act of Congress and can be done away with by Congress . The Electorate elects Congress. The Electorate does not know the difference between money and currency. The Electorate is by and large ignorant of sound money and the Congress wants to keep it that way. Congress likes keeping 1/2 of the electorate at the throat of the other 1/2 with bull shit. The Electorate does know that $7/lb ground beef…bad. $4 a gallon gas…… bad. 25% increase in rent……bad. What the Electorate is confused about is how Vlad raised the prices.
The true argument has been the negative earning rate on treasuries, based on inflation. There is always a give/take to balance out the equation, and savers have def given. Many pension plan treasury funds just mimic certain treasuries, usually short term bills. Taxes will not be counted until these funds are cashed in, and that will not be just around the corner. Get ready for the pain of the huge elephant in the room, Medicare/Medicaid.
Dawn
” There is always a give/take to balance out the equation, and savers have def given.”
Balance? This has been TAKE from one group to assist the other group for 12 years. (Since QE)
Savers are also earners…..and not only are their current wages being cut, their past wages (if saved) are being cut as well.
Hardly fair or balanced, IMO.
Yeah, that was my point.
Savers provide liquidity,so that the system can work
Having run a business using a cost plus 14% pricing formula, if interest “cost” rises, so does the nominal value of that 14%.
Also, my first mortgage was at 10% fixed 30 year. But home prices were rising at 15% per year, so it was a prudent purchase.
Wolf said: “First, the US government issues its own currency and can always pay for anything with the Fed’s newly created money.”
——————————————–
interesting use of words for a man as precise you.
government vs Fed
currency vs money
1. Is it accurate to say The government issues its own currency and money and can always pay for anything with its newly created currency and money. ?
2. Is it accurate to say The FED issues its own currency and money and can always pay for anything with its newly created currency and money?
Also, is it true that most USA money is not currency but is composed of digital dollars?
Yes and Yes
1 yes. 2 Yes. 3. No, you’re mixing things up
Most “money” isn’t money at all but usually someone else’s debt.
Maybe I’m not seeing it, but wouldn’t the current situation of ever-growing annual deficits to cover ever-expanding Federal spending eat up all these perceived “new revenues”?
It’s not like the demands of government spending will recede in a decade where the vast majority of the largest generation of Americans in history stop working and start sucking out their “benefits”, right? To say nothing of all our “leaders'” plans to win re-election, I mean…save us all, though various spending schemes.
Ever since Cheney DickDickovich boasted back in 2001 that “Deficits Don’t Matter”, they really haven’t, at least to anyone in power in DC. So why wouldn’t spending/borrowing increases also dwarf any new revenues we might reap in the future, just as they have these past 20 plus years? Thanks!
That’s my take on it too. The spending addiction is invincible so far and the demographics are against reigning it in, not to mention the warmonger’s thing we have going.
Excellent point on demographics. Last time inflation / rates roared ( 77 – 81 approx), boomer generation was just coming of age of buying homes, etc.. What a tail wind for the real economy. Now we are just passing peak retirement year for boomers ( assume 65 ). Demographics are now a giant head wind and will be for many years forward.
I read the millennials demographics is bigger than the retiring boomers and thus helping the housing boom.
The question is do they want McMansion and will they be able to afford McMansion.s
Jucifer
“current situation of ever-growing annual deficits”
Isnt the near free money with almost zero cost to borrow the cause of the ever growing annual deficits?
The Fed is instructed by the Federal Reserve Act as amended in 1977 to “promote moderate long term interest rates.”
For at least two years, we have had ALL TIME LOWS IN LONG TERM INTEREST RATES. 4000 yr lows. That is “immoderate” by any metric.
IF the Fed had been held to this mandate, if it had not played the “dual mandate” game which carves out this mandate, the Fed would not have been able to flatten the yield curve, force investors to take greater risks, and prevented them from pulling wealth forward via long term debt creation to “fluff the present”.
That wealth has burdened the generations x,y,z ‘s future with TRILLIONS in debt, and that money has been used to bid away from those same generations any reasonable entry into housing and stock prices.
They might wake up to that fact some day.
Problem with past 10 years of Fed Policy is it resulted in 10 years of malinvestment. The most disciplined big investor in the world has basically bought nothing except Apple over the last decade. Too much cheap money driving up prices of financial assets so that they are most likely long term losers.
What an interesting article.
Much to contemplate.
As to those who predict a housing crash I would like to interject that a decline in housing prices has in the past been rather slow. Foreclosures take a long time. Just because interest rates go up and sales decline, doesn’t mean every seller will be calling their Realtor and lowering the price enough to matter. This is usually a long slow painful process for people who find themselves over their heads.
As for business bankruptcies. Same thing. It’s not like anything happens quickly. It could be a year or more of raising rates before we see the first signs.. Could be quicker but only because some corporations are Unicorns and their banks decide that they are already dead.
Also until businesses start laying off, especially the high value employees, most people will just keep making their payments and houses won’t go into foreclosure.
So don’t look for significantly lower house prices for at least a couple of years. That is IF this goes from a mild recession into something more severe..
You’re correct about foreclosures lagging. However foreclosures are a result of lower prices. Not the cause. There are many reasons some home sales happen. Death divorce etc. The market determines sales prices, not the sellers or agents.
Read a pretty good article that said starter homes might not not be in a bubble because they can never be built for $250,000 again so there will always be tight supply.
Just because it can’t be built again at some arbitrary price point doesn’t mean the target market can afford it.
I expect this problem to be solved by future buyers moving down market. Too many first time buyers seem to be more interested in buying one closer to their “dream” home as their first.
Few believe in delayed gratification.
In the future it is going to be damn hard to find a building lot in a desirable area for 250k, let alone building costs.
With environmental restrictions the amount of buildable land is shrinking.
I was just driving through Redmond [WA, home of Microsoft] and it is 6 story apartments/condos everywhere.
“ This is usually a long slow painful process for people who find themselves over their heads“
Yup…
I see a lot of these folks learning about the five stages of grief…
Historical comparisons are pretty clear that corrections from this level of overvaluations are deep. Today, in the “everything bubble’ created by the Fed, there is no safe place to put your money.
” A few hedge funds might blow up along the way because their highly leveraged bets went awry.”
I come here not only for the education but for the entertainment as well. The above quote completely satisfies my need for entertainment as it just brings a smile to my face. A big smile.
The markets will move well in advance of any news made available to the public.
Prophet
“The markets will move well in advance of any news made available to the public.”
Are you a former Fed governor who resigned in fake disgrace?
historicus,
You are one perceptive historian, for you have exposed my true identity. But I can assure you, my resignation was not “faked,” for I am truly ashamed (that I got caught). I beg you to understand that it was the Chairman that made me do it.
67 trillion, that’s what you will need to buy a loaf of bread in near future
at that point, bread will be priced in francs.
if you can get it.
b
And you’ll have to “buy” it with lead!
The engine of commerce in this country is credit (aka debt), and so when credit dries up, commerce dries up… big time. For instane, if rates went to 7%, housing would be a train wreck.
One can certainly hope.
“For instance, if rates went to 7%, housing would be a train wreck.”
For instance, if inflation was 7% and the return on holding dollars was .05%, it would be a train wreck for everyone who WORKS and SAVES.
Buying any asset has its risks, and apparently everyone under the age of 35 thinks the Fed is the tooth fairy. Buying bulges in real estate markets has a poor history.
If you are living in the house and have a 3.1% 30yr, what is your real concern?
BUT, if you own two or three …. maybe rental properties…..maybe doing a little pyramiding ……. well, you are rolling the dice, arent you?
Yes….historicus.
If you have a fixed 3.1%. Most likely you will never see that again.
But owning 2 or 3 houses via some leveraging is all about the cash flow now now matter what the rates will be.
Jeff D.
Three points:
1. One man’s “train wreck” is another mans opportunity of a lifetime.
2. Credit is just one of the many “engines of commerce.” Others include: abundance of natural resources, an educated workforce, creative entrepreneurs, and functional and sustainable institutions (judicial, legislative, money, property rights, etc.)
3. I think of “Credit (aka Debt)” as more of an accelerant than an engine…
I promise you that if you took away credit, at least half of businesses and three quarters of households would go into bankruptcy.
I went to the supermarket yesterday to buy some milk.
I went again today and there had been some ‘growth’ and it was more.
What good news! Let’s hope housing doesn’t get cheaper, that would be really terrible.
Manufacturers would be able to buy land for less.
Manufacturers could pay less to their staff who would enjoy the same standard of living as before house prices fell, making them more competitive internationally.
All sorts of terrible things.
A lot of the recent debt issued by the Treasury was short term bills right? Weighted average debt maturity of US debt was 65 months— last year….it’s true that the government can always print dollars to pay off dollar debt and that the bills, notes, and bonds will be replaced gradually with higher yielding debt….but with a five year average maturity, “gradual’ might be relative.
More of that ‘whooshing’ sound for dollar purchasing power. It is the dying of money:).
I’m old enough I remember back when Wolf said MMT was bunk garbage.
I’m still saying that, more so than ever.
I’m explaining to you in this article why the Fed can and will raise interest rates, and why the reason often cited by those saying that the Fed cannot raise rates – that the US cannot afford higher rates – is a red herring. I’m telling you in this article that the US can afford higher rates just fine, and that higher rates would be good long-term for the real economy (though maybe not your portfolio).
Most likely government would look at higher tax collection as an opportunity to blow even more money.
Harry Dent is correct.
The spending cycle for the majority of those that hold fixed income securities is over. Start families, purchase homes, buy new cars, boats, Rv’s etc? Not likely.
Sorry, but for those that have had the common sense, to save it away, during this entire mess are not likely to run out and spend it away…
“Harry Dent is correct”!!!! That is hilarious! Would you care to put a date on that statement, or, even, pick a decade?
Wolf, I’ve always been interested to know what happens to the value of the Feds current treasury/bond holdings as rates increase? Will the market value of the Feds balance sheet fall as rates rise? Furthermore, would this have an effect as they begin to sell off holdings as discussed with QT?
Alfred,
The Fed will likely let its Treasury securities mature and roll off the balance sheet. At that point, the Fed gets face value for those securities. The day-to-day fluctuations don’t matter.
The Fed still might sell some Treasury securities outright, like it has done with its corporate bonds last year. It made money selling its corporate bonds. A lot of the Treasuries with long maturities were bought at far higher yields than today, and the Fed would make money selling those. Others were bought at lower yields, and the Fed would lose money, if it sells them.
In terms of the MBS, they’re constantly being paid down through the pass-through principal payments when the underlying mortgages are paid off through sale of the house or refis, and are paid down via mortgage payments. These principal payments are passed through to all holders of the MBS. This is a huge flow. In 2021, the Fed received about $65 billion a month in pass-through principal payments, and then went out and re-invested them in new MBS. If the Fed just stops buying MBS, over half of its portfolio of MBS will be gone in three years. This would not entail any losses.
The Fed made $108 billion in net income in 2021, most of which was remitted to the US Treasury Department. Any losses on the bonds would reduce the Fed’s net income, and would reduce the amount it remits to the Treasury every year. If the Fed takes such big losses on its bonds that they’re larger than its interest income, then those remittances would go to zero. Since the Fed can create its own money, it can never go bankrupt.
https://wolfstreet.com/2022/01/15/the-fed-released-its-preliminary-financial-statement-for-2021/
Thank you for the thorough reply Wolf, helps me better understand the situation and potential outcomes.
The market value of bonds will matter to anyone holding them in their 401k or IRA funds! Bond funds refigure their NAVs every night. Over the course of this year folks will likely see negative returns on their bond funds as yields rise…but there’s no where to run within the 401k/IRA choices of funds. What to do, sell and move balance to large cap fund, to small caps, foreign??? They’re all getting touched.
Our fearless leader recently responded to a reporter’s question about inflation. To paraphrase Biden’s answer: “inflation is an asset”
“What me worry?”
The Fed and congress is out of control. Spend, spend spend. Print, pump, pump.
Real interest rates should be 3% above the rate of inflation. 10 per cent will kill this bogus economy.
Cheers from the bunker,
B
Brewski,
I may be misunderstanding you, but President Biden was being extremely sarcastic when he said that inflation is an asset. He’s well aware that persistent inflation will likely seal-the-deal on the Democrats mid-term prospects.
But if r-star really is low … Won’t higher rates increase unemployment substantially leading to lower overall tax revenue & greater spending on social safety nets?
Negative 7% rates are no good … But higher rates can also create other social problems. Is it possible low rates are the lesser of two evils?
Ugh, confusing
Lesser rates I think might for awhile be a lesser evil. But it has been run out so far now. Like water flowing, the politically wobbly government has taken the path of least resistance which was cheap creation of money and credit. The crowds cheer and buy fun wacky stuff — for awhile, until the purchasing power starts visibly, quickly disappearing (now). This too-one-sided process has made the system fragile on both sides. No tack now can guarantee avoiding serious dislocation across the whole economy (which Wold and the commenters here illustrate so well). So the path ahead I think needs calibration and re-calibration, which Powell is jawboning right now. But he missed it on the last leg, which was the easy, people-pleasing part of a Fed’s job: bring the booze to the raging party.
It wouldn’t surprise me if a lot of us get totally wasted financially in next 10 years. Nobody knows what is going to happen. People 65 and older remember the time when Volker had to crush inflation and that muscle memory will help us if it plays out similar. Stock market Price to Earnings got to 7.
PNWGUY,
Right now, there is a labor shortage. Unemployment isn’t going to rise as long as there is a labor shortage. But the labor shortage might become less severe, and that would be a good thing.
There are now 10.9 million job openings. Maybe 3 million of those 10.9 million job openings will go away in a slow-down, still leaving 7.9 million job openings, which prior to 2021 would have been an all-time record. And employers would still scramble to fill job openings. Before unemployment rises, the labor shortage will have to disappear first.
Right, the labor/asset markets are way too hot right now, and rates need to go up from here.
I just wonder how much they can rise before the 10.9M job openings – plus even more jobs – go poof?
My guess would be that end of QE + lower stimulus/fiscal spending will rebalance the labor market quickly (late 2022). Minimal rate hikes needed. I think that’s the Fed’s bet too.
We’ll certainly find out soon … living through economic experimentation sure is exciting!
Dear Wolf,
for once I think the flow of your argumentation is not complete.
This is because:
1. If the government starts to pay for the interest via newly issues money that would basically mean a return of QE, so the whole point of why interest rates should rise (the Fed buys less) is obsolete.
2. In aggregate the tax revenue from interest income has to be a lot smaller than the income itself so that there remains a funding gap that had to be filled via the wealth effect of higher spending and therefore higher taxes from other sources.
3. BUT, if interest rates rise to 3% or more, the US would almost certainly enter recession thereby reducing tax revenue. Many unprofitable enterprises that were held up by cheap money would close down, causing a negative feedback loop even to the profitable ones.
So I think the snake is biting its tail here: A rise in interest rates will inevitably lead to a new round of QE or a default.
Great reply, I was fumbling for that and you drew it out perfectly.
pigeon.
Essentially what has occurred is that the Government is spending the interest income they normally would be paying out if rates were “historical”.
Why is it that the government can spend that interest income? Why is it “better” for them to do so?
Why is the supply of debt not depressing the price of debt, increasing the rates?
Well, the FED has had its foot on the scales of supply and demand of federal debt pricing, and that is a clear interference of free market forces. It has fomented the creation of 21 Trillion in debt in the last 12 years. (the prior 215 yrs of this nation, 9 trillion in national debt). That is the real problem. The irresponsible debt creation has made what you think is a good argument not to raise rates. So the SOLUTION is a continuation of the CAUSE (fake low rates)? That is nutz.
MMT holds that debt is good, that its benefits are dispersed throughout the economy. But ONLY if the government does the “dispersing”.
Why is interest income dispersed to the LENDER at a fair rate of return also not good for the economy? MMT only sees it good if the government spends it. What a surprise.
MMT is something an economist can cook up like Hugo Chavez cooked up a plan that worked for a while. Any plan works temporarily if you flood a functioning economy with free money til it starts affecting people’s psychology.
MMT is contrary to human nature, just like socialism. That’s why both are guaranteed to fail economically.
Yep. There is far more leveraged bets than ever before.
Although some safety measures were put in place from the 2008 debacle, the probability that the percentage of defaults will be more then they were in 2008 seems high in the private sector.
The Mae family, Fred and Fan, have beome part of the government extended family.
It also seems unlikely that the FED will be as aggressive with bailouts as they were the first time due to political and economic backlash. They have have just started trying to dig themselves out from debacle 2. It will be a long dragg out affair.
I like that term…the Mae family.
One thing I am thinking is the MAE family probably can prevent any type of future housing bust.
The reason why HB1 was so sever beyond the subprimes not paying their mortgage payments was because nobody knew who held the bad mortgage paper. Now the Mae family holds it all and they an take any type of loss because the FED will buy the bad loans.
I have a friend who worked for a utility company. Utility companies have a captive customer who will skimp on other things to keep the house electricity on and heated/cooled.
During the HB1 when the contagion spread. 4 of the 5 banks they had credit lines with shut them down. At the time they bought and sold commercial paper to make their short term payroll payments each month. That market dried up too. This was a sound financially solid Utility company that could not find anyone to loan them short term money to allow them to pay their payroll.
That probably will not happen this time.
Don’t forget that the Feds picked the winners and lovers, not the market.
3. “Many unprofitable enterprises that were held up by cheap money would close down, …”
Um, isn’t that the whole point of a free-market supply & demand economy?
Yeah, that is not what the USA is currently under; a free-market supply & demand economy, but in theory at least, that is what the USA’s economy should be.
Rule Number 1: “Capital must have value.”
Rule Number 2: “Tomorrow’s capital must be worth more than today’s capital.”
To the members of the Federal Open Market Committee, for God’s sake, “Play by the fuc#ing rules!”
pigeon,
“If the government starts to pay for the interest via newly issued money…”
Nope, that’s not what the government is doing. The government will be borrowing at higher interest rates. That’s it. And it can afford to do so without having to rely on the Fed buying securities. That was the point of the article.
However, the government cannot go bankrupt because it controls its own currency. I always have to point that out because so many folks expect the government to go bankrupt next week, or whenever. Won’t happen. What we’re getting is higher inflation and higher interest rates. And that’s what this discussion is all about.
If short-term rates go to 3% and long-term rates go higher, there will be a lot more spending which is good for the economy – and less speculation, which is also good for the economy. Good investments will be made, instead of ridiculous misallocations of capital.
People always forget to see the benefits of higher rates. In 2018, we got higher rates, and the economy was cranking along just fine. GDP grew at 2.9% in 2018, the highest since 2005. But asset prices were taking a hit. Low asset prices is the reason for the resistance against higher rates. But the real economy will be better off, as we have seen in 2018.
A federal funds rate of 3% won’t trigger a recession. Rates would have to go far higher to trigger a recession in this inflationary environment. Short-term rates below the rate of inflation are stimulative. CPI inflation = 7%. So you do the math about what rates might trigger a recession.
There is likely going to be an inflationary recession, and the deficit will be closed, govt spending shrinks. Yields rise and bonds are more attractive as an investment, govt has no problem funding (reduced) spending That will keep down the cost of money, borrowing rates, and bond yields. Bullard says we are going to break the 3% low on unemployment, and that is a recession warning signal. Fed will be reluctant to raise short term rates, if rates fall and the yield curve inverts. Foot on the gas, eye on the sparrow.
I am amazed how easily people seem to accept the idea of a secular change in a 40 year trend. A change apparently brought about by the very institution that drove the 40 year trend: the Fed. It’s not going to happen. What we are seeing is a whipsaw event that will settle back into the prevailing trend.
If real change is desired, then it has to happen on the political / fiscal level. The country has to embark on a war-like effort to again insource value creation. The US has to focus on strengthening our own domestic productive resources, including human resources. But the political system is falling back into austerity and deficit talk. Remember the talk about our suffering kids and grandkids?
So here you have it. Nothing has changed. Maybe except the growing unrest where trust in institutions and ‘elites’ is eroding at an exponential paste, and where every idiot’s opinion has equal weight. The US has to ‘go through the tunnel’ before anything secular really changes. So forget about a new secular uptrend in rates. All we will get is a policy error and back to ZIRP. And maybe a political upheaval on the horizon.
“All we will get is a policy error…”
BS. The policy error occurred in March 2020 with massive QE and interest rate repression, and the policy error re-occurred every month since then through continued QE and interest rate repression. This has now caused an inflation spiral out the wazoo. By tightening, the Fed is will be trying to mitigate the effects of its policy errors since March 2020, and it’s trying far too slowly and far too little.
I have a lot of sympathy with your analysis.
I think it could be policy error and retreat. However when you say about a political change, the USA isn’t really a democracy, the “shots” for medium term strategy seem to happen behind the scenes and the short-term presidents jaw-bone about them until its someone else’s turn.
If that’ the case then do we need a wholesale sentiment change to start this journey? I think not.
1) No – the dreaded N word – to zero rates during inflation
2) N word to fake & phony. That’s why Meta, ARKK and Disney are falling.
3) N to woke, to the radical left.
4) N to Creeptos, a backlash to fake money.
5) N to the radical lawyers.
6) No to bigness. Yes to smallness.
Wolf…
Dead on.
Interest income is the grease that lubricates the consumer.
As one put it….” I used to go on vacation with my interest income, and now I can’t fill up my gas tank with it.”
A fair return on money is ………………….FAIR
And as Hayek said, “When central planners decide, they decide to assist one group at the expense of another.”
Well, for 12 years, and especially in the last two, savers and fixed income people have been SLAUGHTERED by central bankers INTENTIONALLY harming them to assist asset holders.
For 70 years prior to 2009, Fed Funds tracked inflation, often exceeding inflation. This helped tamp down inflation and also protect the holders of US currency from harm. That was tossed aside by Bernanke, and harming the one group became sport for the Fed. “Forcing” investors to take more risk, the plan of the Fed, even on the surface, is a dangerous tactic, IMO. When did the Fed get into the business of “forcing” anyone?
1) If US 10Y rise to 4% – 5% gravity with the German negative rates will pull it back. 2) If the Eurozone bomb itself JP might raise interest rates, but
the smart money will park in US treasury, sending rates down, because there is nowhere else to go.
3) Results ==> US zero or negative rates during inflation.
Hyperinflation will cause the U.S. dollar to implode. Investors will park their money in foreign currencies paying higher interest rates as the foreign currencies appreciate vis-a-vis the U.S. dollar. I can’t see any other possibility?
Low rates keep people poor, if your just starting out in life and you can only get 1% on your savings it will take 72 years of compounding for your savings to double,and that’s without taking the eroding effect of inflation into account, if the you can get 6% then it takes only 12 years to double your savings, again excluding inflation. Think about the effect that has on young people staring out saving for a home, and then think about the fact that having not been able to save a deposit and buy a home they then dont buy chairs and tables and all the goods they need to fill it with, low rates = depressions, contrary to conventional thinking.
7% inflation causes odd behaviour, I have investments LOSING 2.5% a year, fantastic, compared to cash I’m winning by 4.5%.
Fascinating article.
Wolf wrote:
“So about $67 trillion total investments would gradually begin to generate higher interest income as interest rates rise. And that income would generate income taxes for the federal government.”
Couple of observations:
1) The interest income generated by most of the $4T in muni bonds is not taxable at the federal level.
2) A sizeable chunk of the higher interest income may be sheltered in tax-free (e.g. Roth IRA) or tax-deferred (e.g. 401K) retirement accounts so may not be taxable for decades or ever.
3) One person’s interest income is another’s interest expense and some interest expenses are tax-deductible so if these interest expenses increase with higher rates, the federal government will receive less taxes from those paying the interest. This might offset most or all of the extra tax receipts from those receiving the higher interest income.
e.g. residential MBS interest incomes derives from interest payments paid by homeowners and those interest payments are tax-deductible (fully on loans of up to $750K). If interest rates rise and prices fall so that mortgage payments remain about the same, then a higher proportion of the mortgage payment is interest and so is tax-deductible so the overall federal taxes paid by the homeowner will drop.
One more:
Foreign holders (e.g. foreign CBs) of bonds issued by US entities don’t normally pay US taxes on interest income from those bonds.
1) US gov debt/ GDP = $30T/ $24T.
2) Robert Morris, US treasurer, finance 1776 war by promising
land in the west, because there was no US dollar, no bonds or greenback, and no gold in the empty US Treasury vault. The French & Spanish gov and their financiers paid the price. The Treaty of Amity and Commerce results : GB was extracted, but not from Canada. The French aristocrats were chopped. Robert Morris was sent to jail. George
3) Lincoln financed the war by promising Indian land in the west and the greenback.
4) A $5,000 loan by James Madison to Charleston SC might have saved
the civil war bloodshed. Charleston built a wall to protect themselves from the British invaders in 1812 and went broke. James Madison had no money
to pay for Charleston defense.
i have an idea. how about if we drastically cut the size of govt spending and raise interest rates.
1) $67T debt : $30T GDP that’s the Roman Empire.
2) $67T x 0.03 = $2T dividends to investors. // $30T x negative 5% = $1.5T JJ profit.
3) Pay retirees $2T SNAP instead of doubling US debt.
4) There are about $20T in banks deposits, because investors are out of
the stocks, creeptos and the temp inflated RE, before all bubbles decay by traders herding together, creating the mother of all panics.
A Federal Reserve that takes from Peter to pay Paul can always count on the support of Paul.
And the Fed is composed of guys named Paul.
Re. Wolf’s recent article that he is “laughing hysterically” at people who think the “Fed is trapped” ……
Well, I guess you’re laughing at Jeremy Grantham ( co-founder of GMO), and William Fleckenstein – as of yesterday.
Both of whom just said – “The Fed is trapped”
I’m laughing hysterically and have trouble using the keyboard for that reason
Wolf,
I’m hoping you can clarify a statement from the BLS about CPI. I was doing some research on the inflation numbers, and came across the following on the BLS website:
“Starting in January 2022, weights for the Consumer Price Index will be calculated based on consumer expenditure data from 2019-2020. The BLS considered interventions, but decided to maintain normal procedures.”
Can you explain this? If the method of calculating CPI suddenly changes,
will this not effectively be moving the goalposts during the game? Admittedly, I don’t know what direction this is likely to shift the numbers, but if this change incidentally resulted in lower inflation numbers, that would certainly be convenient for some parties involved.
Thank you.
This is routine. Every two years, the BLS adjusts the weights.
Each item in the basket of consumers goods and services has a “weight” – its percentage in the overall CPI. For example, “Rent of primary residence” = 7.58% in the overall CPI. All weights combined = 100%.
What the BLS changes every two years reflect the purchasing patterns by consumers. They bought more x but bought less y due to changes in technologies, preferences, etc. And the weights will be adjusted to reflect that, with some going up and some going down. Total weights still = 100%. I’ll cover the new weights when the January CPI comes out.
Thanks Wolf.
Harold,
Covered a few articles back, I believe…
“The higher rates would only show up when securities mature and are replaced by new securities, and as deficit spending is funded with new securities. So higher interest rates would only gradually filter into actual interest expenses for the government.”
I know that and a calculation of that is exactly what I’ve asked for here in the past. So, where’s the (approximate) calculation? Especially, where is the calculation of that from the Fedgov although I’d trust it more if it was independent? VERY RARELY I’ve seen figures with no specifics or mention of variables in articles touching on the subject.
Also, will 1% total hike over a year be enough considering it took Volker 20%, such a long time for that to fix inflation, and China and emerging markets which borrow in dollars weren’t a factor? Admittedly, there is probably far more debt leverage now than then making smaller rate moves more significant, but that also makes the situation far more volatile.
Also, supposedly, nearly one in ten companies in the US are cheap debt dependent zombies. What happens to them and what happens to the “wealth effect” when something triggers a crash of cheap money bloated markets?
Finally, if its so easy, why hasn’t it been done long before now? We’ve been at the “temporary emergency measure” rates since the GFC.
Winston,
People always forget to see the benefits of higher rates. In 2018, we got higher rates, and the economy was cranking along just fine. GDP grew at 2.9% in 2018, the highest since 2005. But asset prices were taking a hit. Low asset prices is the reason for the resistance against higher rates. But the real economy will be better off, as we have seen in 2018.
A federal funds rate of 3% won’t trigger a recession. Rates would have to go far higher to trigger a recession in this inflationary environment. Short-term rates below the rate of inflation are stimulative. CPI inflation = 7%. So you do the math about what rates might trigger a recession.
Zombie companies will be restructured in bankruptcy court at the expense of investors – who got paid to take those risks – and will emerge with less debt and a better business model. Or their parts will be sold off to the highest bidders. This cleans up the economy. Zombie companies are a weight on the economy. Every recession serves this function of clean-up. But it wasn’t allowed to happen over the past two recessions. So now we have the massive debt overhang.
Yes, the wealth effect is a terrible way to stimulate the economy, in part because it doesn’t effectively stimulate the economy, and in part because it creates wealth disparity. So now, under the tightening regime, the wealth of the top 10% will unwind to some extent, and they can afford it, they had it so good for so many years, and it will not be noticed by the real economy.
Agree.
The market “adjusting” to higher rates is not a recession or a depression……
Market Corrections are called corrections for a reason…..they CORRECT.
Spiked prices are not to be defended just because ……
Wealth effect is the other side of economic rent extraction. People at the top got theirs and command a larger premium on anyone else to use their capital and assets. It’s insane to engineer this unless you looking to bring back Feudalism.
Wolf,
Congratulations on a most thought (and comment) provoking article. Your topic selection and writings are excellent; too, the interesting readership commentary.
One can not know with “certainty” what the our fearless leaders will do, when or the consequences. Reminds me [of] a second grade school poem: Into the Valley of Death Rode the 500. Cannons to the left and cannons to the right. Onward they rode……” Best of luck and good fortune to you and all your readers.
A not retiring soon Baby Boomer CPA in WDC. PS: I (baby boomers) did not “cause” any of the current or future problems; which I see oft mentioned. We, too just ride along.
Interesting theory how raising interest rates increases government revenues above interest expenses. Leveraging some giant pot of OPM. Like the theory that debts don’t matter.
Kind of ignores little things like inflation and business losses and failures, and offshore stashes, and foundations under higher rates. Interest received is taxed. Interest paid is a business expense.
Let Max/MIN it. Why not raise rates to 15%? Should be way bullish for everyone.
No need to take it to the absurd.
Take to a balance, a historical balance……pre QE, when Fed Funds were raised to address inflation, and often exceeded inflation. Why different now?
Government debt and spending are increasing a lot faster than tax receipts.
The increase since 2008 is higher than the previous increase.
That’s the difference.
There is only one way out of this mess, lower living standards and I’m not referring to a short recession either.
I don’t believe American society can handle that, voluntarily. There has been too much social decay.
Sure, rates rising 2% or 3% might not make much of a difference, but that’s questionable due to the financialization in the US economy. We don’t know because it’s not physics and therefore predictable in advance.
It’s also virtually a slam dunk that interest rates won’t increase equally or proportionately across all debtors.
The biggest risk is with corporate, as this is where the most excess exists. A 2% increase in FFR could correspond to much higher rates on junk debt or near it, which is most corporate debt now.
All of it won’t reprice immediately but it will make a lot of new borrowing uneconomical and reduce cash flow.
“Government debt and spending are increasing a lot faster…”
allowed, aided and abetted by Fed policy
Putting cost to debt creation should temper debt creation…
call me old fashioned.
Judging from signs I see there is an extreme shortage of labor where I live. Most people that I talk to that are working are being over worked.
Plus people seem to be pretty insensitive to prices for home projects.
It seems like the example in a book I read when you ring fenced a town and gave everyone a large sum of money. It created a temporary boom and higher prices, but everyone in the end was no richer.
only one counter-point. the temporary boom results in some permanent creation of things. i.e. someone builds another house and another wagon. So at the end of the day, there are more goods and the same number of people. So the prices will be higher, but the number of goods per person has increased because of the initial boom.
If Velocity of money can increase (i.e. people do more work), than GDP rises.
Interest rates are climbing and will be increased until we have a calamity in the markets (deflating asset prices). Then course will be reversed (inflating goods prices much more than today).
These are my thoughts. I could be totally wrong.
I would recommed Christopher Leonard, The Lords of Easy Money. I am half way through so far.
Reading also. Much a recap, but many revelations.
Recommended reading.
Markets that are overdone, markets that are where the Fed FORCED people to “take more risk” are not to be defended at the expense of all others. Not addressing inflation is to defend the spiked markets. Overdone is called overdone for a reason, just like corrections are called corrections because they……………………correct.
Fed, get out of the way.
Notice the Fed went from attempting to solve a problem to BEING the problem.
No calamity in sight. Stocks still near all time high. Bitcoin rebounded solidly. Gold still high. Assets still growing.
All this despite rapid rise in rates and yields and more coming.
People said the same in August 1929. “Permanently high plateau ” or some such.
Everyone here definitely should read “Lords of Easy Money”.
P.S. jm and JM are different people.
This is a radical comment and everyone will probably scream, but I think the FED should be forced to pay back all the interest it has stolen from old retired people since 2008. Then maybe next time it’s so inclined it will think about it twice.
Yes, I put some of my money in the stock market, I was facing a bleak future with the banks paying zero on it. I bought large cap stocks which at one time were called Blue Chips. And they paid interest, and I still have them and have no plans to sell. They haven’t gone up that much except for Ford, which has doubled in value but now it too is having problems due to the chip shortage and its EVs are unsalable. Its dividends have been cut from 7% to 2% and I expect its value to decline as well but this is considered normal risk in the markets, and I am in my 80’s and likely won’t survive to see a recovery. So be it. I did not invest in social media stocks or unicorns, which I see as frivolous, but I grew up during WWII when there was real privation affecting the food supply of the general population along with air raid drills when all the lights went out. We lived on what was then the southwest shore of Alameda and were right in harms way.
I am not being malignant when I say I think something should be done about the FED, it has too much power and too easily comes under the sway of ego maniacs like Ben Bernanke.
Never gonna happen.
One can argue that Americans should be forced to give back land to natives and Mexico.
Not to worry about the lands stolen from earlier peoples and especially those families deeded lands by the kings and popes and so on K:
Sooner and later, lands will go back to the folks who are ready, willing, and able to work those lands for the benefit of the land and the various and sundry species, etc.
” Move your meat, you lose your seat.” has many meanings, including with re land, eh
Well the FED has in effect stolen from you. And they have lined the pockets of others. They are a reverse Robin Hood.
The Federal Reserve has created much uncertainty in our economy. They’ve interpreted mandates in reckless fashion, with total disregard for systematic financial risk. We’ve watched their efforts blow up spectacularly twice in recent history, yet they just keep doing the same thing for some unknown reason.
The Fed was way too heavy on the accelerator. The car is doing 80 mph on an icy highway, and it just started fishtailing. We know what happens next.
Look at how the FRB is expanding (or looking to expand) its “mandate”, into areas that have nothing to do with monetary policy and only loosely economically.
It’s hubris at it’s a finest and another version of socialistic central planning. The entire economics profession has been infected with it.
They are too blind or ignorant to recognize that their apparent “policy success” is actually due to an unprecedented mania, not their economic “management”.
Higher interest rate do mean the value of those fix income assets come down significantly. Although it’s not guaranteed as markets are still near all time high and Bitcoin has solidly rebounded despite rapid rise in rates and yields. Who knows as rates rise further there will be another rally.
But There got to be a debt threshold at which US govt will be in trouble. No?
Kunal,
“But There got to be a debt threshold at which US govt will be in trouble. No?”
We can drive this discussion to absurd levels and at some point, at this theoretical level, something is going to blow up.
But realistically, there is a threshold of interest rates above which the economy will get in trouble.
And there is a threshold of inflation above which the economy will get into even more serious trouble.
That’s the tradeoff. Will the Fed allow inflation to tear up the economy or will it raise rates enough to get inflation back down and save the economy.
“And there is a threshold of inflation above which the economy will get into even more serious trouble.”
I am not sure about this. US and EU inflation of 2% is a random number that some academics at Fed threw and it became a mandate. China India, Russia, etc. are doing just fine at 10% inflation. Turkey is doing fine (discount Western media) at 40% inflation. And you are right, the debt threshold can also be absurdly high. Any number can be made to work with Fiat currency and manipulated financial system.
We will go bankrupt slow, then all at once.
If only congress would adjust accordingly like fixed-income savers and reduce spending.
This is nothing new. We could of done this all along! Instead, in the name of saving the financial system, the govt has had an open ended credit card with no interest! Instead, we got massive bubbles, massive wealth transfer, and massive debt. Same song, different verse.
…. massive Stonks bubble, massive inflation, and massive censorship.
> First, the US government issues its own currency and can always pay for anything with the Fed’s newly created money.
Thank you for writing this. I see people saying “they can’t afford the interest payments” all over this site and others. How does that make any sense when you can write yourself any amount you want?
Regarding increased fixed income interest payments, I’ve even seen people say this can be inflationary.
Now put some numbers to what you wrote. If interest rates go up 1%, it cost the government an additional annual amount of $300B on its $30T debt (eventually, as there would be a large time lag before everything was refinanced). And if interest rates increased 1% on the $67T fixed income assets it would yield an additional annual amount of $670B, but even with a tax rate of 20% it would only equal $134B of new tax revenue.
I don’t know how to estimate the additional taxes generated by consumers spending their extra interest income, but I bet you do.
That 670 gets spent over and over and the gov.gets 20%
each time
There are also offsets. To start, it will reduce tax revenues from future unaffordable economic activity which isn’t exactly low, though we don’t know how much
There is a reason the current fake economy requires artificially low interest rates.
In a legitimately prosperous economy with stable money, borrowing costs for sound credits will be low.
The US has a fake economy disproportionately composed of actual deadbeats and zombies, some of whom only look like sound credit risks because of the extended economic fakery, regardless of their credit score or debt rating.
Exhibit 1 is the USG whose actual credit quality is the worst since at least WWII if not the Civil War, regardless that it can “print” unlimited USD to pay its debts. It could always do that, yet its borrowing costs have never been so low, even when inflation, debt and spending were lower or much lower.
@ Wolf –
Seems like if these fixed income assets suddenly get more attractive because they provide a decent yield, there is going to be big demand for dollars to buy them. That makes for a lot of potential turmoil in a big dollar chase. How would you position for that?
People with assets can sell assets and use the proceeds to buy other assets, no problem. They can also borrow and use the proceeds to buy assets (such as margin loans, cash-out refis, etc.). What assets they buy and sell is up to them. If there is a lot of buying pressure on one side for the same asset, then prices rise. If there is a lot of selling pressure, prices fall. Markets are good at managing this.
So if the 10-year yield becomes attractive to retail investors – a yield of maybe 4% or 5% — they might sell stocks to buy Treasuries, and this would increase the selling pressure on stocks and prices would have to drop to entice enough buyers to buy those stocks that folks want to sell. This relationship is pretty well established.
The problem with savers is that, apart from the value they created to have excess savings, they are useless eaters. If only there were a way to devalue their savings and take that excess value creation back from them.
I’ve got it! First I’ll create a central bank…
The useless eaters are the “consumers” who produce little or nothing feeding at the public trough, regardless of their class status.
AF-when the message to the American public since WWII is that their primary mission in life is to consume, and that that consumption has long been massively promoted and glorified, little wonder that belief and honor in general ‘productive work’ has been in a long, society-wide decline…
may we all find a better day.
It would be interesting to estimate the increased tax income vs increased cost of debt.
Of the 67T of fixed income, assume 2/3 are taxable (exclude munis, IRAs etc) = 44T**.
3% income on 44T = 1.32T taxed 22% (average fed tax rate in 2020) = 290B additional fed tax collected.
Lets say it takes the Fed 2 years to raise rates to 3%, our debt by then should be around 35T. Further assume average interest rate on that debt is 2% (mixture of old and new debt) would result in 700B of interest expense on debt.
Based on these ballpark assumptions, increased tax collection would cover about 1/2 of interest expense on debt.
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** only the RMD portion of IRAs would be taxable any year
Thanks for the estimate. Just my gut feeling said it was silly to expect the government to increase tax revenues by raising rates even ignoring the resulting business bankruptcies.
Unless the government increases the tax rate to 100% – for the children of course.
I think Wolf’s point that Federal tax revenue will increase if investors move to interest income.
It depends on investment income types.
If an investor in the last few years moved to stocks long term gain income or dividend income, the tax rate is:
15% for $83,351 to $517,200 in income for married filing jointly.
For interest income (and RMDs) the income is taxed at the much higher level earned income level.
22% – for $81,051 to $172,750 in income for married filing jointly
24% – for $172,751 to $329,850 in income for married filing jointly
32% – for $329,851 to $418,850 in income for married filing jointly
This is income dependent but tax revenue generated from increased interest rates could bring in 17% more in income tax than LT Capital Gains or Dividends.
I’m sure this will affect investment decisions. If I am in a higher tax bracket the Federal Government is collecting up to 17% more in revenue.
1) On Nov 4 2019 US 10Y was 1.94. On Nov 5 2018 when JP was defeated US10Y reached 3.24%. Higher rates were the caused Dec 2018
Xmas massacre.
2) The current US 10Y is : 1.94%%. There are $20T cash in the banks, but
the banks don’t lend, because they can’t make money when interest rates are too low.
3) The economy is strong, but banks are not lending. Small businesses are hurting. IWM hit the bottom of the weekly cloud. IWO breached it, got support from the weekly ma200.
4) If in late Feb/ Mar 2022 QQQ rise to a lower high < Nov 22 high and within few weeks breached Jan 24 low and keep diving on the way to Mar lows : for speculators it will be an opportunity to buy, but for JP a warning signs that the temp inflation might flip to deflation.
6) For entertainment only.
Massacre or correction?
The NY Fed updates their market dashboard every Thursday and under SOMA (Summary of Open Market Account) Holdings you will see the Fed usually (some weeks they drain a few billion $’s out) has been increasing all their holdings. The balance sheet continues it’s upward trajectory.
Yes, QE is being “tapered” — meaning the amount of QE is being reduced, and the purchases are getting smaller but the purchases are still taking place, on a smaller scale. And you can see that just fine. QE ends in March.
If the Fed is tapping on the brakes their using a feather duster.
As I said, they’re not tapping on the brakes yet. They still have their foot on the accelerator but have backed off some. They’re going to lift the foot off the accelerator in early March, and on March 16 they’ll step on the brake — yes lightly, too little too late, trying to mitigate what shouldn’t have been done in the first place.
Meanwhile, inflation rages out of control. So much talk about rate hikes, yet no rate hikes.
DC
if we get a “hot” inflation number Thursday, and the Fed doesnt IMMEDIATELY bump rates 1/2pt, then it will be clear exactly who they are defending and who will continue to get raped. IMO.
Filled up my Propane tank the other day and the dude screwed me. When I put the tank on my Webber Grill it only registered 2/3 full. INFLATION!
Anybody know why BitCON has exploded by over $10,000, erasing all of the recent losses and then some?
Did not you read NYT article yesterday:
“Why Is Matt Damon Shilling for Crypto?
Just buy it, he seems to suggest; what are you, a wimp?”
Matt Damon’s ad is absolutely brutal,along the lines of WWII b&w propaganda movie “Why We Fight”
No more cute kittens,expensive cars, or IT pixies watching their computer screens.
Wright Brothers flight,Moon Landing,climbing Mount Everest…
So,if you are not a wimp and want to join that League of Heroes – PROVE IT ! BUY THE F… CRYPTO !!!
From “Saving Private Ryan” to shilling for Crypto. Matt Damon has let himself descend into the pits.
But it is working,is not it ?
Proverbial bell rung and Pavlovian dogs started salivating (and buying cryptos !)
Whatever Matt Damon was paid ROI is strongly positive.
Brent-can’t seem to acquire a heroic/admired self/public image??? Then buy one! It’s an old ‘Murican tradition (with fewer relative scars and blood loss…).
may we all find a better day.
Is it really any wonder why people are straight up gambling in BitCON when they just got a 34% return in 2 weeks, while my savings account is paying .28% per year? Jerome I Talk From My Bowel is a fraudster and criminal.
gambling mania
My BKKT swing-trade is up 33% on the day (but still underwater), presumably because bitcoin had a 10% weekend rebound. BKKT is a Bitcoin exchange with hardly any users or revenue. You gotta out-stupid the market to make money in this environment. Or at least that’s what I’m telling myself …
Don’t you need willing borrowers to pay interest on loans, to pay interest on deposits?
That works in a hot economy suffering from growth inflation.
What about a supply inhibited inflation economy?
Will the government just print money to give out as yield on bonds?
Either print it and helicopter then tax the spending.
Print it for return on bonds to then tax the spending.
Print it to buy bonds off themselves.
It’s so easy I don’t understand why they didn’t do this earlier.
How about they roll off the treasuries from the balance sheet and quit QE?
Maybe there is a free market price?
Anyone know how to short Euro country bonds. They cannot stay an NIRP forever.
Any inverse ETFs?
Zillow said they made a mistake and late last year said house prices would go up 11%. They revised the number to 16$.
To a 16% increase in 2022
Their “owned” house didn’t do that well…..LOL!
I hope it’s $16 and not 16%. My property taxes have been on a vertical rampage the last X years and I know I’m not the only one!
“First, the US government issues its own currency and can always pay for anything with the Fed’s newly created money/” That’s stating the obvious and sounds very MMTish in doing so.
No, in the long run, the US, as the world’s largest debtor nation, can’t afford ever increasing debt in the form of bonds / fixed income assets. We all know this.
I think you’re attempting to oversimplify things without taking into full account ALL possible “secondary effects”. Those secondary affects (positive & negative) matter, as we all know.
First and foremost, we can’t continue issuing more and more debt because the dollar will continue to devalue as you mention, but once it reaches a certain point, it will stop being the world’s reserve currency. And that would spell big trouble for us. But along that timeline, a lot of very bad things are going to happen to our economy, so it’s not like it will sneak up on us.
Next, it matters in that it reenforces Congress’ unwillingness to have their come to Jesus moment, specifically as it relates to reining in spiraling out of control social programs costs.
Then, the current MMT’ish stance of the FED means they sanction enormous QE again and again. This means the FED will entrench higher than 2% inflation into the system, possibly much higher the next 10-20 years.
And we all know the increased tax revenue won’t be used to pay down the debt or slow the growth of social spending programs. And as our tax code becomes more complex and the rich are taxed more and more or find other places to put their money, then all that extra revenue will dwindle down to nothing and certainly won’t truly slow down the growth of our annual deficits.
Again, there will come a time that the faith in the dollar will begin to collapse, causing the US fixed assets market to completely implode.
These are just a few examples, so it’s disingenuous to simplify it down to “we issue our own currency” so everything will be hunky dory. This is Uncle Sam we’re talking about here. Nothing is ever simple or to be trusted.
Jay said: “it will stop being the world’s reserve currency. And that would spell big trouble for us.”
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Why would the dollar losing its status as the world’s reserve currency be bad for us (the USA)?
“… First, the US government issues its own currency and can always pay for anything with the Fed’s newly created money. The Federal Reserve Board of Governors, of which Powell is Chair Pro Tempore, is an agency of the US government. So the US won’t ever run out of money, but the dollar might run out of purchasing power – the trade-off that is now particularly ugly.”
Specifically noteworthy is that the Fed rebates most of the interest it receives on its Treasury holdings back to Treasury. So all the Fed would need to do is buy up a larger portion of the outstanding Treasury debt and that portion becomes very cheap, even at higher rates.
Not that there wouldn’t be economic side effects, but the medicine would be there if it were needed.
Yes, neither the government nor the Fed can go bankrupt.
But the price is rampant inflation (plunge in purchasing power). People who worry about the government going bankrupt worry about the wrong thing.
The thing to worry about with too much deficit spending and too much money-printing is inflation.
Amen!
I read the other day that Stephanie Kelton has finally admitted that there’s no real answer to inflation in the MMT playbook. We all know that they’ve proposed a pseudo answer as increased taxation. However, we all ALSO know that in real life raising taxes is a political death knell.
There is an answer to inflation. It is called ….. more inflation. This has been clearly demonstrated for decades.
But the ECB can go bankrupt – a slight wrinkle, when you’ve just bought some trillions in negative yielding peripheral bonds.
The ECB cannot go bankrupt either but it can decide to let its member states default, which it did with Greece.
Should the bonds on the Feds balance sheet lose value, and those bonds were acquired on consignment, yeah the Fed deserves a big margin call. If the Fed were truly independent that would be the case. The private banks would have to pony up for their public dalliance and there is a move afoot to have banks monetize government spending (QE). The Fed never owes more than it has on hand since the funds are borrowed anyway. What happens after the Fed goes bankrupt is the question you are answering, not why is the Fed allowed to continue to operate while holding deferred assets.
clear as mud …………….
The FED doesn’t ever have to go bankrupt …….
(they can render themselves irrelevant)
Why would the money printing FED need to borrow funds?
With the right to create money, is there any limit to the amount funds the FED has “on hand”
We have had continuous inflation for years. A retired millionaire could have trouble trying to live middle class without the insecurity of eating his seed corn. I would say it qualifies as rampant.
Exactly. I think of inflation as the sovereign mode of default … when you lend to the government, you get your money back, but it’s not worth as much.
Wolf …
Much discussion on the book “Lords of Easy Money”.
Have you read it, and if you have, your comments would be interesting I suspect.
I have found something on which I would like your comments
page 116
“These hedge funds could borrow money from a big bank, buy a Treasury bill, and then have a primary dealer sell that Treasury bill to the Fed for new cash. In this way, the hedge funds could borrow and buy billions of dollars of bonds, and sell them to the Fed for a profit.”
Did the dealers truly do this for the hedge funds? I understood the dealers did this for themselves (a lock) but did hedge funds have the same game going?
?
Too busy to comment on books. I just ignore this stuff.
Would love to know the real answer to that question. I have suspected that could be the case.
Wolf
Informative as usual, thank you for your blog posts!!
So at this point do you agree with one of MMT core tenets that higher interest rates (up to a point) actually cause inflation to rise via the interest income channel and because the cost of credits is reflected in the cost of all goods and services??
Thank You!!
No, I don’t agree. Not at all. In part because asset prices will head down when interest rates rise, and that will take some of the crazy price-doesn’t-matter exuberance out of the psychology. My first paragraph outlines this.
The future buyers of those fixed income assets get the higher interest rates. The current holders get lower prices, or face value at maturity and low yields until then. Stocks prices and RE are also negatively impacted.
Inflation is a complex phenomenon, and what can cause it is not well understood in economics. There are all kinds of factors that feed into it. Modern economies are marked by a status of gluts — you have too many goods and services, and you need to advertise to sell them. And yet, even in this environment, inflation can thrive.
Well, if not belatedly, we’ve all figured out that $10T in fake money + new debt makes inflation. Thank goodness we finally figured that one out. It’s not like you’ve got to be an Einstein of economics to figure that one out.
@ Wolf – “Inflation is a complex phenomenon, and what can cause it is not well understood in economics.”
———————————
creating large sums of money and encouraging easy credit seems an easy guess
“Inflation is always and everywhere a monetary phenomenon.”
1. A lot of the interest generated from corporate and government debt is owned by foreign investors. The withholding tax on interest paid to these investors can be as little as zero, depending on international tax treaties.
2. US based pension and other retirement accounts don’t pay income tax. Their beneficiaries may not collect their retirement benefits for decades. Only then, will the US government collect its deferred tax revenue.
3. Even US bond interest paid currently to wealthy individuals is not taxed at a 100% tax rate.
Folks are so scared of higher rates…….
what they should be scared of is a lack of capital formation……leaving the government to be the source of capital…….using all of their top notch non political manner of picking who to fund…..that was sarcasm for those that don’t know me.
What level would be high?
Assuming a CEO thinks that the ongoing inflation rate will be near 5% for the next five years…….and his/her ability to deduct interest costs……..the CEO should be willing to borrow at 6% of lower with a back up the truck attitude. Even paying 7, 8, 9….assuming the CEO will earn a small rate of return on the borrowed funds would be a no brainer. Earning a good return like Apple…..the rate don’t matter. Considering the huge fiscal stimulus just passed in the infrastructure bill….heck even that much will do just a little damage.
So….until 5 year rates exceed a minimum of 10%……its stimulating!
This fed has shown no interest in even going near 5%.
So, just remember that the crooks are being paid and promised great after government jobs in order to continue stripping the middle class. If rates increase it will just be window dressing to give the political class cover during the election. Mom and Pop will earn 5%….pay their taxes on it….and end up losing funds after inflation and taxes…..but think they are doing well so the vote will be a happy one.
Which is why gold has not declined…..the makers of that market know that even high rates are stimulative
“The debt is now too large, we can’t raise rates”….is the argument of some.
This reminds me of the college student who willfully enters into a college loan then shirks the responsibility of their actions….seeking forgiveness.
THIS is why massive debt creation, intentionally FORCING people to yield chase and take on more risk, doesnt end well.
To continue with fake rates below inflation will be to enlarge the problem…and destroy working Americans.
These are reasons WHY the Fed has gone way too far and is way too late.
And for grunts and grins, why is the IRS taking so long to release the Social Security Worksheet, that has hardly changed and is used by millions of people!
If assets become cheaper, the capital gains on their transactions will be lower. The government will make more from higher interests, but will make less from lower capital gains. How can we know which effect will prevail?
– One should also look at the combination of the US Trade Deficit and US Budget Deficit. That tells how much foreign demand there is for e.g. US T-bonds.
– When the Trade Deficit shirnks (foreign) demand for US T-bonds will shrink.
Wouldn’t continued asset price inflation at the same clip we have seen over the last 18 months have a much more meaningful impact to potential future US federal tax revenue than a 2% interest rate increase would have on fixed income debt instruments?
That wasn’t the question. The question was whether or not the government can afford higher interest rates. And the answer is yes.
BTW, most big investors pay little or no capital gains taxes. There are lots of strategies for that. That is one of the biggest fairness issues this country has. Small investors pay taxes on some of their capital gains, but not on their homes and not on their tax-deferred accounts, etc., where most small investors have most of their investments.
The question is how much is going to be lost as the capital gains tax, if the stock market corrects in response to the interest rate rises. Same goes for property taxes as property markets are likely to correct as well. Corporate incomes may also be hit by higher interest rates.
Th economics are pretty simple. The GDP is based on aggregate demand and since 2008 meltdown there has been more or less 10% gap that was plugged in by Fed money-printing. If Fed stops buying the government debt the GDP would fall because there is no one there to plug in the aggregate demand gap. If the GDP falls, the tax revenues would fall too.
This is one of several reasons why ZIRP/QE, while inflationary in theory, proved deflationary in practice. The Keynesian dogmatists at the Fed will never accept or understand that, which is why they will be aghast when QT results not in lower CPI, but higher. Their pavlovian response will naturally be to double down on ‘deflationary’ QT, until they are chasing their tail just as inanely as before but in the opposite direction. The effect on asset prices will then be wondrous to behold.