Econ help - can the Fed never raise rates?

[chakalaka]

It´s a dead end. Either they rise and a recession happens. Or they keep it low and more debt is accumulated leading to a bigger recession when they rise the rates. The only possible exit is if economy picks up. Or maybe inflation.

 

[JayJuanGee]

If Trump were to "restructure" the debt, it would be the only "solution" ... and of course it would carry a cost.

Otherwise, obviously they can't raise them.

What I want to know is the nature of the black swan, even though we have no idea when precisely it's coming ...

Also, being that getting cash out of the bank will be increasingly difficult, if you aren't getting a return anyway, why not store a good amount (in a safe of course)?

Mattress time, boys (-:

Trump really scares me, almost to death, and I think that he scares a lot of folks of a lot of political persuasions... Hilary is also scary, but in a different way..

Anyhow, regarding Trump, this building a wall idea is so fucking stupid for both it's symbolism and its economics and its lack of practicality, and it has just been incorporated into the Republican platform, and wow, if expenditure of such a wall was embarked upon, it certainly would be a short term economic stimulus... and even the employment of other silly tactics could be economic stimulus and even shake ups of the economy to restructure the whole way that we think about government and debt (if it does not kill us, it may actually cause stimulus... hahahahaha)...

By the way, such a wall, if built, is also a sign of trapping Americans "in" in a variety of ways.. rather than keeping immigrants out, but that is a whole other story.... My feeling is what a fucking mess to be trapped in America.. even though I have lived here (apparently in a kind of comfort) for more than 90% of my total life.

 

[thoughtgypsy]

So my question is, can the fed just never raise rates?

In theory, no. In practice, yes.

Interest rates are being kept at zero to allow the Federal government to spend money into oblivion. Secondly, it allows financial companies (who control the government through campaign finance) to take massive profits when they sell off or rent out their massively overvalued assets.

The Fed is stuck, and will keep interest rates at 0% until we're faced with a currency crisis. Which might be sooner than later.

If the fed never raises rates, and investors continue pumping cash into in the stock market due to lack of other options, could the stock market continue to grow to infinity? Why not? Maybe now is the best time ever to invest?

No, there's actually been an outflow of money from stocks recently on the part of retail and hedge fund investors. At a certain P/E level and when balance sheet internals point to a company being massively overvalued, no sane investor would ever put money in a stock.

It looks like the only people buying stocks anymore are companies doing buy backs (which allows them to give themselves higher bonuses), and central banks (particularly the ECB). They know we're fucked, they're just trying to make out like a bandit before the house of cards fall.

We're in the "bust out" phase of the global economy.

Why is the yield on bonds so low?

Central bank interference.

It seems to me that we are not likely to see any rate hikes, ever. The politicians and the fed know that raising rates will destroy the economy, so theyll keep them low forever, until there is just less money to pump into the stock market, because its all already in there. At this point we will see a massive deflation, the dollar will get stronger, gold will FALL and be a BAD investment, companies will be unable to service their debt (because deflation means interest rate payments become more expensive) and the economy will come to a complete standstill in 20-30 years. At this point, the money will come out of the stock market, there will be a huge crash, and we will finally have a buying opportunity.

What is unsustainable must end. It's a law of the universe, no matter how much the political and financial class wishes to deny it. We won't see rate hikes until there is no choice, and believe me, that day will come.

Raising rates would improve the economy long term, at the cost of an initial pain period. It will help shake out bad loans, resolve massively inflated asset prices, and allow people to start save and invest productively. But the ones who will have to eat their losses will be the major financial companies and governments, which is why they're trying to delay it as much as possible.

Deflation or Inflation is harder to call. As more non performing loans end up in default, credit will contract, causing deflation. As we move closer to full blown currency crisis, people will try spending their worthless dollars on hard assets, which will lead to inflation. However, wages have decreased in the last 10 years, and most people have no savings to their name, so they likely won't have any money to even buy hard assets.

Gold isn't an investment. It's a store of value that's finite, difficult to mine, and difficult to debase without detection.

The economy will come to a complete standstill much sooner than 20-30 years from now, in my opinion. The financial crisis of 2008 occurred due to a bubble in housing. The next crisis will involve a bubble in nearly everything, and lead to the destruction of the entire world financial system.

 

[RichieP]

I dont necessarily see it as a bad thing that passive investing (dumping money in stocks/bonds) has a much lower ROI and may stay that way.

Maybe it will spur more active investing (VC funding, etc) which is much more often tied to overall wealth creation, innovation and improvements in standards of living.

It does suck that pension funds and etc are getting hit. People have been mis-sold that stuff - everyone expected certain returns and now they're realising that isn't (and never was) the deal.

But fundamentally there's always growth, progress and wealth creation on earth - and thus potential for people to get a return. It just may not be in the traditional capital markets.

What does matter is stability of the financial system, investor confidence, checks on hyper inflation/deflation, etc. Central banks and governments will have to look at more innovative methods to ensure stability. They are actually doing that, but perhaps not fast enough.

 

[Different T]

Interest rates are being kept at zero to allow the Federal government to spend money into oblivion. Secondly, it allows financial companies (who control the government through campaign finance) to take massive profits when they sell off or rent out their massively overvalued assets.

Why do you think the federal government, which already has trillions of debt and operates under its own sovereign fiat currency, is so concerned with the cost of borrowing?

Have you looked at operating performance of the financials? How sure are you they are taking "massive profits" in this environment?

Raising rates would improve the economy long term, at the cost of an initial pain period.

What are you basing this on? Are you aware that the 10 year yield low took place after QE ended and after the Fed raised their target rate?

Initially, those like you said QE and ZIRP would cause massive inflation. Now, after years of being wrong, they are settling for raising rates will improve the economy?

 

[Hell_Is_Like_Newark]

Also, being that getting cash out of the bank will be increasingly difficult, if you aren't getting a return anyway, why not store a good amount (in a safe of course)?

Mattress time, boys (-:

This is what has been happening in Japan. The government is deep in debt but the Japanese people themselves are very lightly leveraged. A lot of yen isn't being deposited in banks. It is going into safes and mattresses. Or it is being used to buy gold.

 

[Kid Twist]

What is unsustainable must end. It's a law of the universe, no matter how much the political and financial class wishes to deny it. We won't see rate hikes until there is no choice, and believe me, that day will come.

...

The economy will come to a complete standstill much sooner than 20-30 years from now, in my opinion. The financial crisis of 2008 occurred due to a bubble in housing. The next crisis will involve a bubble in nearly everything, and lead to the destruction of the entire world financial system.

When will there be "no choice"? Pensions and insurance markets are already suffering insolvency ... when do these finally, ultimately (final blow and destruction) fall is the actual question.

What's your over/under on the next huge bubble? 10 years? 15?

 

[N°6]

The Fed is just an enabler. The problem is that our federal government is borrowing about $0.40 for every dollar it spends.

From whom?

 

[thoughtgypsy]

When will there be "no choice"? Pensions and insurance markets are already suffering insolvency ... when do these finally, ultimately (final blow and destruction) fall is the actual question.

What's your over/under on the next huge bubble? 10 years? 15?

Difficult to tell.

Japan was able to keep their interest rates extremely low and pump their economy with QE for decades. However, Japan is a homogeneous society with high social cohesion, it's hard to say if the same thing could be done here for that long.

As our debt levels become exponentially worse, as they continue to do so, less countries and investors will want to purchase US debt bonds. The Fed will be forced to soak up all of the bonds on the market to prevent the interest rate from rising.

Eventually there will come to a point where the Fed monetizes the vast majority of marketable debt to suppress interest rates. All good in theory, but eventually, it will cause major trade and economic issues.

As foreign governments note that US bonds are increasingly worthless (through central bank monetization), and the debt picture in the US is increasingly bleak, they'll no longer accept US debt bonds for international trade.

Therefore, imports will become extremely expensive, where they're available at all. The country will be forced to produce everything internally, sell off assets at fire sale prices, and we'll experience hyperinflation or a currency crisis or both.

Following the failure of the currency, banks will be closed, government spending will be forced to cut drastically, debts will be defaulted on, and a new currency will be created or swapped with the old currency at a huge face value loss for the old currency.

When debt markets reopen, interest rates will be much higher to account for the added risk of lending to a country which has recently defaulted. Recall that after Nixon defaulted on the gold standard, interest rates and inflation nearly crept into the double digits.

The question of when this all goes down is beyond our ability to precisely forecast, in my opinion. I think the reality of this is best reflected in the old quote: "The market can stay irrational longer than you can stay solvent."

 

[Hell_Is_Like_Newark]

The Fed is just an enabler. The problem is that our federal government is borrowing about $0.40 for every dollar it spends.

From whom?

The Federal Accounts is intra-governmental debt. A big chunk of that is IOUs the Federal Government owes Social Security. The extra money that SS collected during the Reagan Years to about 2010 (when SS went cash flow negative) was spent in general funds.

 

[Days of Broken Arrows]

No one's mentioned it yet, but the Federal Reserve did raise interest rates this past December, on Dec. 16, 2015.

There were a lot of articles on this, but here is info from CNN Money: "The Federal Reserve raised its key interest rate on Wednesday from a range of 0% to 0.25% to a range of 0.25% to 0.5%.

"The rate hike is a small one, but it will affect millions of Americans, including investors, home buyers and savers. Savers should eventually see a little more interest on their deposits at the bank, but big banks didn't make any increases Wednesday. Mortgage rates will gradually rise."

This might be a reason the market went into a freefall in the early part of 2016 -- although some people claim there were other factors as well. But if the reaction in Jan.-Feb. 2016 is any indication of what's going to happen after the next rate hike, it would be a good idea to prepare and sell off some stocks very soon.

 

[Kalkin]

So, is it possible that the fed will never raise rates?

Just a clarification here: the Fed does not have total, or direct, control over any and all interest rates. It can influence them--quite a bit. But it is not completely omnipotent.

The Federal Reserve directly controls two interest rates: the Federal Funds Rate and the Discount Rate. Explaining what those are would take another post...

If bondholders start selling bonds, then interest rates rise regardless of the Federal Reserve. The Fed could counter this process by buying them up--a process called "monetization", but not without significant consequences (inflation).

If so, will this eventually lead to deflation or inflation?

It can go either way, depending on what the Federal Reserve does. If it monetizes too much debt, then that is inflationary.

That is a common pattern in third world countries, but it is less common in bigger, more "advanced" economies. That's because hyperinflation sucks way more than "deflation": prices have a lower bound. THEY HAVE NO UPPER BOUND. The more common pattern in the USA, Europe, and Japan is this:

When the amount of debt in an economy is growing dangerously large, as it is at the moment, eventually there comes a time when economic growth is too small to earn enough profit to service all the debt.

When that happens, more and more individuals, companies, and governments (in the USA, that would be mostly state and municipal debt--but outside USA it's whole countries) start defaulting on their debt payments.

Those of you who know something about radioactive decay: one atom splits, and knocks nuclear debris into the nuclei of other atoms, that split and repeat the process. If you hit the right threshold, it goes critical and starts an avalanching chain reaction.

If a company goes insolvent, then it's not paying off its creditors. If A can't pay B, then B can't pay C, then C can't pay D, and so on. The cascading defaults eventually go critical, so that they spread from one company to another to another to another. And some of those companies are banks and other financial institutions.

So, usually, "deflation" comes first.

The process can continue cleanly, with huge numbers of defaults happening rapidly, but that's not usually what happens either. Usually central banks organize bailouts, etc. Those are technically inflationary, but usually not on a big enough scale to overcome the avalanche of defaults.

Eventually, quickly or over a painfully long period of time (Japan, courtesy "Abenomics"), the bad debt gets written off, and resolved through bankruptcy, etc. The so-called "deflationary spiral" has an absolute lower bound. It can't go on forever, though government and central bank interference can keep it going indefinitely, unfortunately.

But what do you suppose happens as the debt runs out, but governments are running extremely inflationary policies?

The central banks can try to slow down the inflationary processes before they run out of debt, but it's a little like trying to change the course of a gigantic ship. There's a lot of momentum.

The result, when the debt to be resolved has been worked out of the system, is something called the "crackup boom". Severe inflation that could turn hyperinflationary if it gets out of control.

One more thing: most people tend to think of "inflation" as rising prices. But it's better to think of it in terms of rising amounts of money circulating in the system, along with rising "velocity" (the money is changing hands faster....think about it, if money is becoming worthless, nobody wants to be sitting on the "hot potato"!) Accelerating monetary velocity has the same effect as rising amounts of money in the system, and it produces a "feedback loop" (the expectation of inflation turns self-fulfilling, as monetary velocity starts accelerating), which is one of the causes of "runaway inflation" that can turn into "hyperinflation".

Now then, if people think of "inflation" as rising prices, they might also be tempted to think of "deflation" as falling prices. THAT IS NOT THE CASE.

Whether prices rise or fall during "deflations" depends on

• whether the item to be bought and sold is typically bought using debt or cash
• how illiquid the asset becomes

During recessions, people still want to eat. The cost of living can and often does continue RISING, not falling!

What tends to fall in price are "investment assets" and "use assets" (houses...pleasure boats...vacation homes...etc). How fast and how much depends on various factors that would take a while to explain. Just assume that the stock market and bond markets can crash rather suddenly, which is why I suggested someone who wanted to know how to get into the stock market to learn about business cycles (and credit cycles) first.

Similarly, during inflations, not all prices rise equally fast! This is important to understand:

• Companies can go bankrupt even as they report rising profits every quarter! It's weird but true. What happens is they don't discount their profits to account for inflation, so they book phantom profits and one day go insolvent as they are unable to keep up with rising costs of inventory replacement! You can simulate how it works with a piece of scratch paper, or on a computer program or spreadsheet.
• They not only can, they do. Company bankruptcies actually ACCELERATE during steep inflation.
• You can also lose money or even go broke with phantom profits in use assets or investment assets. The stock price goes up...but not as fast as prices in general! You're actually LOSING purchasing power, but being taxed on a bogus capital gain. This is called a "stealth bear market".

In a "deflation", the trick is not to lose money. In an inflation, the trick is to lose as little purchasing power as possible, though effectively it is practically impossible not to lose some due to being taxed on bogus capital gains, not to mention, losing purchasing power on all the cash you need to keep in reserve to stay solvent. That's why inflation really sucks.

Does this explanation make sense to you? Is it clear enough?

 

[Kalkin]

By the way, I can't over-emphasize how important it is to understand these processes to protect your own prosperity. Feel free to ask for clarifications. I suggest at some point discussing the counter-strategy. Good luck to all.

 

[Kalkin]

This is John Exter's liquidity pyramid. The higher an asset is on the pyramid, the less liquid it is during a liquidity crisis ("deflation").

The Exter Inverted Pyramid - A Refresher

Notice that treasury bills are low in the pyramid. That's how the interest rate on German Bunds went negative. :wink: I do not suggest buying bonds that pay negative interest! (ie, you have to pay more money for the bond than its face value!!).

Here in the USA you can park money in an FDIC-insured account, and you can put money into certificates of deposit that pay negligible interest, but at least won't go negative. Make sure all accounts are "insured" (that's a misnomer, since bank failures are not technically an "insurable event"...that's a topic for another time...).

It would be wise to check your bank's credit rating on a regular basis:

Veribanc

There are bank-rating agencies in Europe too and I strongly suggest looking for a credible one.

Physical gold (no "paper gold" please--it's over-allocated) remains highly liquid because it has zero counter-party risk. If you have a gold coin in your safe when the stock market and the bond markets all crash, and your bank goes insolvent--it's still there. :wink: It's also rather useful as an inflation hedge when that hits. However, it's not fungible, so maintain plenty of cash reserves. Now I'm starting the strategy discussion myself!

Not investment advice. You are responsible for your own financial decisions. Educate yourself first. Good luck and great prosperity to all.

 

[Different T]

That is a common pattern in third world countries, but it is less common in bigger, more "advanced" economies.

Instead of this crude delineation, can you point to a hyperinflationary crisis that took place in a country whose debts were denominated in their own sovereign currency (no peg and/or bond sales in a foreign currency) or whose trade deficit was financed with their own sovereign currency?

The Fed could counter this process by buying them up--a process called "monetization", but not without significant consequences (inflation).

What happens when the Fed buys a USG bond from a bank or financial institution? What happens on the bank's balance sheet?

What happens is they don't discount their profits to account for inflation, so they book phantom profits and one day go insolvent as they are unable to keep up with rising costs of inventory replacement! You can simulate how it works with a piece of scratch paper, or on a computer program or spreadsheet.

Who told you this (or did you think it up yourself)? Bankruptcy is determined by the value of liabilities exceeding the value of assets (equity < 0). What does this have to do with inventory replacement? Are you familiar with the terms LIFO, FIFO, average cost? What the fuck is this.

 

[Kalkin]

Instead of this crude delineation, can you point to a hyperinflationary crisis that took place in a country whose debts were denominated in their own sovereign currency (no peg and/or bond sales in a foreign currency) or whose trade deficit was financed with their own sovereign currency?

I can, but I'm not sure what the point would be, since having debt and deficits denominated in own sovereign currency is in modern times the privilege of a country whose currency has "reserve currency" status, or in other words it's an "advanced economy" versus a "developing"/3rd world economy.

Reserve currency status allows the beneficiary to "export inflation". But it doesn't confer absolute immunity to inflation. The point of referring to more advanced versus less advanced economies is to make it easier for a reader to decide what is most likely to happen in his own country; I'm not trying to make any point about cause and effect. I'm trying to help someone make plans.

What happens when the Fed buys a USG bond from a bank or financial institution? What happens on the bank's balance sheet?

I do not know what you are getting at.

Who told you this (or did you think it up yourself)? Bankruptcy is determined by the value of liabilities exceeding the value of assets (equity < 0). What does this have to do with inventory replacement? Are you familiar with the terms LIFO, FIFO, average cost? What the fuck is this.

Your strong language makes it sound like you're getting a little over-excited about this. If you run a simulation, you can create a scenario where a company books nominal profits but can not keep up with the inflating price of replacement inventory. I'm not saying this happens to every company, or that this is the usual way of going insolvent, or whatever it is that you're interpreting what I am claiming.

Many people do not seem to realize that rising prices don't necessarily translate into profits. That's my only point. I am trying to help someone else create more realistic mental models of inflation and deflation.

I'm glad that you know so much about finance. I hope it serves you well during the coming hard times.

 

[Kid Twist]

^ "When the amount of debt in an economy is growing dangerously large, as it is at the moment, eventually there comes a time when economic growth is too small to earn enough profit to service all the debt. "

Critical.

Great analysis, but I didn't think you treated the topic of "deflation" enough.

What assets are better than gold due to their intrinsic value, and the fact that you can't easily break down gold as a trade means ... (?)

 

[Kalkin]

I appreciate the feedback, Kid Twist.

Great analysis, but I didn't think you treated the topic of "deflation" enough.

I assume that you're interested in what to do about it, rather than the actual breakdown mechanisms. If I am wrong, set me straight.

What assets are better than gold due to their intrinsic value, and the fact that you can't easily break down gold as a trade means ... (?)

As a longstanding traditional token of value, and form of money, not much is better than gold!

But I think you are complaining that gold is not fungible, which is correct. In fact, the recommended strategy is to hold it all the way to the next rebuilding cycle. It's not for trading during a crisis; it's for having any money at all when most people are broke.

Ready cash is the king's command during a default crisis. If you look at John Exter's liquidity pyramid, people owning the assets at the top of the inverted pyramid are trying to get out. They can only get out to the extent that someone has cash and is willing to part with it, even if they are trying to trade down the pyramid for something other than cash they still need some cash to complete the transaction (you don't trade CDOs for pork bellies or something like that...).

The problem as you are aware is that most "currency" doesn't exist in physical form. Your bank account does not consist of a pile of money in a vault; it's nothing but numbers on a ledger. When an individual, company, municipality, or any other debtor defaults on a loan, those numbers start disappearing!!

That's where your comment about "matress time, boys" comes in.

The ideal strategy depends on personal circumstances, but it's probably a mix of assets low on the inverted liquidity pyramid. For many people, some ready cash at home in a firesafe is probably a prudent precaution. Most people can't deal totally in cash (and here in the States at least it's being actively discouraged), but they should at least do due diligence to monitor their bank's credit worthiness, through a bank credit report.

Bill Holter recently commented that he heard that several Italian banks are close enough to the brink that they are likely to be the ones to start the dominoes in Europe. There are some dozen or so really big banks on the brink. Sooner or later, Deutsche Bank, the largest bank in Europe, at 5 times the size of Lehman Brothers, will blow.

If it's any consolation, the world's central banks are aware of the seriousness of the situation and will try to keep the banking system solvent. If the banking system goes down, you'd better have a cache of food and water stored up and that is not a joke. The bread trucks stop delivering when the drivers and their bosses aren't getting paid. The bad news is that we don't necessarily know exactly what the central banks are doing because they don't necessarily tell us. And, we can tell that it doesn't look like it's working long term. The system keeps looking as though it's getting more fragile, not less.

Thankfully, most average people don't have much exposure to the stock market or bond markets anymore, but many people do have some exposure via retirement accounts, sometimes not even realizing it. Some people also have money in money-market accounts, not realizing that they're full of unsecured corporate paper and municipal debt, and also not realizing they're not "insured" by FDIC even if sponsored by a bank.

I have an eBook that goes over some of these issues, within a bigger context that mentions other things going wrong at the same time, and lists some basic preparedness strategies. I'll let it be known when it is available. It will be FREE.

 

[Different T]

I do not know what you are getting at.

You do not know the answer to the question. That's the point. And it's a very basic accounting question. Yet you're on here talking and talking.

If you run a simulation, you can create a scenario where a company books nominal profits but can not keep up with the inflating price of replacement inventory. I'm not saying this happens to every company, or that this is the usual way of going insolvent, or whatever it is that you're interpreting what I am claiming.

No you cannot. Insolvency is when equity is < 0. Inventory is an asset, cost of goods sold are reported on the P/L, and what you say is wrong; yet you continue to talk and talk.

 

[Kid Twist]

Kalkin, isn't there a worry as well about the value of the currency, though it is close to the gold at the bottom of the pyramid?

Is your prediction that currency doesn't lose as much value as you might think when the shit hits the fan with securities, the LARGER danger is that they literally shut down the banks and start switching numbers around (or bail you IN), and in that case you'd much rather have stacks of hundreds in your safe at home with the gold and guns?

I find it amusing to talk about this. The cost seems little to get large Hinckley and Schmidt's with some food stores at a residence, compared to how up for grab's it'll be if the supply lines fail overnight ...