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Tuesday, April 13, 2010

Endgame

Via Ad Orientem

Interest Rates Have Nowhere To Go But Up
... Last week, the yield on the benchmark 10-year Treasury note briefly crossed the psychologically important threshold of 4 percent, as the Treasury auctioned off $82 billion in new debt. That is nearly twice as much as the government paid in the fall of 2008, when investors sought out ultrasafe assets like Treasury securities after the collapse of Lehman Brothers and the beginning of the credit crisis.

Though still very low by historical standards, the rise of bond yields since then is reversing a decline that began in 1981, when 10-year note yields reached nearly 16 percent.

From that peak, steadily dropping interest rates have fed a three-decade lending boom, during which American consumers borrowed more and more but managed to hold down the portion of their income devoted to paying off loans.

Indeed, total household debt is now nine times what it was in 1981 — rising twice as fast as disposable income over the same period — yet the portion of disposable income that goes toward covering that debt has budged only slightly, increasing to 12.6 percent from 10.7 percent.

Household debt has been dropping for the last two years as recession-battered consumers cut back on borrowing, but at $13.5 trillion, it still exceeds disposable income by $2.5 trillion ...

As interest rates rise, the economic activity enabled by artificially cheap credit ceases. The central bank's 'boom' is inevitably followed by the 'bust.' Malinvestments are liquidated, asset prices fall to realistic levels, and prices again reflect supply and demand rather than the false signals of the Fed's and the Treasury's monetary games. This is bitter medicine we have avoided for a long time, so the correction will be that much more difficult. Americans are still in way too much debt, and the exotic vacations, McMansions, and SUV's must go. But anecdotally, I see a lot of over-extended people still in firm denial of reality.

So, with ever more debt sloshing around the market, we can no longer deny economic reality and interest rates must go up. Bernanke is out of tricks and the correction will happen, and there is nothing that the Fed's Ivy League economists in their marble palaces can do about it.

Incidentally, alot of that high-powered money injected in the waning days of the Bush administration went into sovereign and municipal debt. That is the next bubble in line to be burst. (Again, HT to Ad Orientem).

There are now so many false signals and externalities built into the US financial sector that it is impossible to determine what any asset's 'real' value is. People are still grimly shoveling money into their 401k's and hoping the fund managers in their tailored suits and German cars will shepherd all those billions in OPM as prudentially as they would their own. (Right? Right?). For myself it's humble gold and silver coin, and I really couldn't care less about all the 'sure things,' or 'next big things' touted by anybody's brother-in-law's cousin's friend, much less the biz school grad twenty years my junior at the Fidelity branch. Americans are about to get disabused of the notion that they can get rich owning itty-bitty bits of gigantic funds that own percentages of derivatives of securities issued by multi-national corporations. Who are all those Late and Early Boomers going to sell those 401k shares to, each other? What's the real rate of return going to be on that money after inflation and the deferred taxation on fund withdrawals?

2 comments:

Acilius said...

All too true, I'm sure. It's been amazing, or maybe the better word is terrifying, to hear so many establishment voices cheer as the treasury and the Fed have reinflated the asset bubbles.

Daniel said...

This might sound cruel, but I am actually looking forward to the Student Loan bubble popping.