Weekend Show – Sat 16 May, 2020

Hour 1 – All you need to know about ZIRP around the world
Full First Hour

This week was packed with company updates and introductions. Please check out the links below to all the interviews. It really helps me out when you all send me questions so please keep them coming to Fleck@kereport.com.

I hope you all have a great weekend and enjoyable long weekend for all our Canadian listeners.

  • Segment 1 and 2 – Peter Boockvar, Chief Investment Officer at Bleakley Advisory Group kicks off the show with his thoughts on ZIRP and the damage it has done to other Countries. We also comment on the markets ability to ignore the consistent bad economic data.
  • Segment 3 – Marc Chandler, Managing Partner at Bannockburn Global ForEx outlines how the currency markets have reacted to ZIRP around the world.
  • Segment 4 – Mike Konnert, President and CEO of Vizsla Resources wraps up the first hour with an update on recent drill results and an overview of the exploration plans for this year. Vizsla is a new silver exploration company that is exploring a newly consolidated land package called the Panuco Project in Mexico.

Exclusive Company Updates and Introductions


Peter Boockvar
Marc Chandler
Vizsla Resources – Mike Konnert

Mike Larson – Safe Money Report – Thu 14 May, 2020

NIRP in the US? Just How Crazy Of An Idea Is It?

Mike Larson joins me to discuss the idea of negative interest rates from the Fed. Even the Fed Presidents have stated they do not plan on cutting rates into negative territory we all know that market could very well force them into it.

Mike and I discuss the sectors which are impacts the most by negative rates. We also look around the world to other countries that have dropped rates into negative territory and what it has done to the economy.

Click here to follow Mike on Twitter. It’s well worth your time to stay up to date on what’s catching his eye.

Chris Temple from The National Investor – Wed 13 May, 2020

US Markets vs Gold Stocks – Two very different outlooks

Chris Temple joins me today to share his thoughts on the outlook for US markets and gold stocks. Are the US markets beginning a longer term rollover? Can gold stocks weather another broad market sell off? All of this is discussed.

Click here to visit Chris’s site and see what stocks he has on his recommended list.

Exclusive Comments from Marc Chandler – Fri 8 May, 2020

Recapping the biggest financial stories of the week – German Court vs ECB and Fed Fund Futures negative

Marc Chandler joins me today to recap the biggest financial stories of the week.

We start with the German court putting pressure on the ECB. This is more than just Germany trying to assert its dominance.

The other major story is the Fed Funds Futures for December dropping into negative territory. What this could mean for markets is wide ranging.

Click here to visit Marc site – Marc to Market.

Peter Boockvar Insights – Fri 8 May, 2020

The idiocy of NIRP

Here is a selected segment of post made by Peter Boockvar over at his site – The Boock Report. Peter does a great job of breaking down the issues with the negative interests rate policy (NIRP).

Click here to visit The Boock Report website.

Here are Peter’s thoughts on NIRP.

After seeing the fed funds futures in December pricing in the very slight chance of negative rates and hearing Ken Rogoff on CNBC yesterday calling for a -3% negative interest rate, I feel the need to lay out the idiocy of implementing it. A while ago I referred to it as poison for a financial system and the dumbest idea in the history of economics. 

1)It’s a tax. A tax on bank capital housed at a central bank that someone has to eat, either the bank itself or they pass it on to their clients. Taxes aren’t stimulative.

2)It would blow up the $4 Trillion money market industry as money would flee and this money finances government repo’s, commercial paper, CD’s, etc…

3)It would damage bank profitability, which is the blood of small and medium sized business lending and a big help to large ones that also have access to capital markets. To remind you, the Japanese Topix bank stock index is down 92% in nominal terms since its peak in 1989. The Euro STOXX bank stock index is down by 89% from its 2007 high. 

4)We’re seeing in Europe that banks have passed on some of the tax on to retail deposits. There is a story today on BN that UBS is offering some of its high net worth clients a payment holiday for a few months from paying the negative rate penalty for keeping money at the bank. They are doing this because money is leaving the bank.

5)It hurts insurance companies and pension funds that have little low risk options in meeting their investment return goals.

6)It crushes the saver and retiree.  

7)It has created a massive bubble in sovereign bonds that will be a complete mess when reversed considering the large debt taken on that NIRP encourages. 

8)It therefore becomes a trap for central banks because of the potential damage to bond prices when unwinding it.

9)The Swedish Riksbank saw the error of its negative rate ways and got its benchmark rate back to zero, but only zero. Even the BoJ realized the damage done as they stopped at a negative rate of .10% years ago. 

“The Only Thing to Fear Is Deficit Fear Itself”

This post “The Only Thing to Fear Is Deficit Fear Itself” appeared first on Daily Reckoning.

Dr. Paul Krugman — a man of knowledge — is talking again. The Nobel laureate informs us:

“The only fiscal thing to fear is deficit fear itself.”

Do you fear the latest cyclone of deficit spending will rip a swath through the Treasury?

This year’s budget deficit will likely near $4 trillion, after all — the largest in history.

Goldman Sachs estimates a $6 trillion combined deficit over the next two years alone.

Meantime, the Committee for a Responsible Federal Budget (do not laugh!) projects publicly held debt will eclipse its post-WWII record by 2023.

Let us assume these projections alarm you. And why should they not?

But Dr. Krugman would set you down as a sort of ox… an imbecile… some poor undersoul who is deaf to the music of the spheres.

The celestial bells are audible only to those — like him — with a nuanced and penetrating grasp of economics.

And these bells chime an ode to deficits.

So What if Debt Soars to 108% of GDP?

Reports the good professor, heaven’s tunes jingling in his ears:

It’s true that we’re headed for some eye-popping numbers. Last week the Congressional Budget Office released preliminary economic and budget projections for the next two years, which were both shocking and unsurprising…

In particular, the budget office expects the COVID-19 crisis to drive the unemployment rate to 16% in a few months, which might even be on the low side.

Soaring unemployment will cause federal revenues to plunge and also lead to a surge in spending on safety-net programs like unemployment insurance, Medicaid and food stamps. Add in the large relief packages Congress has passed and the budget office projects a deficit that will temporarily rise to levels we haven’t seen since World War II, and it expects federal debt to rise to 108% from 79% of GDP, which sounds scary.

Yes, it “sounds scary.” But of course it is not scary — to those who understand:

But the government will be able to borrow that money at incredibly low interest rates. In fact, real interest rates — rates on government bonds protected against inflation — are negative. So the burden of the additional debt as measured by the rise in federal interest payments will be negligible. And no, we don’t have to worry about paying off the debt; we never will, and that’s OK.

Borrowing costs are incredibly low, it is true. But if the price of hemlock were incredibly low… should you lay in?

“The Dose Makes the Poison”

The question is not entirely fair, of course. Debt is not lethal in itself.

“The dose makes the poison,” as argued Swiss Renaissance physician Paracelsus.

You may liken debt to alcohol…

In light doses drink lightens the heart. It flushes the cheeks. It unties the tongue… like the initial glass of bubbly at a wedding.

It is a fabulous facilitator of fun and frolick.

A second glass goes immediately down the gullet. But this second glass soon becomes the fourth glass, becomes the eighth glass, becomes the 10th glass — or 13th.

The dose makes the poison.

And so with debt. In the proper doses it is a pleasant stimulant, a spirit-lifter, a social lubricant.

But when abused… debt no longer stimulates, but inhibits. It no longer lifts, but drags. It no longer lubricates, but parches.

It poisons.

A Rascal With an Unquenchable Thirst for Rum and a Running Tab

Fifty years ago, $1 of debt may have yielded an additional dollar of economic growth, real or otherwise. Perhaps even more.

That is of course because the national debt burden was vastly lighter. The gold standard enforced a general fiscal sobriety, feeble though it was in its dying days.

Until 1971 the federal government might crave a tumbler of debt. But the barkeep could demand gold in return — payable on the nail.

But then the gold window came slamming down. And Uncle Samuel could raid the shelves without fear for his gold. The entire bar was thrown open to him — on credit.

Extend a running tab to a rascal with an unquenchable thirst for rum… and here you have the results:

IMG 1

More Liquor, Less Joy

By now the hopeless sot has acquired such a tolerance for drink… he requires ever increasing helpings to obtain a boost.

Each dollar borrowed since 2008 has yielded under $1 of growth. It is perhaps 40 cents, by some estimates we have encountered.

More liquor, that is. But less joy.

And now this tosspot is ordering doubles and triples, sinking them faster than the barman can pour them out…

Crisis spending may add $2 trillion to this year’s deficit alone. The nation’s debt already rises above $24.8 trillion — a $5.3 trillion ballooning in only four years.

The ladies and gentlemen who run the National Debt Clock project it will read $41.7 trillion four years from today.

It is a mere projection, of course, a gazing into crystal. But we wager high it rings in nearer to $41.7 trillion than $30 trillion.

At what point will the world abandon confidence in the dollar?

The question is more easily asked than answered. But it is a question best left unanswered… if you live and die by the dollar.

“The Wicked Borroweth, and Payeth Not Again”

Yet Dr. Krugman is ruffled neither by deficits nor the national debt. Again, he writes:

The government will be able to borrow that money at incredibly low interest rates. In fact, real interest rates — rates on government bonds protected against inflation — are negative. So the burden of the additional debt as measured by the rise in federal interest payments will be negligible. And no, we don’t have to worry about paying off the debt; we never will, and that’s OK.

Is it “OK”? Reads Psalm 37:21: “The wicked borroweth, and payeth not again.”

But we will overlook Dr. Krugman’s wicked counsel. Instead we ask:

Is borrowing at extremely low rates truly a warrant to plunge deeper into debt?

It is true, again, the government can presently borrow at these rates. But this is likewise true:

The sheer accumulation of debt can wash out the lower rates. That is, interest payments on the debt increase nonetheless.

Low Interest Rates, Ballooning Debt Payments

Writing in November 2017 is Michael Kosares, founder of USAGOLD:

As interest rates have declined over the last several years, the interest paid by the federal government has increased markedly due to the rapid growth in size of the accumulated debt…

In 2008 when the national debt stood at $10 trillion, the federal government paid $336 billion in interest. For a measuring stick, the 10-year Treasury bill drew an average interest rate at the time of around 3.66%.

In 2012 when the debt crossed the $16 trillion threshold, the interest payment was almost $456 billion. The 10-year Treasury bill drew an average interest rate of 1.80%.

In 2016 with the national debt approaching the $20 trillion mark, the interest payment was $497 billion. The 10-year Treasury bill drew an average interest rate of 1.84%. It is difficult to overlook the fact that 2016’s interest payment was an all-time record at the second-lowest rate [in 46 years].

Today the 10-year Treasury note yields a vanishing 0.61%. Total debt is nonetheless $5.3 trillion higher than in 2016. And it is piling high.

What if rates increase as the bond market recoils in horror at the prospect of a $41 trillion national debt?

Interest payments could wash over the entire budget.

A Grim Forecast

Debt service is already rising faster than any other federal shell-out.

Prior to this crisis the Congressional Budget Office already projected debt service would scale $915 billion by 2028 — nearly 25% of the entire budget.

The Lord only knows the ultimate figure. But it will likely be far higher absent a drastic reversal of economic fortune.

How will the government afford to pay for anything else?

We foresee little reason to expect a change. Yet we cling to hope, as a drowning man clings to a life ring — or as a drunkard clings to his bottle.

The nation’s debt is not a crisis because “we owe it to ourselves,” argue the spenders.

But one scalawag takes them at their word. “Note to self,” he writes:

“Pay up.”

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post “The Only Thing to Fear Is Deficit Fear Itself” appeared first on Daily Reckoning.

Heading Into Negative (Real) Interest Rates

This post Heading Into Negative (Real) Interest Rates appeared first on Daily Reckoning.

Last July I was in Bretton Woods, New Hampshire, along with a host of monetary elites, to commemorate the 75th anniversary of the Bretton Woods conference that established the post-WWII international monetary system. But I wasn’t just there to commemorate  the past —I was there to seek insight into the future of the monetary system.

One day I was part of a select group in a closed-door “off the record” meeting with top Federal Reserve and European Central Bank (ECB) officials who announced exactly what you can expect with interest rates going forward — and why.

They included a senior official from a regional Federal Reserve bank, a senior official from the Fed’s Board of Governors and a member of the ECB’s Board of Governors.

Chatham House rules apply, so I still can’t reveal the names of anyone present at this particular meeting or quote them directly.

But I can discuss the main points. They essentially came out and announced that rates are heading lower, and not by just 25 or 50 basis points. Rates were 2.25% at the time. They said they have to cut interest rates by a lot going forward.

Well, that’s already happened. The Fed cut rates last September and October (each 25 basis points), bringing rates down to 1.75%. And now, after Tuesday’s emergency 50-basis point rate cut, rates are down to 1.25%.

That’s a drop of one full percentage point. If the Fed keeps cutting (which is likely), it’ll soon be flirting with the zero bound. And if the economic effects of the coronavirus don’t dissipate (very possible), the Fed could easily hit zero.

But then what?

These officials didn’t officially announce that interest rates will go negative. But they said that when rates are back to zero, they’ll have to take a hard look at negative rates.

Reading between the lines, they will likely resort to negative rates when the time comes.

Normally forecasting interest rate policy can be tricky, and I use a number of sophisticated models to try to determine where it’s heading. But these guys made my job incredibly easy. It’s almost like cheating!

The most interesting part of the meeting was the reason they gave for the coming rate cuts. They were very relaxed about it, almost as if it was too obvious to even point out.

The reason has to do with real interest rates.

The real interest rate is the nominal interest rate minus the inflation rate. You might look at today’s interest rates and think they’re already extremely low. And in nominal terms they certainly are. But when you consider real interest rates, you’ll see that they can be substantially higher than the nominal rate.

That’s why the real rate is so important. If you’re an economist or analyst trying to forecast markets based on the impact of rates on the economy, then you need to focus on real rates.

Assume the nominal rate on a bond is 4%; what you see is what you get. But the real rate is the nominal rate minus inflation. If the nominal rate is 4% and inflation is 2%, then the real rate is 2% (4 – 2 = 2).

That difference between nominal and real rates seems simple until you get into a strange situation where inflation is higher than the nominal rate. Then the real rate is negative.

For example, if the nominal rate is 4% and inflation is 5%, then the real rate of interest is negative 1% (4 – 5 = -1).

The U.S. has never had negative nominal rates (Japan, the eurozone and Switzerland have), but it has had negative real rates.

By the early 1980s, nominal interest rates on long-term Treasury securities hit 13%. But inflation at the time was 15%, so the real rate was negative 2%. The real cost of money was cheap even as nominal rates hit all-time highs.

Nominal rates of 13% when inflation is 15% are actually stimulative. Rates of 3% when inflation is 1% aren’t. In these examples, nominal 2% is a “high” rate and 13% is a “low” rate once inflation is factored in.

What is the real rate today?

The yield to maturity on 10-year Treasury notes is currently at a record low of under 1% (it actually fell to 0.899% today before edging slightly higher). That’s never happened before in history, which is an indication of how unusual these times are.

Meanwhile, inflation as measured by the PCE core deflator (the Fed’s preferred measure) is currently about 1.6% year over year, below the Fed’s 2% target.

Using those metrics, real interest rates are in the neighborhood of -.5%. But believe it or not, that’s actually higher than the early ’80s when nominal rates were 13%, but real rates were -2%.

That’s why it’s critical to understand the significance of real interest rates.

And real rates are important because the central banks want to drive real rates meaningfully negative. That’s why they have to lower the nominal rate substantially, which is what these central bank officials said at Bretton Woods.

So you can expect rates to go to zero, probably sooner or later. Then, nominal negative rates are probably close behind.

The Fed is very concerned about recession, for which it’s presently unprepared. And with the coronavirus, now even more so. It usually takes five percentage points of rate cuts to pull the U.S. out of a recession. During its hiking cycle that ended in December 2018, the Fed was trying to get rates closer to 5% so they could cut them as much as needed in a new recession. But, they failed.

Interest rates only topped out at 2.5%, only halfway to the target. The market reaction and a slowing economy caused the Fed to reverse course and engage in easing. That was good for markets, but terrible in terms of getting ready for the next recession.

The Fed also reduced its balance sheet from $4.5 trillion to $3.8 trillion, but that was still well above the $800 billion level that existed before QE1 (“QE-lite” has since taken the balance sheet up above $4 trillion, and it’s probably going higher since new cracks are forming in the repo market).

In short, the Fed (and other central banks) only partly normalized and are far from being able to cure a new recession or panic if one were to arise tomorrow.

The Fed is therefore trapped in a conundrum that it can’t escape. It needs to rate hikes to prepare for recession, but lower rates to avoid recession. It’s obviously chosen the latter option.

If a recession hit now, the Fed would cut rates by another 1.25% in stages, but then they would be at the zero bound and out of bullets.

Beyond that, the Fed’s only tools are negative rates, more QE, a higher inflation target, or forward guidance guaranteeing no rate hikes without further notice.

Of course, negative nominal interest rates have never worked where they’ve been tried. They only fuel asset bubbles, not economic growth. There’s no reason to believe they’ll work next time.

But the central banks really have no other tools to choose from. When your only tool is a hammer, every problem looks like a nail.

Now’s the time to stock up on gold and other hard assets to protect your wealth.

Regards,

Jim Rickards
for The Daily Reckoning

The post Heading Into Negative (Real) Interest Rates appeared first on Daily Reckoning.

5,000 Years of Interest Rates, Part II

This post 5,000 Years of Interest Rates, Part II appeared first on Daily Reckoning.

Yesterday we hauled out evidence that interest rates have gone persistently down 500 years running.

And the high interest rates of the mid- to late 20th century?

These may be history’s true aberration, a violent but brief lurch in the chart… like a sudden burst of blood pressure.

Let us here reintroduce the graphic evidence:

IMG 1

Here is an extended picture of downward-trending rates — with the fabulous exception of the mid-to-late 20th century.

As Harvard economics professor Paul Schmelzing reckoned yesterday, as summarized by Willem H. Buiter in Project Syndicate:

Despite temporary stabilizations such as the periods 1550–1640, 1820–1850 or in fact 1950–1980… global… real rates have persistently trended downward over the past five centuries…

Can you therefore expect the downward journey of interest rates to proceed uninterrupted?

We have ransacked the historical data further still… rooted around for clues… and emerged with worrisome findings.

Why worrisome?

Details to follow. Let us first look in on another historical oddity, worrisome in its own way — the present stock market.

A Lull on Wall Street

It was an inconsequential day on Wall Street. The Dow Jones took a very slight slip, down nine points on the day.

The S&P scratched out a single-point gain; the Nasdaq gained 12 points today.

Gold and oil largely loafed, budging barely at all.

Meantime, humanity’s would-be saviors remained huddled at Davos. There they are setting the world to rights and deciding how we must live.

But let us resume our study of time… and money.

For light, we once again resort to the good Professor Schmelzing.

The arc of interest rates bends lower with time, he has established. But as he also establishes… no line bends true across five centuries of history.

Put aside the drastic mid-to-late 20th century reversal. Even the long downturning arc has its squiggles and twists, bent in the great forges of history.

To these we now turn…

“Real Rate Depression Cycles”

Over seven centuries, Schmelzing identifies nine “real rate depression cycles.”

These cycles feature a secular decline of real interest rates, followed by reversals — often sudden and violent reversals.

The first eight rate depression cycles tell fantastic tales…

They often pivoted upon high dramas like the Black Death of the mid-14th century… the Thirty Years’ War of the 17th century… and World War II.

IMG 2

The world is currently ensnared within history’s ninth rate depression cycle. This cycle began in the mid-1980s.

Schmelzing says one previous cycle comes closest to this, our own. That is the global “Long Depression” of the 1880s and ’90s.

This “Long Depression” witnessed “low productivity growth, deflationary price dynamics and the rise of global populism and protectionism.”

Need we draw the parallels to today?

It is here where our tale gathers pace… and acquires point.

A Thing of Historic Grandeur

Schmelzing’s research reveals this information:

This present cycle is a thing of historical grandeur, in both endurance and intensity.

Of the entire 700-year record… only one cycle had a greater endurance. That was in the 15th century.

And only one previous cycle — also from the same epoch — exceeded the current cycle’s intensity.

By almost any measure… today’s rate depression cycle is a thing for the ages.

Turn now to this chart. The steep downward slope on the right gives the flavor of its fevered intensity:

IMG 3

Schmelzing’s researches show the real rate for the entire 700-year history is 4.78%.

Meantime, the real rate for the past 200 years averages 2.6%.

Beware “Reversion to the Mean”

And so “relative to both historical benchmarks,” says this fellow, “the current market environment thus remains severely depressed.”

That is, real rates remain well beneath historical averages.

And if the term “reversion to the mean” has anything in it, the world is in for a hard jolt when the mean reverts. Why?

Because when rates do regain their bounce — history shows — they bounce high.

Schmelzing:

The evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable… Most reversals to “real rate stagnation” periods have been rapid, nonlinear and took place on average after 26 years.

Twenty-six years? The present rate depression cycle runs to 36 or 37 years. We must conclude it goes on loaned time. What happens when the loan comes due?:

Within 24 months after hitting their troughs in the rate depression cycle, rates gained on average 315 basis points [3.15%], with two reversals showing real rate appreciations of more than 600 basis points [6%] within two years.

The current rate depression cycle ranges far beyond average.

It is, after all, the second longest on record… and the second most intense.

If the magnitude of the bounceback approximates the magnitude of the cycle it ends… we can therefore expect a fantastic trampolining of rates.

That is, we can likely expect rate appreciations of 6% or more.

What Happens When Rates Rise?

The stock market and the decade-long economic “recovery” center upon ultra-low interest rates. And so we recoil, horrified, at the prospect of a “rapid, nonlinear” rate reversal.

We must next consider its impact on America’s ability to finance its hellacious debt…

A violent rate increase means debt service becomes an impossible burden.

How would America service its $23 trillion debt — a $23 trillion debt that jumps higher by the minute?

Debt service already represents the fastest-growing government expense.

Interest payments will total $460 billion this year, estimates the Congressional Budget Office (CBO).

CBO further projects debt service will scale $800 billion by decade’s end.

$800 billion exceeds today’s entire $738 billion defense budget. As it exceeds vastly present Medicare spending ($625 billion) and Medicaid spending ($412 billion).

CBO Doesn’t Account for Possible End to Rate Depression Cycle

But CBO pays no heed to the rate depression cycle. It — in fact — projects no substantial rate increases this decade.

But what if the present rate depression cycle closes… and interest rates go spiraling?

Debt service will likely swamp the entire federal budget.

Financial analyst Daniel Amerman:

If the interest rate on that debt were to rise by even 1%, the annual federal deficit rises by $200 billion. A 2% increase in interest rate levels would up the federal deficit by $400 billion, and if rates were 5% higher, the annual federal deficit rises by a full $1 trillion per year.

Recall, rates rocketed 6% or higher after two previous rate reversals.

Given the near-record intensity of the present rate depression cycle… should we not expect a similar rebound next time?

Hard logic dictates we should.

But what might bring down the curtain on the current cycle?

Unforeseen Catastrophe

Most previous rate depression cycles ended with death, destruction, howling, shrieking.

Examples, again, include the Black Plague, the Thirty Years War and World War II.

Perhaps a shock on their scale will close out the present cycle… for all that we know. Or perhaps some other cause entirely.

Of course, we can find no reason in law or equity why the second-longest, second-most intense rate depression cycle in history… cannot become the longest, most intense rate depression cycle in history.

The cycle could run years yet. Or it could end Friday morning.

The Lord only knows — and He is silent.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post 5,000 Years of Interest Rates, Part II appeared first on Daily Reckoning.

5,000 Years of Interest Rates, Part II

This post 5,000 Years of Interest Rates, Part II appeared first on Daily Reckoning.

Yesterday we hauled out evidence that interest rates have gone persistently down 500 years running.

And the high interest rates of the mid- to late 20th century?

These may be history’s true aberration, a violent but brief lurch in the chart… like a sudden burst of blood pressure.

Let us here reintroduce the graphic evidence:

IMG 1

Here is an extended picture of downward-trending rates — with the fabulous exception of the mid-to-late 20th century.

As Harvard economics professor Paul Schmelzing reckoned yesterday, as summarized by Willem H. Buiter in Project Syndicate:

Despite temporary stabilizations such as the periods 1550–1640, 1820–1850 or in fact 1950–1980… global… real rates have persistently trended downward over the past five centuries…

Can you therefore expect the downward journey of interest rates to proceed uninterrupted?

We have ransacked the historical data further still… rooted around for clues… and emerged with worrisome findings.

Why worrisome?

Details to follow. Let us first look in on another historical oddity, worrisome in its own way — the present stock market.

A Lull on Wall Street

It was an inconsequential day on Wall Street. The Dow Jones took a very slight slip, down nine points on the day.

The S&P scratched out a single-point gain; the Nasdaq gained 12 points today.

Gold and oil largely loafed, budging barely at all.

Meantime, humanity’s would-be saviors remained huddled at Davos. There they are setting the world to rights and deciding how we must live.

But let us resume our study of time… and money.

For light, we once again resort to the good Professor Schmelzing.

The arc of interest rates bends lower with time, he has established. But as he also establishes… no line bends true across five centuries of history.

Put aside the drastic mid-to-late 20th century reversal. Even the long downturning arc has its squiggles and twists, bent in the great forges of history.

To these we now turn…

“Real Rate Depression Cycles”

Over seven centuries, Schmelzing identifies nine “real rate depression cycles.”

These cycles feature a secular decline of real interest rates, followed by reversals — often sudden and violent reversals.

The first eight rate depression cycles tell fantastic tales…

They often pivoted upon high dramas like the Black Death of the mid-14th century… the Thirty Years’ War of the 17th century… and World War II.

IMG 2

The world is currently ensnared within history’s ninth rate depression cycle. This cycle began in the mid-1980s.

Schmelzing says one previous cycle comes closest to this, our own. That is the global “Long Depression” of the 1880s and ’90s.

This “Long Depression” witnessed “low productivity growth, deflationary price dynamics and the rise of global populism and protectionism.”

Need we draw the parallels to today?

It is here where our tale gathers pace… and acquires point.

A Thing of Historic Grandeur

Schmelzing’s research reveals this information:

This present cycle is a thing of historical grandeur, in both endurance and intensity.

Of the entire 700-year record… only one cycle had a greater endurance. That was in the 15th century.

And only one previous cycle — also from the same epoch — exceeded the current cycle’s intensity.

By almost any measure… today’s rate depression cycle is a thing for the ages.

Turn now to this chart. The steep downward slope on the right gives the flavor of its fevered intensity:

IMG 3

Schmelzing’s researches show the real rate for the entire 700-year history is 4.78%.

Meantime, the real rate for the past 200 years averages 2.6%.

Beware “Reversion to the Mean”

And so “relative to both historical benchmarks,” says this fellow, “the current market environment thus remains severely depressed.”

That is, real rates remain well beneath historical averages.

And if the term “reversion to the mean” has anything in it, the world is in for a hard jolt when the mean reverts. Why?

Because when rates do regain their bounce — history shows — they bounce high.

Schmelzing:

The evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable… Most reversals to “real rate stagnation” periods have been rapid, nonlinear and took place on average after 26 years.

Twenty-six years? The present rate depression cycle runs to 36 or 37 years. We must conclude it goes on loaned time. What happens when the loan comes due?:

Within 24 months after hitting their troughs in the rate depression cycle, rates gained on average 315 basis points [3.15%], with two reversals showing real rate appreciations of more than 600 basis points [6%] within two years.

The current rate depression cycle ranges far beyond average.

It is, after all, the second longest on record… and the second most intense.

If the magnitude of the bounceback approximates the magnitude of the cycle it ends… we can therefore expect a fantastic trampolining of rates.

That is, we can likely expect rate appreciations of 6% or more.

What Happens When Rates Rise?

The stock market and the decade-long economic “recovery” center upon ultra-low interest rates. And so we recoil, horrified, at the prospect of a “rapid, nonlinear” rate reversal.

We must next consider its impact on America’s ability to finance its hellacious debt…

A violent rate increase means debt service becomes an impossible burden.

How would America service its $23 trillion debt — a $23 trillion debt that jumps higher by the minute?

Debt service already represents the fastest-growing government expense.

Interest payments will total $460 billion this year, estimates the Congressional Budget Office (CBO).

CBO further projects debt service will scale $800 billion by decade’s end.

$800 billion exceeds today’s entire $738 billion defense budget. As it exceeds vastly present Medicare spending ($625 billion) and Medicaid spending ($412 billion).

CBO Doesn’t Account for Possible End to Rate Depression Cycle

But CBO pays no heed to the rate depression cycle. It — in fact — projects no substantial rate increases this decade.

But what if the present rate depression cycle closes… and interest rates go spiraling?

Debt service will likely swamp the entire federal budget.

Financial analyst Daniel Amerman:

If the interest rate on that debt were to rise by even 1%, the annual federal deficit rises by $200 billion. A 2% increase in interest rate levels would up the federal deficit by $400 billion, and if rates were 5% higher, the annual federal deficit rises by a full $1 trillion per year.

Recall, rates rocketed 6% or higher after two previous rate reversals.

Given the near-record intensity of the present rate depression cycle… should we not expect a similar rebound next time?

Hard logic dictates we should.

But what might bring down the curtain on the current cycle?

Unforeseen Catastrophe

Most previous rate depression cycles ended with death, destruction, howling, shrieking.

Examples, again, include the Black Plague, the Thirty Years War and World War II.

Perhaps a shock on their scale will close out the present cycle… for all that we know. Or perhaps some other cause entirely.

Of course, we can find no reason in law or equity why the second-longest, second-most intense rate depression cycle in history… cannot become the longest, most intense rate depression cycle in history.

The cycle could run years yet. Or it could end Friday morning.

The Lord only knows — and He is silent.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post 5,000 Years of Interest Rates, Part II appeared first on Daily Reckoning.

5,000 Years of Interest Rates

This post 5,000 Years of Interest Rates appeared first on Daily Reckoning.

“At no point in the history of the world has the interest on money been so low as it is now.”

Here the good Sen. Henry M. Teller of Colorado hits it square.

For 10 years plus, the Federal Reserve has waged a nearly ceaseless warfare upon interest rates.

Savers have staggered under the onslaughts. But the timeless laws of economics will not be forever put to rout.

We suspect they will one day prevail, and mightily. Interest rates will then revert to historical averages.

When they do, today’s crushing debt loads will come down in a heap. They will fall directly on the heads of governments and businesses alike.

This fear haunts our days… and poisons our nights.

Wait… What?

Let us check the date on the senator’s declaration…

Kind heaven, can it be?

Our agents inform us Sen. Teller’s statement entered the congressional minutes on Jan. 12… 1895.

1895 — some 19 years before the Federal Reserve drew its first ghoulish breath!

Were the late 19th century’s interest rates the lowest in world history?

Here at The Daily Reckoning, we are entertained infinitely by the dazzling present.

Its five-minute fads, its 15-minute fames, its popinjay actors strutting vainly across temporary stages…

All amuse us vastly and grandly.

They amuse us, that is — but they do not fascinate us.

It is the long view that draws us in — the view of the soaring eagle high overhead, the view from the mountaintop.

So today we rise above the daily churn, canvass history’s broad sweep… and report strange findings.

Quite possibly scandalous findings. Scandalous?

That is, we will investigate the theory that falling interest rates the historical norm… rather than the exception.

And are central banks powerless to direct them?

The Lowest Rates in 5,000 Years

The chart below gives 5,000 years of interest rate history. It shows the justice in Sen. Teller’s argument.

Direct your attention to anno Domini 1895. Rates had never been lower. Not in all of recorded history:

IMG 1

Rates would sink lower only on two subsequent occasions — the dark, depressed days of the early 1930s — and the present day, dark and depressed in its own way.

The Arc of the Universe Bends Toward Low Interest Rates

Paul Schmelzing professes economics at Harvard. He is also a visiting scholar at the Bank of England. And he has conducted a strict inquiry into interest rates throughout history.

Many take the soaring interest rates of the later 20th century as their guide, he begins:

The discussion of longer-term trends in real rates is often confined to the second half of the 20th century, identifying the high inflation period of the 1970s and early 1980s as an inflection point triggering a multidecade fall in real rates. And indeed, in most economists’ eyes, considering interest rate dynamics over the 20th century horizon — or even over the last 150 years — the reversal during the last quarter of the 1900s at first appears decisive…

Here the good professor refers to “real rates.”

The real interest rate is the nominal rate minus inflation. Thus it penetrates the monetary illusion. It exposes inflation’s false tricks — and the frauds who put them out.

In one word… it clarifies.

And the chart reveals another capital fact…

The Long View

Revisit the chart above. Now take an eraser in hand. Run it across the violent lurch of the mid-to-late 20th century. You will then come upon this arresting discovery:

Long-term interest rates have trended downward five centuries running. It is this, the long view, that Schmelzing takes:

Despite temporary stabilizations such as the period between 1550–1640, 1820–1850 or in fact 1950–1980 global real rates have shown a persistent downward trend over the past five centuries…

This downward trend has persisted throughout the historical gold, silver, mixed bullion and fiat monetary regimes… and long preceded the emergence of modern central banks.

What is more, today’s low rates represent a mere “catch-up period” to historical trends:

This suggests that deeply entrenched trends are at work — the recent years are a mere “catch-up period”…

In this sense, the decline of real returns across a variety of different asset classes since the 1980s in fact represents merely a return to long-term historical trends. All of this suggests that the “secular stagnation” narrative, to the extent that it posits an aberration of longer-term dynamics over recent decades, appears fully misleading.

Is it true? Is the nearly vertical interest rate regime of the mid-to late 20th century a historical one-off… a chance peak rising sheer from an endless downslope?

What explains it?

Interest Rate Spikes, Explained

Galloping economic growth explains it, says analyst Lance Roberts of Real Inves‌tment Advice.

He argues that periods of sharply rising interest rates are history’s lovely exceptions.

Why lovely?

Interest rates are a function of strong, organic, economic growth that leads to a rising demand for capital over time.

In this view, rates soared at the dawn of the 20th century. It was, after all, a time of rapid industrialization and dizzying technological advance.

Likewise, the massive post-World War II rate spike owes directly to the economic expansion then taking wing. Roberts:

There have been two previous periods in history that have had the necessary ingredients to support rising interest rates. The first was during the turn of the previous century as the country became more accessible via railroads and automobiles, production ramped up for World War I and America began the shift from an agricultural to industrial economy.

The second period occurred post-World War II as America became the “last man standing”… It was here that America found its strongest run of economic growth in its history as the “boys of war” returned home to start rebuilding the countries that they had just destroyed.

Let the record show that rates peaked in 1981. Let it further show that rates have declined steadily ever since.

And so we wonder…

Was the post-World War II period of dramatic and exceptional growth… itself the exception?

The Return to Normal

Let us widen our investigation by summoning additional observers. For example, New York Times senior economic correspondent Neil Irwin:

Investors have often talked about the global economy since the crisis as reflecting a “new normal” of slow growth and low inflation. But just maybe, we have really returned to the old normal.

More:

Very low rates have often persisted for decades upon decades, pretty much whenever inflation is quiescent, as it is now… The real aberration looks like the 7.3% average experienced in the United States from 1970–2007.

That is precisely the case Schmelzing argues.

Now consider the testimony of a certain Bryan Taylor. He is chief economist at Global Financial Data:

“We’re returning to normal, and it’s just taken time for people to realize that.”

Just so. We must nonetheless file a vigorous caveat…

A Pursuit of the Wind

Drawing true connections between historical eras can be a snare, a chasing after geese, a pursuit of the wind.

Success requires a sharpshooter’s eye… a surgeon’s hand… and an owl’s wisdom.

The aforesaid Schmelzing knew the risks before setting out. But he believes he has emerged from the maze, clutching the elusive grail of truth.

Today’s low rates are not the exceptions, he concludes in reminder. They represent a course correction, a return to the long, proper path.

How long will this downward trend continue, professor Schmelzing?

The Look Ahead

Whatever the precise dominant driver — simply extrapolating such long-term historical trends suggests that negative real rates will not just soon constitute a “new normal” — they will continue to fall constantly. By the late 2020s, global short-term real rates will have reached permanently negative territory. By the second half of this century, global long-term real rates will have followed…

But can the Federal Reserve throw its false weights upon the scales… and send rates tipping the other way?

With regards to policy, very low real rates can be expected to become a permanent and protracted monetary policy problem…

The long-term historical data suggests that, whatever the ultimate driver, or combination of drivers, the forces responsible have been indifferent to monetary or political regimes; they have kept exercising their pull on interest rate levels irrespective of the existence of central banks… or permanently higher public expenditures. They persisted in what amounted to early modern patrician plutocracies, as well as in modern democratic environments…

We have argued previously that central banks wield far less influence than commonly supposed. Here we are validated.

But we are unconvinced rates are headed inexorably and unerringly down.

Tomorrow, another possible lesson — a warning — from the book of interest rates.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post 5,000 Years of Interest Rates appeared first on Daily Reckoning.