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Which effect wins out?
There is a major paradox with interest rates, especially relative to leveraged assets such as real estate.
Increasing inflation ---->increasing interest rates------>decreasing real estate prices
What ? (the big rise in RE prices is delayed. Attention cash shoppers....)
History surely won't repeat itself exactly, but still it is hard to predict how this is going to unfold. Maybe we can hear from some of those who think they know.
Increasing inflation —->increasing interest rates——>decreasing real estate prices
I think a lot of the inflation of the 1960s and 1970s was due to plain economic growth -- real gains in productivity -- increasing the borrowing power of the population, and the more we borrowed the more inflation we saw.
Demographically, the baby boom started turning 20 in 1966 (its peak year, born in 1955, was only 11). Then by 1976 the peak baby boom was 21 -- and it's no accident that both Bill Gates and Steve Jobs, both born in 1955, founded their world-changing companies in the mid-1970s!
The "All-Devouring Rent" Theory predicts that land values and rents will rise to take any consumer surplus gained through productivity, and I think that's a good explanation of the 1970s, as rising productivity, baby boom household formation, and new economic development served to push production and consumption in a cycle of inflation and debt expansion.
Ceteris paribus, rising interest rates push down land values. But if people can see a healthy batch of inflation coming, they will discount any interest rate you can throw at them to get in on the inflation train. Volcker finally had to be brought in by Carter to combat this inflationary spiral.
All that's fine and good, but this:
http://research.stlouisfed.org/fred2/series/CMDEBT
is the reality of our current situation. Until the PtB can turn that machine back on, we are in Japan Mode, or, if we're particularly unlucky, Weimar Republic 1930-32 mode.
Patrick I live in SF n pay 1000 a month for rent. I want to move to Portland and buy a home for 150k and mortgage would be 700. Is it a good time to buy in POrtland or wait 2 years? thanks Patrick!!!
Did anyone catch the Maestro (aka Greenspan) on the PBS Newshour this past Friday? He scared the $%^&! out of my wife. He was basically like WE MUST LET THE BUSH TAX CUTS EXPIRE! He seemed truly frightened that US government borrowing (to service the debt) was out of control and interest rates could explode once our creditors start getting squirrelly. He blamed both the Democrats (spend and finance) and Republicans (tax cuts through borrowing). Or perhaps he's just trying to shore up his 'legacy' and hoping he can got out in front of this one. At any rate, given all the political rhetoric as they sunset, quite interesting to see one of their original supporters say the times they are a changin'.
The ws journal is a far better source for that kind of thing.
Be careful Marcus .... the WSJ is "right wing." You might read something in there that will cause you to think.
>>But on the other hand, creating more dollars must lower the value of existing bonds, pushing their actual yields higher, not lower.
I don't think there is any paradox here. The Fed bids up the prices of long-term bonds, old ones and newly created ones, from their current value to a higher value.
This decreases the yield for all of them, old and new.
As an aside, this is how the Fed-Treasury-Banks merry-go-round works, it is quite a racket:
First the Fed buys treasury bonds directly from the US Treasury (debt monetization). Then the Fed uses the very same Treasury Bonds as payment for the junky private long-term bonds (MBS and corporate debt, etc) that they purchase from certain preferred and privileged private parties, such as banks and primary dealers. This way the Fed won't have to give actual cash to the banks. It looks less sinister and inflationary when using bonds than giving out cash.
But if the bank needs something even more liquid than a long-term T-bond, the Fed will exchange it for something shorter or even cash, as needed.
Like I said, quite the racket, and you and I would never be able to participate at the terms that banks are getting.
I don’t think there is any paradox here. The Fed bids up the prices of long-term bonds, old ones and newly created ones, from their current value to a higher value.
This decreases the yield for all of them, old and new.
But other participants in the market for bonds could decide the Fed is printing too many dollars to buy those bonds, and just refuse to buy bonds, causing bond prices to fall.
It's definitely a racket. I'm just trying to figure out how much corruption the bond market can take before the other players give up and stop playing.
Be careful Marcus …. the WSJ is “right wing.†You might read something in there that will cause you to think.
Only their editorial page. Unlike Fox news they are (or at least used to be) a legit newspaper. With a politically conservative editorial page, and politics free news and business journalism.
Another thing for you to consider. It's not that business is always, pro republican. It's the degree to which republican policy is pro business. I have no problems with business or the business world. It's just that our politics is sometimes too skewed toward their benefit.
Hi Patrick,
I see what you mean. It is the question of whether the so-called "bond vigilantes" will come out in force, or not. Paul Krugman has a lot to say about this topic :-)
This is, essentially, what is keeping Greenspan up at night. The market buys your debt... until it doesn't.
It's more about "we're all in this together" mentality. It doesn't matter where you live, or what you do, we're all in this same financial market together. We've all got money, and it's all tradable to USD.
So it's all one big currency affair.
The fed, the government and other governments are doing what they're doing because they have to right now. Which means other investments aren't necessarily better. If you have to put your money somewhere, these bonds are still the best bet. Professional investors don't invest in get rich quick schemes, which means investing in something right now which is stable, not likely to tip over, and if it does tip over, you're not the only person in the same boat. Bonds are that boat. We're all in it, if the bonds tip, we're all going in. If you invest in some "cowboy hat making business", if it goes belly up, you're pretty sure they aren't taking anyone else with them.
I guess our advantage is that other parts of the world are even more corrupt than we are, and even more willing to debase their currency. So foreigners still buy our bonds, because they know too well what their own government is like.
Hmmm, what are Chinese government bonds paying? Looks like they track own own yields. Not that you could necessarily buy a Chinese gov't bond.
I don’t think there is any paradox here. The Fed bids up the prices of long-term bonds, old ones and newly created ones, from their current value to a higher value.
Any student of the debt markets knows there is a paradox, or whatever you want to call it. The feds adding long term securities to their balance sheet is highly unorthodox, and everyone knows they are doing it only because these are such unusual times. The credit markets still aren't even functioning normally.
And it is true that the fed can't corner the market for long term securities or anything close to that without completely invalidating it. And the long term debt market is somewhat independent of the short term market which the fed can completely control. (although again, Patrick has a point that they can't make banks want to lend money short term at such low rates - at least not to any but the very lowest risk borrowers)
I guess our advantage is that other parts of the world are even more corrupt than we are, and even more willing to debase their currency.
Like Brazil (or perhaps not):
An "international currency war" is underway, Brazil's finance minister, Guido Mantega, has warned. His comments follow a series of interventions by governments to weaken their currencies and boost export competitiveness. Japan, South Korea, and Taiwan are among those that have recently tried to cut the value of their currencies. In a speech in Sao Paulo, Mr Mantega said the competitive devaluations were effectively a new trade war.
"We're in the midst of an international currency war," he told a meeting of industrial leaders. "This threatens us because it takes away our competitiveness.
"The advanced countries are seeking to devalue their currencies." Mr Mantega has been trying to talk down the value of Brazilian real. The currency is at a 10-month high against the dollar, and has been described by analysts at Goldman Sachs as the world's most overvalued major currency.
Basically everyone is doing their own thing right now, trying to keep afloat during a world recession and world recovery. Whoever can keep things moving along until a full recovery shows up, will survive.
But, who's boat do you want to be in? If the the whole thing goes belly up, who will be the best off? If the US goes belly up, the waves will crash everyones boat. So if you're in someone elses boat when the US goes belly up, you're coming down hard too. However, other peoples boats will only tip over smaller countries, they won't take down the US. Sit in the largest boat and wait this whole thing out, take 1% or 0% but keep it safe.
So how far can they go? That's the interesting question.
How close can Helicopter Ben get to unlimited printing before the other participants in the bond market decide that dollars are a losing bet, and start to sell US Treasury bonds?
And the paradox is that by then, with mortgage rates going up (monthly cost for all but cash buyers going up just on the change in mortgage rates alone), real estate may be steady to actually declining in price, in spite of the inflationary expectations.
At least that's how it worked last time. I'm sure that most people recall that inflation hit real estate (and the stock market) last, as inflationary expectations and long term interest rates finally came down.
But as I said before, we all know it's not going to be the exact same movie this time.
Well considering they're offering them at the lowest rates ever, in the largest quantities ever and they're being gobbled up.... awhile...
I've read that property prices stayed nominally flat in Argentina even as the currency devalued, because there were opposing forces at work which were approximately equal: a great fall in purchasing power and large unemployment, opposed by people desperate for somewhere to store their wealth who were buying property.
But also, a reader of this blog told me that there are no mortgages in Argentina so interest rates are irrelevant. Property deals are accomplished with suitcases of cash in the bank lobby. You pay cash - not even a check, real cash - or you don't buy at all. Probably a good thing too, given this crazy interest rate swing:
http://www.latin-focus.com/latinfocus/countries/argentina/arginter.htm
More history of Argentine property:
http://www.globalpropertyguide.com/Latin-America/Argentina/Price-History
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The feds adding long term securities to their balance sheet is highly unorthodox, and everyone knows they are doing it only because these are such unusual times. The credit markets still aren't even functioning normally.
Rising Interest Rates Will Crush the Federal Budget
Patrick says
Rising Interest Rates Will Crush the Federal Budget
No they won't. The Fed will just print more money. It will crush the economy.
marcus says
The feds adding long term securities to their balance sheet is highly unorthodox, and everyone knows they are doing it only because these are such unusual times. The credit markets still aren't even functioning normally.
Where has Marcus been ? He stated the above back in 2010 and it is prophetic. Fed has lost money and I wonder how much they will continue to lose money as they continue Quantitative Tightening. They are selling Treasuries at depressed prices due to the increase in interest rates.
.
They are holding 'em to maturity and letting them roll off their balance sheet that way,
The Fed is not selling the longer term Bonds they hold. They are holding 'em to maturity and letting them roll off their balance sheet that way, but yeah if they marked to market, they lost about $1 trillion.
The Federal Reserve can make up as much funny money as they want. They'll never go bankrupt.
What is interesting is that QE and ZIRP back in 2008 to 2016 did not cause annual inflation over 3% based on government reported statistics.
If I give you a trillion dollars, and you just bury it, no inflation. I
This along with other policy errors caused the country to have the weakest bounce back from a recession ever.
Yesterday, the US government tried to borrow $24 billion by selling a bunch of 30 year debt.
It was a huge disaster. In order to get enough people to buy, the rate had to dramatically increase. Even then, then primary dealers had to buy 25% of the debt. The primary dealer are the buyers of last resort who have to buy.
China, Japan, Saudi Arabia, Russia ... none of them are buying our debt. In fact, most are selling what they already have.
With few buying, the US government is borrowing more than ever. $1.5 trillion in the past 4 months and they announced another $1.5 trillion in the next 6 months. The US government will have to offer higher and higher rates to attracted lenders.
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I'm still confused about exactly how the Fed can push long-term interest rates lower.
From http://www.latimes.com/business/la-fi-petruno-20100925,0,6008425.column we have:
If the Fed prints up more dollars and lends them out to big banks at 1% interest long term, that does seem to force other lenders to lower interest rates to compete with the Fed. And it does seem to give retail lenders the ability to lower rates, because their own cost of money is lower if they can get it from the Fed.
But on the other hand, creating more dollars must lower the value of existing bonds, pushing their actual yields higher, not lower.
Which effect wins out?
#investing