Tuesday, September 28, 2010

We should all pray for higher rates!



Frequent contributor to this blog, Matt Franko, posted a brilliant observation in the comment section of the prior post.

He points out that the public's holdings of Treasuries exceed $10 trillion, which is more than total loans and leases outstanding. If the Fed were to raise interest rates it would constitute a HUGE fiscal transfer via the interest/income channel. This means that, while most of the "know-nothings" (including many Fed board members) are talking about the need to raise rates now to stave off an incipient inflation, doing so would result in just the opposite. Higher rates would give a huge income boost to the public via higher interest payments, without a concomittant increase in production. That would absolutely drive inflation higher. The Fed is unwittingly keeping inflation down by keeping rates at or near zero, yet their own members and much of the financial community and the public don't even realize this.

Kudos to Matt for pointing this out. Trust me folks, you won't find this stuff anywhere else!!


16 comments:

Tom Hickey said...

Warren Mosler observes that low interest rates are deflationary, and high interest rates are inflationary, for the reason that Matt cites. Interest payment add to somebody's income. A lot of government bonds are held by pension funds, for instance. This is becoming a political issue in the UK at the moment.

Bank of England Tells Old People to Eat Their Seed Corn, Um, Principal

Matt Franko said...

Mike/Tom,

WM has put out a campaign release this AM that identifies the dust up between the Obama admin with China on trade and their currency peg as potentially inflationary here in the US.

I think that (import channel) is where we could get some stagflation going and then what would the Fed do? Perhaps then start to tighten a la 1981...thinking they were helping but then just fueling the fire...

Im very concerned about bonds in this regard. Even though the DDC has nothing good to say about bonds here also, a broken clock can be correct 2 times a day.

But I also feel that this type of scenario if it were to develop it would not be soon... I dont think the Fed would move to tighten with 9.5% unemployment until the PPI/CPI started to show substantial price instability..

PS Tom that is an inhumane policy that BOE is advocating...this does not look good. (btw we rented the Robin Hood movie w Russell Crowe the other night and the King was actually taxing away the seed from the country Lords! Robin Hood had to steal it back...) I think instead they should look at something like an expanded US savings bonds program for savers that they could just get from the Treasury directly and would pay a decent rate, I think youve commented elsewhere to this effect and I agree with you here...the Fed/Congress is soooo out of touch.

Resp,

Eric Z said...

No can do; it might hurt the banks.

Tom Hickey said...

Matt, what the administration wants to do is devalue the $ to raise the price of imports in order to reduce demand for them here and to lower the price of exports in order to increase demand for them abroad. This, in essence, is their jobs program.

When that doesn't work, they will be forced politically to go to "punishing China," perhaps even imposing some tariffs, if unemployment remains high going toward the '12 general.

DavBosko said...

How does this jive with the charts that Rodger Mitchell puts up from the St Louis fed that seem to show that inflation is tied to the price of energy.

There doesn't seem to be any correlation between interest rates and inflation according to the graphs Roger posted.

http://rodgermmitchell.wordpress.com/category/interest-rates/

Musgrave said...
This comment has been removed by the author.
Musgrave said...

Re interest rate rises and the “fiscal transfer” to which Mike refers, I suggest the effect is as follows.

I agree that the INITIAL effect is stimulatory. But at the end of the year the Treasury gets less from the Fed than it would have without the interest rate rise. So that suggests a more or less neutral effect as from the end of the year.

Joe said...

Wouldn't raising rates crush the ability of the private sector to carry it's debt? Isn't that where the real danger lies?

Tom Hickey said...

I've discussed this with Rodger, and he admits that there is a difference between and cost-push inflation which is the result of supply-side factors, the principal one of which has been petro prices, and demand-pull inflation resulting from fiscal policy generating an of net financial assets resulting in excessive effective demand relative to the productive economy to supply it at optimal capacity/full employment.

His contention is that most recent inflation has come from petro prices, and his argument for this view is a good one. This is also the cause of stagflation, not the breakdown of Keynesianism as the monetarists claimed.

Matt Franko said...

Joe,

Sadly I dont think they care.

I think the Fed, if faced with a CPI/PPI of above 5%, with what they interpret as rising inflation expectations, will raise rates, perhaps substantially even if unemployment remains high.

Resp,

Joe said...

Matt,

You don't think the Fed cares that raising rates will detonate an already badly damaged loan portfolio on all the big banks' balance sheets?

It seems to me that part of the ZIRP strategy was to keep people from defaulting on all the option-ARMs and other private debt holdings out there.

googleheim said...

What would be the direct effect of raising rates against commodities like oil ?

The oil co's are obviously fighting the deflation by shutting down the Gulf of Mexico in an attempt to save their bottom line against $20 / barrel oil which is teh reality.

Is raising the rates the same as "inflating the debt away" ?

would raising the rates make China richer in terms of their treasury accounts ?

googleheim said...

What would be the direct effect of raising rates against commodities like oil ?

The oil co's are obviously fighting the deflation by shutting down the Gulf of Mexico in an attempt to save their bottom line against $20 / barrel oil which is teh reality.

Is raising the rates the same as "inflating the debt away" ?

would raising the rates make China richer in terms of their treasury accounts ?

Matt Franko said...

Joe,

I see your point about the book of existing loans...but I dont think this is directly under the Feds responsibilty to prevent. After all they got us into this in the first place. As their responsibilty is full employment with price stablity, if they see inflation, they will raise imo. Let FDIC sort out the losers, or let Congress give them more equity again. That is not the Feds problem.

Count on them to do the exact opposite of what YOU might do. Even though you probably have a better idea of how to proceed here for the country, they will not do it, they will do the opposite. That has and continues to be the true course of events since 2008, no matter how much we desire a more logical, fair, successful approach.

I think we have to assume this until they prove otherwise.

Resp,

Matt Franko said...

Goog,

It may be bullish if the raise results in higher fiscal transfers to non-govt and then higher demand within the overall economy.

Agree oil is overpriced but they do have a monopoly after all. We need choice in vehicular fuels imo.

Resp,

RS said...

This is exactly what Peter Schiff has been aruging for a while. For those who don't know, Schiff is the guy who taught Mike Norman proper economics. Google - Peter Schiff was right.

But yes Schiff has been saying for a while that higher interest rates would create inflation in the LONG TERM because it would entice people to save more and make the economy more productive and hence creating inflation. But in the short run it would be disinflationary as Schiff argues. The reason that the Fed is keep rates low is because in the short term people would save that money without spending it and it would drive all interest rates on all spread products higher including mortagages, corporate bonds etc.. making people stop borrowing and driving home prices down in the short term which would be disinflaitonary in the short run. But schiff has been talking about the need for higher rates for a while. He is more knowledgable economist than mike norman as evidenced on the video i suggested.

So yes this observation you are making is true but not unique as mike norman claims. Peter schiff has been talking about it for a while.