Inflation has fallen over the last quarter-century, so one would expect to find Treasury yields have fallen, but there is more than just benign inflation at work. The Fed has also been suppressing long-term interest rates, with QE1, QE2, Operation Twist and now QE3.
The yield on 10-year Treasuries is now below the Fed’s long-term inflation target of 2 percent, offering savers a negative return on investment unless they are prepared to take on risk. The Fed’s aim is to induce investors to take on more risk, in the hope that increased capital spending will stimulate employment and lead to a recovery. But they risk leading savers into another disaster, with falling earnings or rising yields ending in capital losses.
Corporations are reluctant to expand and will remain so until they see a sustainable increase in consumption. Fueled by new jobs — not short-term credit. Low interest rates without job growth could cause another speculative bubble, with too much money chasing too few opportunities.
Without jobs, no monetary policy is likely to succeed.
The alternative press suggests that true inflation is much higher than official figures that use obfuscation and creative accounting.
Annual consumer inflation is running at just below 10% according to Shadowstats, using 1980 methodology. Forcing investors, let alone ordinary savers, to risk their capital for yields above this level is irresponsible and callous. They have to earn 10% just to preserve the value of their capital and 15% to make a modest gain in real terms. There are no ‘acceptable risk’ investments at today’s zero/sub-zero interest rates that can yield such a return.
The problem is the Fed’s grasp of the US economy is more like clasping a tiger by the tail. It can let the rotten parts of the financial system – meaning most of the hallowed names in banking, investment, insurance, etc. – to fall apart and allow the economy to rebuild on what remains as a healthy core. This will mean an immediate devastation of people’s capital but, eventually, real growth and stable returns under a more honest system. Or it can continue what it is doing now – pumping endless phony money into the economy to keep its rotted parts moving around in zombie-like trance until a slow, but certain, collapse of the system occurs due to diminishing benefits from each wave of money printing. The choice it has made is political, based on Keynes’ cynical remark that in the long run we are all dead.
The Fed was too lenient when rescuing Wall Street. Shareholders and management should have been taken to the cleaners rather than leaving the taxpayer to foot the bill. Bond-holders, however, should have been rescued to preserve confidence in the financial system — similar to Sweden in the 1990s.
Jobs are not coming back. Computers and robots are increasing in power exponentially. Companies will hire less and less people and use computers and robots more and more. I was struck that Foxcon, the megamanufacturer using cheap chinese workers is building the biggest robot factory in the world. Even chinese labor will be too expensive to compete with robots in the future. Our economic system was built to deal with scarcity. What will a new economic system that deals with technologically created abundance look like? What will people do when robots do most everything that needs doing?
As some of our needs are filled we develop others. Consider the agricultural revolution where mechanisation and scientific techniques displaced millions of rural farm workers around the world. As food became cheaper, society developed other needs. The same is likely to occur with manufacturing.
Colin has given a perfect description of what KEYNES termed the “LIQUIDITY TRAP”. I rarely see it mentioned but it is fundamental to understanding where we are at the moment. The LIQUIDITY TRAP is a situation where EVEN AT ZERO INTEREST RATES the private sector does not want to borrow money. Private consumers are actually repaying debt because they are so pessimistic about their job and wealth prospects. Private firms are either repaying debt or refinancing at very low interest rates. They will not invest even at zero interest rates because they have spare productive capacity and are pessimistic about future demand for their products.
In these circumstances, simply increasing the money supply has no impact on real output. The excess of the supply of money over the demand for it has to go somewhere. At the moment it is going into the shares of the largest multinational corporations or into the hands of the governments, who are using it to refinance their debt at very low interest rates.
Monetary policy is a waste of time in these circumstances. The only way toi reduce the public debt level in the medium and long term is to INCREASE IT INNTHE SHORT TERM. This a paradox that very few people understand. We all need a much bigger budget deficit. The Obama boost to the economy in 2009-2010 was much too small. We urgently need a big increase in the deficit in order to kick start the economy.
For a generation KEYNESIAN economic has been taboo. This is a dogmatic rejection of the finest analysis that has ever been achieved of how economies work.
“For a generation KEYNESIAN economic has been taboo”. Really? On which planet? On earth here, Keynesian economics has been the mainstream economics for a generation with practically every major economy indulging in deficit financing for decades. It is the cause of our present predicament, not the solution.
KV, I would suggest that misinterpretation of Keynes is the cause of our predicament.
Well, as a student of the Austrian School, I tend to see it differently, Colin. One thing I agree on though about Keynes. He hit the nail on the head by proposing Bancor. Had it been accepted, the US, and the rest of the world, wouldn’t be in the present mess.
I prefer not to align myself to any camp. Some of Keynes is brilliant. Some is not.
The same can be said of Austrians and Monetarists.
Great post Alan. I agree with your conclusions but would qualify that any deficit should be used to fund productive infrastructure investment and not just “spent”. That way the state has productive assets (that hopefully generate an income) as a counter-weight to the public debt.
The artificial interest rates have already cast the mold for the next disastrous crisis which could be the worst in history. This imminent crisis will have a deleterious affect on the World standing of the United States of America.