Musings

27 January 2015 - 22:16, by , in Musings, Comments off

Raising interest rates…

It’s the one thing that everyone is sure is going to happen, unless you are Japan or Europe or perhaps the United States. Long term bond interest rates in many of the developed world currencies are falling sometimes into negative rates. That means that some people are happy to receive most of their money back.

The modern economies are in the grips of a crisis that is caused by too much debt and entitlements. The solution that politicians want to use to fix this problem is more debt…

It has worked so well in Japan that Europe and the US will adopt the same useless policies. If you look at the interest rates in Japan, they have been going down for a long time as you can see below.

ycharts_chart-5

Rather than rehash some of the research as to why interest rates can stay low for a long time, let’s look at a practical one.

The US government runs a deficit; they spend more than they take in. They finance this deficit by issuing bonds. At the moment there are $12.5 trillion bonds outstanding, of this T Bills represent $1.457 trillion. T bills are the easiest to crunch numbers on as they are very closely associated with the Fed Funds rate. The yield on these T Bills is currently 0.03 %.*

That means the US Treasury pays interest on these T bills of about $437m dollars a year. The artificially low interest rates manufactured by the Federal Reserve Bank have been a huge boon for the Government; they can continue to spend money and not have to pay for it.

Now let’s imagine interest rates “normalize” to 4% – a number that many people think might happen sometime soon.

With $1.457 trillion dollars of T bills at 4%, that’s an annual expense of $58b dollars a year. That’s a monstrous number. The president proposed free community college at a cost of $60b over 10 years, that’s almost us much in one year if interest rates change.

People will do what they are incented to do. Politicians are incented to come up with crappy policies that enable them to seek reelection.

It would be impossible to function with higher interest rates because of the additional debt that has been incurred. The current budget allocates about 6% of spending to interest expense. If that number doubles or triples, it would be almost as much as the current military budget.

For me this is a more practical reason as to why interest rates won’t go up much if at all. It doesn’t require Austrian economic theories, neo-classical theories or global macro theories.

Rates can’t go up as the government can’t afford it.

Bye for now.

 

*Data pulled from:

http://www.whitehouse.gov/omb/budget/Historicals/,

https://www.nationalpriorities.org/

http://www.sifma.org/research/statistics.aspx

About author:
Damien is the founder and owner of Lanyon Advisory Services and has a extensive knowledge and experience in financial planning and wealth management.

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