Hi LongIslandGuy.
OK, let's try this again after I've got my facts straight. (smile)
((I do not agree that the US will raise rates in a deflationary environment. That is an oft cited mistake of 1930's monetary policy. Perhaps in 75 years, the Fed's recent rise in rates may be seen as a mistake!!))
I think I may stand corrected on this one (blush). For some reason, I was under the impression that U.S. interest rates spiked in the 1930-33 period, only to moderate around the 2.5 percent range later in the decade. But after some quick checking, I see “real” interest rates did indeed spike during the 1929-32 period, but only because of collapsing prices (i.e. deflation), and nominal interest rates remained very close to zero. (See p. 4 of the following document)
dallasfed.org
So let me explore things a bit here.
It’s interesting to note in page 4 of the above document that in the U.S., “real” interest rates from mid-1929 thru 1932 ranged from a low of 5%, to a high of 15%, and never rose fell below 5%. (Can you imagine the effect real interest rates of this magnitude would have on today’s housing market?!)
Now what if these very high real interest rates were not primarily the result of “policy error”, but much more so the effect of a monster K-wave type credit bubble bust.
Consider 2 distinct ways of realizing 15% real interest rates: (i) a 0% interest rate, and a 15% collapse in the price level (i.e. deflation), or (ii) a 15% interest rate, and a constant price level (i.e. no deflation).
Now the experience of the U.S. in the 1930’s was an instance of the first scenario above, but the U.S. of the 1930’s is not the U.S. of today. In the 1930’s the U.S. was the world’s largest creditor nation, today it is the world’s largest debtor nation. That the U.S. is the world’s largest debtor nation is best evidenced by the massive foreign bond holdings in the hands of most importantly the Asian Central Banks.
So I guess my question is, does the 21st century U.S.-version of a credit bust look like the U.S. of the 1930’s or Japan of the 1990’s, or does it look a bit more like Mexico or Argentina’s recent experience which is more typical of scenario #2? The important question being, IMO, what path do we take to very high real interest rates?
Scenario #1 would be great for bond-holders (i.e. foreigners), but enormously ruinous to debtors (i.e. the U.S.). So how likely is this scenario really? Scenario #2 would be disastrous for bond-holders, and a boon to foreign creditors. Is this really the likely resolution here?
The absence of either scenario 1 or 2 – i.e. continuing negative real interest rates – is a recipe ultimately for hyperinflation (the Jim Puplava scenario if you will), continued misallocation of scarce resources to marginal consumption, and almost assuredly a run on the dollar.
Just some random thoughts, the headwinds certainly are deflationary. But somehow given the sociology of U.S. debt ownership (i.e. foreigners), I just can’t envision a bond bull out of this situation. We shall see.
((I wouldn't knock emerging market debt by the way. There just isn't enough of it to go around so it should outperform over the long haul, even at these spreads.))
Regarding not enough emerging market debt to go around ... It's amazing in times of a credit bubble how there tends not to be enough of any asset to go around - be it debt, tech stocks, commodities, or houses. But if we hit a liquidity crisis, I doubt very much that there won't be enough emerging market debt to "go around". Where the heck is the non-debt based liquidity going to come from to sustain this insatiable demand for emerging market debt? From U.S. household/consumers???
Thanks for the dialogue LIG, and for setting me straight on 1930’s interest rates. :)
Regards,
Glenn |
