The Fed’s EZ money policies will either succeed or fail. Either way, it will be a disaster. If they succeed, interest rates will rise and America’s debt-addicted economy will get the shakes. If they fail, the Fed will double down with further acts of reckless improvisation, including bigger doses of credit, until the whole thing blows up.
On Friday, it looked like the disaster might come from success. Gold took another solid right to the jaw, down $39. Stocks went up 147 points on the Dow. The proximate cause of both these things was the latest news from the jobs arena. Apparently, employers are once again reaching out and dragging able-bodied men and women into their shops.
What does this mean, investors asked themselves.
“The Fed can now taper off,” said some. “Sell gold!”
“The economy is recovering,” said others. “Buy stocks!”
We noticed a few mean-spirited comments on the internet, sniping at the figures. One website post told us that most of the new jobs are as waiters and bartenders. Another reminded us that people are still waiting more than 30 months before they find a job and that the workforce as a percentage of the population is at its lowest level since the ‘70s.
But let’s give credit where it is due. These employment numbers bespeak a kind of success: in spite of the Fed’s policies, the economy is not only still alive, but getting back on its feet.
If this is so, it is good news for the people who have finally found meaningful employment. As for the future of the US economy, it is a disaster.
What’s the most important thing that is happening in world markets?
C’mon… you know.
Bonds are going down; interest rates (yields) are going up.
This is not a fact, of course. It is a guess. Like all guesses, it comes with a caveat lector: it ain’t necessarily so. Mr Market is a fooler. And he could be fooling us now.
But a change of direction in the bond market is inevitable. And when it happens it will be devastating. But for whom, exactly? How? When?
A whole generation has come of age in a time of falling interest rates. When the last turn came, the boomers were just reaching maturity, setting up families, beginning their careers, and starting to think about investing. From 1981 until last month, they knew nothing else: lending rates went down, down, down from mortgages over 10% to mortgages under 4%. Stocks went up (with periodic dizzy spells). Bonds went up. The economy, too, seemed to grow without much effort.
A world of falling interest rates is a gentle, forgiving world. If you get into financial trouble, you refinance at lower interest rates. It’s hard to go broke when people make more and more credit available at lower and lower lending rates. It’s hard not to make money, too, when people are spending money they have never earned.
But it is a strange world. It is a world of make-believe, where people make-believe they have income they don’t really have. Where retailers make believe they have customers who can pay their bills. Where the feds’ economists make believe they have things under control and that the ‘great moderation’ is a feature of their own clever management.
It is also an unsustainable, unbalanced, rickety kind of world. A world that will fall over sooner or later. Why? Because not forever can people spend money they don’t have. And when the turn comes, the world will not be so forgiving, not so easy and not so readily manipulated by the feds’ clumsy economists.
First, the money ceases to flow from lender to borrower to retailer to stockholder. Instead, it begins to flow in the opposite direction; stockholders, retailers, and borrowers all see their revenues decline. Lenders begin to see their money come back to them. But alas, even they are disappointed. Because the loans they made at 3% seem paltry and stupid in a world of 5% yields. Their money went out full of youthful confidence, it comes back hunched over, worn out from too many late nights and too much partying.
If the rise in real interest rates were to begin now (as perhaps it has), it sets the whole show running in reverse. Instead of EZ credit and smiling creditors, borrowers face grumpy loan officers and higher lending rates. They also find that they must cut back their spending in order to pay the higher rates or go broke. And this time, there is no one there ready to catch them when they fall. There are no opportunities to refinance, not even at higher rates.
In a ‘normal’ credit cycle all of this happens with the usual crises and catastrophes. Some businesses go broke. But some increase market share. Some households file for bankruptcy. Others prosper. Some lenders take big losses. Others manage their risks more carefully.
Nothing special, in other words. But what happens when credit has been abnormally expanded? The last bear market in bonds (with rising yields) began after WWII, without very little debt outstanding. What happens when people have debt up the kazoo and interest rates rise? What happens when the whole economy – from the federal budget to household finances – depends on unprecedented levels of debt at unsustainably low interest rates?
That is what we are going to find out. Because, if the economy really is warming up, the unseasonably low interest rates of the ‘Great Correction’ are bound to thaw out too.[xyz_lbx_custom_shortcode id=5]