A history of interest rates through the ages

Double click to enlarge

What this chart shows is how government debt became a source of income, like ownership of land, and then how governments in recent years tried to use interest rates as a way to guide the economy.

The theory is that low interest rates generate cheap money, which stimulates the economy, but also leads to inflation, while high interest rates do the reverse.

The problem with the theory is that we in the USA and UK have been in a period of unprecedentedly low interest rates for years, but that this has neither stimulated productive investment nor led to runaway inflation.

Something’s wrong that isn’t being fixed by tweaking interest rates and the money supply.

LINK

The History of Interest Rates Over 670 Years by Nicolas LePan for Visual Capitalist.

10-year Treasury bond interest at a record low

I thought this chart was interesting.

Chart from the Wall Street Journal via Barry Ritholtz

Interest rates on 10-year U.S. Treasury bonds fell to 1.34 percent on Tuesday, the lowest in 225 years.  They bounced back on Wednesday to only 1.37 percent.

Bond yields of other governments also are low, with the UK, Germany and Japan at record lows.  Ten-year rates in Japan, Germany, the Netherlands and Switzerland are negative—that is, you get back less than you paid for the bond!  France offers 0.13 of a percent on 10-year bonds, Britain 0.91 of a percent.

What this means is that investors are fearful of future, and prefer the safety of government bonds, even at low, non-existent or even negative interest rates, than the risk of investing in the stock market.  Not a good omen!

LINKS

Why the 10-Year Treasury Yield Is at Record Lows by Steve Schaefer for Forbes.

Another Fed Fiasco: U.S. Bonds Fall to Record Lows by Mike Whitney [added 7/14/2016]

Why Interest Rates Are Lower Than Ever, and Why That’s Scary by Paul J. Lim for Money magazine.

10-Year Treasury yield hits record low by Adam Shell for USA Today.

Strong demand for UK gilts at record low yield by Elaine Moore for Financial Times.

Quantitative easing didn’t revive the economy

The Federal Reserve System pumped billions of dollars into failing banks by buying up their toxic assets, and pumped up the stock market by holding down interest rates to as near as zero as possible.

This benefited Wall Street and the big banks, but, as the chart above demonstrates, it didn’t help the real economy much.

The top line on the graph shows the amount of money the Fed pumped into the banks.  The next line shows the amount of new money that actually went into circulation.  The third line shows the amount of loans the banks made.  The line in the second chart shows the rate of inflation by the most conservative measure.

A lot of individual savers bought stocks and bonds because their banks wouldn’t give them any interest on their savings accounts.  This would have been a good thing if the money that went into the financial markets had been invested in starting or expanding businesses, but this didn’t happen.

Corporations are sitting on trillions of dollars in cash.  They understand that the speculative boom sparked by qualitative easing is bound to crash.

LINK

The Chart That Explains Everything by Mike Whitney for Counterpunch.

Fed at Fault: What Goes Up Must Come Down on the Deconstructed Globe.

Why Are the Largest Corporations Sitting on Trillions in Cash? by Gaius Publius for Down With Tyranny!

Big Short Genius Says Another Crash Is Coming by Jessica Pressler for New York magazine.

Does it matter if Fed raises a key rate 1/4 of 1%?

Source: Zero Hedge.

The Open Market Committee of the Federal Reserve System has raised a key interest rate from a quarter of a percentage point to half a percentage point.

Many economists and writers fear this may sink the economic recovery.  I say that if such a minute change will sink the recovery, the recovery was leaky to begin with.

The interest rate is the Fed Funds target rate, the interest rate at which banks lend money to each other overnight in order to have the minimum reserve funds required by the Federal Reserve System.

One of the goals of the Federal Reserve System is to strike a balance between unemployment and inflation by regulating interest rates and the supply of money.

The idea is that when interest rates are low, people borrow more money to spend and investment, resulting in more jobs but also inflation and price increases.  When interest rates are high, the reverse supposedly happens.

But key interest rates have been at nearly zero (or below zero according to some measures), and the economy hasn’t responded.  The increase in jobs is much less than in previous economic recoveries, while inflation continues low.

The U.S. economy on life support

 

The Federal Reserve Board will soon decide once again whether to continue to hold down interest rates or to allow them to rise.

The board is in more or less the same position as a physician trying to decide whether to remove life support a patient who is in intensive care.

All the indicators are that the patient is too weak to be removed from life support.  Yet the patient can’t stay on life support forever.

I used to criticize the Federal Reserve Board on the grounds that it preferred tight money and high unemployment to the possibility of inflation.  That’s yesterday’s news.  Now the Fed’s concern is how to get the country out of its long-term recession.

The historic Keynesian remedy for recession is to increase the money supply and hold down interest rates.  The idea is that putting money in circulation and making credit readily available will encourage consumers to buy things and businesses to invest.

But this time around, it didn’t happen.  Banks and financial institutions invested in debt rather than in production of tangible goods and services.   Savers invested in stocks and bonds because they couldn’t get any interest on their bank accounts, but this didn’t stimulate the real economy either, or at least not very much.

Low interest rates haven’t spurred a recovery

It’s a financial axiom that central banks can make money available and set the rates, but they cannot dictate where it goes.

Yet, the IMF just now seems to be figuring that out.

As for central bank sponsored “risk taking,” haven’t we seen enough already?

Where the Money Went

• Junk bond speculation
• Stock market speculation
• Stock market buybacks at ludicrous prices
• Robots in lieu of hiring
• Free profit for banks thanks to interest on “excess reserves”
• Private equity firms buying up houses
• In Europe, banks loaded up on their own allegedly risk-free bonds
• In China, property bubbles and profitless SOEs [state-owned enterprises]
  

Where the Money Didn’t Go

• Higher wages
• Infrastructure
• Investment

via Mish’s Global Economic Trend Analysis.

(Hat tip to Naked Capitalism)

Who benefits from ultra-low interest rates?

Governments, large corporations and American banks have been the main beneficiaries of lower interest rates, according to a study by McKinsey Global Research.  The results are shown in this chart,

To understand the chart, you have to keep in mind the meaning of the word “net”.  The U.S. government had a “net” improvement in interest income in 2012 over 2007, but what that meant was that it was paying out $900 billion less in interest at the end of the period.   Large corporations and governments in other countries also lowered their borrowing costs, and this constituted a “net” gain for them over the five-year period.

Banks in the U.K. and continental Europe were hurt, but U.S. banks gained because they increased the spread between their borrowing costs and the interest rates they charged.

Families with savings were hurt.  Interest on my own bank account is virtually zero.  Pension funds took a hit.  So did insurance companies; a lot of their income comes from investing the money paid in premiums until it has to be paid out in claims.

The McKinsey analysts, unlike me, don’t think that ultra-low interest rates are driving people into the stock market.  But they didn’t see any signs of increased business investment or economic activity as a result of low rates.  The economy is stuck in low gear, and artificially low interest rates haven’t shifted this.

The LIBOR scandal explained

This is the best explanation I’ve seen of what the LIBOR scandal was and why it matters.

Designed by www.accountingdegree.net

For more about how LIBOR works, read on.

Markets, manipulators and the LIBOR scandal

The great thing about a free market economy is that the market is impersonal.  The rise and fall of supply and demand coordinate the activities of many people without being under the control of any one person or any group of people.  Individuals are impelled by self-interest to compete to provide goods and services of high quality or low price.

That’s how a free market economy is supposed to work, and very often it does work that way.  But when economic power is highly concentrated, what we’re told is the result of free market competition is actually the decision of specific individuals—people with names, addresses and telephone numbers.

The London Interbank Overnight Offered Rate, known at LIBOR, is the average interest rate big banks on London charge each other for overnight loans.  London is as important a financial center as New York City, maybe more important, and lenders all over the world use LIBOR as a base for setting variable interest rates.  Credit card interest rates and variable mortgage interest rates in the United States are usually set at so many percentage points above LIBOR.

It turns out that the LIBOR interest rate has been rigged for at least five years.  One big bank, Barclays, has admitted reporting rates to LIBOR that were lower than what was actually paid, and the outgoing CEO of Barclays says this was done at the request of the Bank of England, which is equivalent to the U.S. Federal Reserve.  It appears that other banks were in on it.  At least 20 banks have been named in investigations and lawsuits.  So the LIBOR rate wasn’t a market rate at all.  It was what certain individuals wanted the world to think the market rate would be.

Why would you rig the LIBOR rate?  The higher the overnight rate a bank pays, the riskier the bank’s perceived prospects.  The higher the LIBOR rate, the riskier the banks’ perception of the economy.  The purpose of falsely reporting a lower rate than the actual rate is to make the public think things are better than they are.

I’m not sure who suffered economic hardship because of the false LIBOR rate.  If credit card interest and variable mortgage interest were lower than they otherwise would have been, that would be good news for borrowers.  It would have hurt municipal and county governments with funds they were parking in short term securities—for example, money they’d raised on a bond issue for a new school or sewerage plant they hadn’t gotten around to spending yet.

If the banks had reported a falsely high LIBOR rate, that would have jacked up the returns on variable rate investments.  Who profited and who lost would have depended on who was borrowing and who was lending at any given time.

What’s at stake is the principle of the thing.  You can’t make good economic decisions based on lies.

If this scandal had happened in the United States, we would expect that (1) the financial institutions would pay fines of lesser amounts than their profits from the rigging and (2) nobody would go to jail.  It will be interesting to see if things work differently in the United Kingdom.

Click on Q&A: Barclays and bank rates for a basic summary of the LIBOR scandal by BBC News.

Click on The LIBOR scandal: The rotten heart of finance for a more detailed summary of the LIBOR scandal by The Economist, which says the LIBOR rate has been manipulated for decades.

Click on JP Morgan, Barclay’s, Other Banksters Investigated for Manipulating Electricity Markets for a report on a completely different financial scandal from Firedoglake.

Click on Why Is Nobody Freaking Out Over the LIBOR Banking Scandal? and LIBOR Banking Scandal Deepens for more about the LIBOR scandal from Matt Taibbi of Rolling Stone.

Click on Massive Furor in UK Over LIBOR Manipulation: Where’s the Outrage Here? and The Real Action in the LIBOR Scandal Was in the Derivatives Trading for more about the LIBOR scandal from Naked Capitalism.

Click on Let’s end this rotten culture that only rewards rogues for an editorial on the LIBOR scandal by The Observer in London.