low interest rates and inflation
secondrepublic
Posts: 2,619 ✭✭✭
Great article a couple of days ago in the Wall Street Journal by a Princeton econ. professor explaining why low interest rates are a form of debt restructuring by Uncle Sam. Link. Explains the paradox of how long-term interest rates can be so low at the same time as money is flowing into gold, etc. because of inflation fears -- a question I've wrestled with the last few years. Some choice quotes:
Artificially low interest rates are a subtle form of debt restructuring and represent a kind of invisible taxation. Today, the 10-year U.S. Treasury bond yields 2%, which is below the current 3.5% headline (Consumer Price Index) rate of inflation. Even if inflation over the next decade averages 2%, which is the Federal Reserve's informal target, investors will find that they will have earned a zero real rate of return. If inflation accelerates, the rate of return will be negative.
We have seen this movie before. After World War II, the debt-to-GDP ratio in the United States peaked at 122% in 1946, even higher than today's ratio of about 100%. The policy response then was to keep interest rates pegged at the low wartime levels for several years and then to allow them to rise only gradually beginning in the 1950s. Moderate-to-high inflation did reduce the debt/GDP ratio to 33% in 1980, but this was achieved at the expense of the bondholder.
Ten-year Treasurys yielded 2.5% during the late 1940s. Bond investors suffered a double whammy during the 1950s and later. Not only were interest rates artificially low at the start of the period, but bondholders suffered capital losses when interest rates were allowed to rise. As a result, bondholders received nominal rates of return that were barely positive over the period and real returns (after inflation) that were significantly negative. We are likely to be entering a similar period today.
Artificially low interest rates are a subtle form of debt restructuring and represent a kind of invisible taxation. Today, the 10-year U.S. Treasury bond yields 2%, which is below the current 3.5% headline (Consumer Price Index) rate of inflation. Even if inflation over the next decade averages 2%, which is the Federal Reserve's informal target, investors will find that they will have earned a zero real rate of return. If inflation accelerates, the rate of return will be negative.
We have seen this movie before. After World War II, the debt-to-GDP ratio in the United States peaked at 122% in 1946, even higher than today's ratio of about 100%. The policy response then was to keep interest rates pegged at the low wartime levels for several years and then to allow them to rise only gradually beginning in the 1950s. Moderate-to-high inflation did reduce the debt/GDP ratio to 33% in 1980, but this was achieved at the expense of the bondholder.
Ten-year Treasurys yielded 2.5% during the late 1940s. Bond investors suffered a double whammy during the 1950s and later. Not only were interest rates artificially low at the start of the period, but bondholders suffered capital losses when interest rates were allowed to rise. As a result, bondholders received nominal rates of return that were barely positive over the period and real returns (after inflation) that were significantly negative. We are likely to be entering a similar period today.
"Men who had never shown any ability to make or increase fortunes for themselves abounded in brilliant plans for creating and increasing wealth for the country at large." Fiat Money Inflation in France, Andrew Dickson White (1912)
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In the end of course the gov't strategy will devalue the dollar, thus the cost is spread far & wide. But the flow pattern is interesting.
The Baleys have recently restructured some debt and taken on some new debt for real estate investment at these new lower rates, figuring now is the time, how can they go any lower??
Out of bonds entirely right now. In fact, got out too early, but that's okay, the other asset classes chosen over bonds have done very well, even the metals are starting to hold their own and are starting to represent decent relative value, so adding there too.
Liberty: Parent of Science & Industry
If I create debt I have to pay it off, I can't stick it over there and forget about it.
What if everyone that held debt said screw it I'm not paying? Thankfully my house is paid for and I carry $0 debt.
One thing I do know, an oz. of gold will always be an oz. of gold