The Federal Reserve maintained artificially low interest rates from approximately 2008 to 2022. This was achieved by generating $8 trillion in credit through the purchase of Treasuries and mortgage-backed securities.
This artificial manipulation led to stock, bond, and real estate markets soaring beyond what the economy could sustain. It also paved the way for an array of speculative ventures.
Speculative booms consistently gain traction with the support of expanded credit. Historical examples illustrate this repetitive cycle.
Take the Dutch Tulip Mania of 1636 and 1637, for instance. In this case, personal credit fueled the craze. At the height of the mania, sellers had no tulip bulbs available, yet buyers made down payments using their personal belongings because they lacked cash.
Another example is John Law’s Mississippi Bubble from 1718 to 1720, which was inflated by paper notes issued by his Banque Générale, later known as Banque Royale. Similarly, the housing boom from 2003 to 2007 was facilitated by low interest rates and credit expansion through mortgage-backed securities.
While the objects of speculation may vary—from canals to railroads to IPOs and electric vehicles—the pattern of boom and bust remains remarkably consistent. One particularly amusing recurrent object of speculation is art.
One memorable incident in 2006, during a period of cheap credit, involved what has been dubbed the “$40 million elbow”. Casino mogul Steve Wynn accidentally pierced the canvas of Picasso’s “Le Rêve” with his elbow, resulting in a reported damage of around $40 million. After hearing the distinct sound of tearing, Wynn lamented, “I can’t believe I just did that.”
Inspiring Foolishness
Fast forward to March 2021, about nine months after interest rates reached an unprecedented 5,000-year low, and the emergence of digital NFT art captured attention. NFTs, or non-fungible tokens, briefly became the hottest trend in the art world.
The NFT collection WarNymph, created by Grimes, fetched an astonishing $5.8 million. Meanwhile, an individual named Beeple sold a digital collage NFT called Everydays – The First 5000 Days for a staggering $69 million.
A group of crypto enthusiasts even live-streamed the burning of a print of Banksy’s Morons and created a corresponding NFT, Burnt Banksy, to symbolize the artwork—now recorded on the Ethereum-based OpenSea marketplace. The individual who ignited the artwork shared his reasoning:
“The reason behind this is because if we had the NFT and the physical piece, the value would be primarily in the physical piece. By removing the physical piece from existence and only having the NFT, we ensure that, due to the smart contract on the blockchain, no one can alter the piece, and it is the authentic artwork that exists in the world.
“By doing this, the value of the physical piece will be transferred to the NFT and become the only way to possess this piece anymore. Our goal is to inspire and explore new avenues of artistic expression.”
This act of destruction somehow inspired someone to buy Burnt Banksy for a digital token representing the work priced at $380,000.
Negative Interest Rates
One potential upside to rising interest rates is that it forces the speculative frenzy to come back down to reality. The absence of cheap credit diminishes the allure of rapid, speculative profits, revealing former speculative objects to be largely worthless.
In fact, with NFTs, it has been found that a significant number are now devoid of value. According to research by dappGambl, an analysis using data from NFT Scan showed shocking results:
“Of the 73,257 NFT collections we identified, an astonishing 69,795 have a market cap of 0 Ether (ETH).
“This statistic essentially means that 95 percent of individuals holding NFT collections are presently in possession of worthless investments. Our estimates suggest that this figure encompasses more than 23 million people whose investments have now lost all value.”
Anyone with even a slight sense of skepticism recognized that NFTs were probably a scam. How could one not?
And what about negative real interest rates—when inflation outpaces the nominal interest rate?
Typically, investors expect bond yields to provide a sufficient risk premium while also accounting for inflation. However, the Fed’s bond purchases have inverted this relationship.
For example, the 10-Year Treasury Inflation Protected Security (TIPS) serves as a useful indicator of real, inflation-adjusted interest rates. Data from the Federal Reserve Bank of St. Louis indicates that real interest rates on the 10-Year Treasury remained negative from early 2020 through April 2022. Credit was essentially offered for free—a massive deception.
Death to Savers
By June 2022, consumer prices—as gauged by the consumer price index—were rising at an annual rate of 9.1 percent, the highest in four decades. The deception of negative real interest rates became unmistakable amid soaring costs for goods and services.
Since March 2022, the Fed has raised the federal funds rate by 5.25 percent in an attempt to curb the inflation it helped create. Consequently, the yield on the 10-Year Treasury note—used as a benchmark for mortgage rates and other consumer borrowing costs—has surged.
As of market close on Thursday [October 26], the yield on the 10-Year Treasury note was at 4.84 percent, reaching over 5 percent earlier in the week, a peak not observed in 16 years.
Simultaneously, while consumer price inflation has decreased from its peak, it remains significantly above the Fed’s 2 percent target. The most recent CPI figures indicate an annual inflation rate of 3.7 percent as of September.
This essentially signifies that a 10-year Treasury yield of 4.84 percent suggests that credit markets still exhibit some accommodative tendencies. Specifically, the real interest rate, as shown by the 10-Year TIPS, was a mere 2.44 percent.
Given the U.S. Treasury’s projected massive issuance of government bonds in the coming year, further increases in yields will be essential to attract buyers. Could this mark the return of a favorable era for savers?
In all fairness, the 21st century has largely been dismal for savers, offering them nominal interest rates that barely exceed a fraction of a percent for most of that time. For over ten years, certificates of deposit (CDs) yielded less than 1 percent.
Nevertheless, a shift may finally be on the horizon, hinting at a new renaissance for savers.
For example, back in August 1984, 1-year CDs were yielding over 11 percent and the 10-Year Treasury yield surpassed 12 percent.
While the journey to return to those double-digit yields is undoubtedly lengthy, the fundamental aspects of America’s debt market may eventually lead us back there.
Yet, it’s important to remain realistic. The divide between what should happen and what will actually occur is vast.
With a staggering $33.5 trillion in debt and annual deficits projected between $2 to $3 trillion for the next decade, the U.S. government will be unable to sustain double-digit interest rates.
It is likely that the Fed will be compelled to re-enter the bond market long before the yield on the 10-Year Treasury reaches 12 percent.
This action would devalue the dollar, once again jeopardizing savers. Moreover, it would trigger a new wave of speculative behavior, drawing individuals into new financial fads as moths are drawn to light.
[Editor’s note: Unconventional investing strategies have never been more crucial. Find out how to safeguard your wealth and financial privacy with the Financial First Aid Kit.]
Sincerely,
MN Gordon
for Economic Prism
