The current state of capital markets is troubling, particularly for savers and retirees. Despite this, central bankers appear indifferent. This disconnect is a direct result of nearly eight years of maintaining interest rates at near-zero levels.
This prolonged monetary policy has disrupted the pricing equilibrium in capital markets. Bond yields, for instance, no longer reflect the true market-determined cost of borrowing, which has led to erratic interest rate fluctuations.
Currently, the yield on the 10-Year U.S. Treasury note is plummeting. Recently, it hit an unprecedented low of 1.34 percent, marking the lowest yield observed since records began, dating back to around 1870.
The last noteworthy low in interest rates occurred in the early 1940s, with yields hovering around 2 percent. As for where we might see yields bottom out this time, that remains uncertain.
So, who is investing their hard-earned money in Treasuries at such insignificant returns? While these yields may exceed the negative rates offered by Swiss 50-year bonds, one has to question whether, with the Federal Reserve’s target of 2 percent inflation, it is feasible for inflation to surpass 1.34 percent over the next decade.
A Matter of Life or Death
For full transparency, we have been predicting the end of the Treasury bond bubble for nearly eight years—perhaps even longer. After a steady decline from a peak of over 15 percent in 1981, it seemed logical that yields would eventually stabilize around 2 percent before embarking on a long-term upward trend. However, this has yet to materialize. Instead, yields have continued to decrease.
In retrospect, we did not fully grasp the significance of a crucial element in this credit cycle, particularly how it diverges from past cycles.
Given the fiat currency system and excessive central bank intervention, we underestimated how far unreasonable situations could stretch beyond the conceivable. Perhaps we needed to envision more drastic scenarios.
In recent years, we have made a concerted effort to recalibrate our expectations—essentially, we have abandoned them.
Despite the lack of expectations, we are not complacent. In fact, we monitor the fluctuations in 10-Year Treasury yields with intense scrutiny, much like we would observe a concerning change on our skin.
We often wonder what slight variations might mean. Could they ultimately become a matter of life or death? These are the pressing questions that linger for us.
Larry Summers Wants to Give You a Free Lunch
This week, one potential solution was proposed by Larry Summers, the former Treasury Secretary. Summers, confident in his intelligence, seems to possess answers before questions are even posed.
According to Summers’ perspective, the world is suffering from a demand shortage. He argues that the real interest rates necessary to balance investment and savings at full employment are unusually low and may often be unattainable due to constraints on nominal interest rate reductions.
As a consequence, we are left with persistently low long-term real rates, sluggish growth expectations, and doubts regarding the ability to achieve an average inflation rate of 2 percent in the long run. This leads to a belief that central banks will struggle to normalize financial conditions in the near future.
Summers believes that in this era of low growth and low interest rates, the implications of government debt are negligible.
In his view, “In a world where interest rates over horizons of more than a generation are far lower than even pessimistic projections of growth, traditional thinking about debt sustainability should be reconsidered. In the U.S., U.K., Eurozone, and Japan, the real cost of 30-year debt could be negative or negligible if inflation targets are met.”
Surprisingly, he seems to possess foresight about interest rates generations into the future. With his outlook on persistently low rates, Summers argues that expansionary fiscal policy could effectively finance itself. This implies that governments can freely increase spending and run up debts, believing that such fiscal stimulus will ultimately balance out.
Do you find Summers’ proposals compelling? What if bond yields were to rise instead of fall over the next generation? In that scenario, fiscal stimulus could become a self-destructive force rather than achieving financial balance.
By our assessment, however, it appears that he is merely offering a promise of something-for-nothing, suggesting he can provide a free lunch. Such thinking may be what has contributed to our current predicament.
We advocate for sound monetary principles and the responsible discipline that accompanies them. Yet, we acknowledge that we may lack some of the unique qualifications that Summers possesses. For instance, we have never lost $1.8 billion of other people’s funds.
Sincerely,
MN Gordon
for Economic Prism
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