An Empty Gesture

On Wednesday Dec 16, Federal Reserve Chair Janet Yellen announced that the Fed was raising the federal funds rate by 25 basis points.

Let’s get one thing out of the way. This is not a move towards free markets. Whether the Fed sets interest lower, or whether it sets interest higher, we still have central planning. We still have price fixing of interest rates.


Central_planning_voodoo_cartoon_05.07.2015_normalThe scientific process of central monetary planning


Interest rates may be set too low. However, forcing interest up is no cure. We need to eliminate central planning, and move to a free market in interest. This is impossible in our present monetary regime.

Anyway, given the system as it is, the Fed is going to have to take back this interest rate hike. Here is Exhibit A of our case: a graph of the 10-year US Treasury bond yield.


chart-1-t-note yield10 year treasury note yield – still positive (phew!) – click to enlarge.


At least the US dollar still has interest. Switzerland and several countries in the European Union don’t. Their currencies are drowning under the zero line.

For example, the Swiss government 10-year bond takes 0.16% per year from lenders. That’s right, if you fork over your francs to buy that bond, you get back less at the end. Germany is little better, with its five-year bond charging investors 0.1%.


chart-2-Germany, 2 year yieldGermany: the 2 year note yield stands at minus 0.34% – at the shorter end of the curve, these “yields” have fallen deeply into negative territory. This stands the universal category of human time preference on its head. It is as if time no longer had any meaning – click to enlarge.


The global trend for over three decades has been falling interest. The yield on the 10-year Treasury even fell after the Fed’s announcement. Yellen thinks to fight this megatrend, but that’s absurd. Let’s look at why.


A One-Way Ratchet

The process that sets the interest rate is complex. I have written many words on its terminal decline. However, there are two simple reasons why the trend remains downward.

One, banks today have a business model called maturity transformation. They borrow short term to lend long term. To understand this, consider the simple example of buying a house. Only, you don’t get a normal mortgage.

You get a balloon loan due tomorrow morning. Every day, you have to borrow anew. This would be crazy for an individual homeowner to attempt. However, it’s what banks do. They risk an increase in their cost of funding. That would be a problem, because the interest they receive on their bonds is fixed.

The problem isn’t just reduced cash flows. When the cost of funding goes up, some bondholders are obliged to sell bonds. That causes a drop in the price of bonds, and all bondholders take capital losses. With reduced capital, banks have to cut back on lending. Funding to business is reduced, and there can be a recession.


yields biteFrom “how cute” to “oh my, what big teeth you have!”. Rising rates are certain to eventually take a big bite out of asset prices.


Two, falling interest has driven down the yields of stocks and real estate. This has been a process of borrowing ever more, of going deeper into debt. What else should we expect people to do, with ever cheaper cost to borrow?

They borrow, to increase their leverage, to own more assets. At least, there are more assets in dollar terms. But remember, prices are rising in this process, so there aren’t necessarily more assets in reality.

Picture both assets and liabilities rising together. It is a ratchet, that cannot go backwards. Any significant interest hike causes the prices of all assets to drop. That turns many balance sheets upside down.

For some, liabilities exceed assets. Their bankruptcies lead to liquidations, which causes further asset declines. Assets must be sold, but no one can get funding to buy them, and everyone’s balance sheet is under stress.


loves me, loves me notSorry boy, it’s probably only going to be a one-night stand…


Janet Yellen will want to avoid this catastrophe. She won’t want to be remembered as the Fed Chair who caused a repeat of 2008. She will find that it’s easier to take another hit of financial heroin. Interest rates will go down.


This article is from Keith Weiner’s weekly column, called The Gold Standard, at the Swiss National Bank and Swiss Franc Blog


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Image captions by PT




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One Response to “Janet Yellen Fights the Tide of Falling Interest”

  • therooster:

    The FED will play with various machinations as we continue to voyage into uncharted territory in search of liquidity and/or lower debt levels. I’m certain that they will use a great deal of pain if required because what we need is for the grass roots of the market to step in and monetize and circulate bullion as a form of debt-free currency. This cannot be done from the apex of political or monetary power in consideration of existing systems and real-time prices. It could risk a crash in fiat currency and other debt markets based on perceived threats to existing markets as they currently operate. Rate of change is critical and could never be done successfully, not by fiat.

    We are all in search for a current “kick-point” where bullion may find support for market monetization and circulation. The CB’s are likely concerned about the prospect of $3000 gold while it still sits in a heap, based on old habits. A habit is a difficult thing to change.

    CB’s are not as anti-gold as many think. They are “anti-gold hoarding” and the difference is very easy to confuse.

    It’s the application and use of gold that is at issue here. Once a circulatory kick-point has been determined, the orchestrated suppression from “on-high” is likely going to subside with a sigh of relief. As for banks having an interest in gold currency circulation that is denominated by weight, where weight if the digital unit of account (currency), one should not forget that the pricing model and measurement tools are fiat based. They are intellectual property and can be used in the debt-free trading of debt-free widgets with no debt used in a transaction.

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