Category: Money & Finance

Why are Interest Rates so Low?

Higher Interest RatesWhy are interest rates so low?

Ask most people on the street why interest rates are so low, and they will reply that central banks are
responsible. Okay, perhaps most people have no idea about interest rates or central banks and would likely shrug their shoulders, but regular blog readers are certainly aware of all of the central bank actions to try to keep rates low!

However, academics and economists are increasingly opposing this commonly held notion, countering that interest rates are affected by more powerful market and economic forces than central banks, contending that the decline in productivity is causing rates to be low. Therefore, which theory is correct? The answer may be both – and linked to the same cause.

The ‘natural’ versus ‘market’ rate of interest

To understand what may be going on, we need to go back to the 19th century economist Knut Wicksell, who differentiated between the ‘natural’ rate of interest and the ‘market’ rate.

Interest rates are a type of pricing and, like prices, they signal the relative supply and demand for something; in this case, the supply and demand for loanable funds. The natural rate of interest is the equilibrium rate that balances the amount of money to be loaned and borrowed, or the level of savings and investment. This natural rate therefore coordinates economic activity much like prices coordinate activity.

Like other prices, the equilibrium or natural interest rate that correctly balances economic activity cannot be known by someone. Only the market process can bring it about, and it is constantly changing and adapting to different conditions.

The natural rate of interest is affected by real economic forces; people changing their preference for saving versus taking on debt, or consuming now versus later. But the market rate is the rate that is the prevailing interest rate, influenced by central bank actions as they target various rates to be lower.

Central banks claim they want to set the market rate at where they believe the natural rate to be, in order to bring about a balanced economy. But this is an impossible task. Just as no central planner knows the correct price of steel or milk, so the Federal Reserve does not know the correct interest rate to set in order to coordinate economic activity.

It is this very attempt at setting rates that causes so much economic upheaval. If the Federal Reserve sets rates too low (or too high), misallocation of resources will occur, typically in the form of inflation, bubbles and then subsequent crashes.

Is the Federal Reserve the perpetrator of low rates?

A main criticism to this theory is that interest rates have been low now for quite a long time, and therefore there is something else going on besides the Federal Reserve and other central banks keeping rates low.

In other words, such critics believe the natural rate of interest is actually very low and has been declining, therefore the Federal Reserve is merely setting market rates to be consistent with this low natural rate level.   

One of the reasons cited for the decline in the natural rate is the decline in productivity of American workers and the general sluggishness of the economy. However, this may actually be a symptom of the previous boom and bust caused by erroneous central bank actions, rather than an unrelated factor.

The Fed set rates too low

The Federal Reserve fueled the unsustainable boom prior to 2008, and we are still feeling the negative effects today, such as  lower productivity. Because the Fed set market rates below the natural rate, misallocation of resources occurred. Instead of allowing those resources to reallocate themselves to better uses (such as out of housing and banking), the Fed was intent on keeping the status quo and avoid liquidations and bankruptcies.

The Bank of International Settlements (BIS) suggested this possibility in their recent annual report, noting that low interest rates could actually cause a cycle of lower productivity:

“Alternatively, persistently low yields could end up having pernicious effects on the economy and become to some extent self-validating… They may also distort financial and real economic decisions more generally, for instance by encouraging unproductive firms to maintain capacity or by inflating asset prices, thereby weakening productivity.”

We see this when we examine so-called zombie banks that continue to hold bad loans on their books in order to avoid the charge-offs. We also see factories and retail stores that continue to operate because the Fed has incentivized consumers to continue to spend, rather than cut back on spending, repay debt and save.

Central banks should stop meddlingRate Hike Calculator Words Increased Interest Cost Borrow Money

In conclusion, there are certainly other factors and forces that determine interest rates, besides the central banks. But lower productivity may actually be a logical outcome of previous low rates set by central banks. This is precisely why central banks should get out of the business of trying to set the correct interest rate, just as Soviet central planners had no business trying to set the price of eggs.

What does this all mean for your investment portfolio? As long as central banks try to guess at what interest rates “should be”, they will fail. This will cause continued misallocation of resources, and therefore investors need to be aware of continued instability such as inflation, bubbles and crashes.


Inflation is the 24 Hour Tax on Everything

Wallet and stethoscopeInflation is the 24-Hour Tax on Everything

The Wall Street Journal recently reported that inflation, after “being given up for dead,” is coming back to life. While that may appear to be the case on the surface, inflation has been alive and well – hiding out beneath the official government statistics for years.

The WSJ is referring to the data released last Friday by the Bureau of Economic Analysis, known as Personal Consumption Expenditures (PCE), which measures the change in actual spending and prices and is the Federal Reserve’s preferred measure of inflation.

More specifically, the article was referring to Core PCE, which is PCE excluding food and energy, and is currently at a two year high of 1.7% on a year-over-year basis. The other measure of inflation is the Consumer Price Index (CPI), which has also been markedly higher, coming in at a 1.5% annual increase as of this past September.

Inflation is NOT a Good Thing

With inflation getting closer to the Fed’s 2% target, WSJ’s columnist Greg Ip casually comments that “This isn’t bad news. To the contrary, markets and central bankers alike will be relieved the world is no longer skirting a deflationary abyss.” But while central bankers might welcome this news, consumers will not.

Sustained inflation in consumer prices is never a positive for any economy, and is also not necessarily an indicator of a growing one. Prices may rise due to changes in supply and demand, and therefore help to reallocate resources and signal those changes; but an overall and sustained increase in prices is different.

If the price of an item rises for consumers, they will then stop buying it or switch to a cheaper item or cut back on another category in order to accommodate the household budget. Therefore, the only way for all prices to rise indefinitely and consistently is for new money to be constantly created and injected into the economy.

This of course is merely a tax on consumers because the new money and consistent increase in prices makes the consumer poorer. Contrary to popular economic theory today, there is no threat of a“deflationary abyss”. During the nearly 100 year history of the classical gold standard, prices gradually declined an average of 2% to 3% per year as technology and productivity increased, giving consumers the benefit of these advancements in the form of lower prices.

Inflation is Worse Than Reported

This week, Visual Capitalist made a stunning infographic using AEI’s Mark Perry’s (equally as interesting) inflation observations. Over the past 20 years, from 1996 to 2016, total inflation has been 55% as measured by the CPI.

However, digging into the Bureau of Labor’s data and then channeling down to the various items that make up the CPI basket of goods, you can see that inflation varies greatly from one type of good to the next.

For example, things that have increased more than the average 55% include tuition (up almost 200%), childcare (122%), medical (105%), food and beverage (64%) and housing (61%) – in other words, virtually all of the living essentials needed to survive or raise a family.

Counteracting this, items that fell in price included TV’s (96% decline!), toys (67% decline), and software and cell phone service (66% and 45% respectively). Clothing and furniture declined slightly, while new cars increased only slightly.

Obviously the dramatic decline in electronics, software and toy prices has brought wonderful benefits, but these are still largely discretionary items, and they take up a much smaller portion of most household budgets. The average family is therefore likely facing more than the average 55% increase in prices over the last 20 years.

Indeed, in his latest book, David Stockman has modified the CPI to put heavier and therefore more realistic weights on the four essential items of everyday life: food, energy, shelter and medical care. Using this measure, he finds the actual inflation rate over the past 29 years (when Greenspan became Fed Chairman) has been 3.1% per annum, rather than the official CPI rate of 1.7% per annum.

How to Protect Yourselfdates falling dollar

Unfortunately, inflation will continue to be a problem for any person living in a country whose money is a fiat currency that is being debased by their government – which includes nearly all modern economies today.

Thankfully, there is nothing stopping you from converting some of that fiat paper money directly into your own store of hard currency: physical gold and silver. During the past twenty years, while the official CPI increased 55%, gold has increased in value 235% and silver 282%.

Time to buy gold and silver, perhaps?

Losing Credibility – Japan’s Central Bank

The central bank of Japan headquarters in TokyoWith the latest Federal Reserve meeting and subsequent announcement last week that interest rates will not be raised at this time, many missed the news from the Bank of Japan. The central bank of Japan not only unveiled a new monetary policy experiment, but also admitted it’s current plans thus far have not worked and that it’s losing credibility.

From Influencing to Manipulating

By now, almost everyone understands that central bank policies push short-term interest rates lower, even though these policies are prompted by a desire to spur borrowing, increase hiring by businesses and boost spending in an effort to increase wealth in a “virtuous circle” that jumpstarts the economy.

The Bank of Japan has been trying particularly hard to shovel money into the economy, not only to spur activity but also to combat deflation. The bank fears falling prices will lead to consumers resisting spending and businesses becoming too risk-averse. As we have noted here before, both of these theories – jumpstarting an economy with money-printing and fearing deflation – are wrong.

Japan Doubles Down on Failure

However, instead of realizing this, the Bank of Japan continues to double down on failure. On Wednesday last week, the bank unveiled a new experiment. Rather than announcing it would inject a certain amount of money into the economy, such as buying a predetermined amount of bonds, it will instead target long-term interest rates directly.

Specifically, the central bank will target the 10-year government bond yield to be zero percent. This means the Bank of Japan will stand ready to buy or sell 10-year bonds so the yield stays near zero. Let that concept sink in for a moment.

Interest rates are important price signals in any economy. Simply stated, they are the price to borrow money. Even more crucially, they coordinate people’s time preference; in other words, they coordinate resources between people who need them now, versus those who want to use them later.

Any institution claiming they know what a price should be, while interfering with the natural free market process of price-setting, is bound to run into trouble. Governments and central banks have tried to control prices of goods before, always resulting in a market shortage or surplus since the price is not left alone to freely coordinate supply and demand.

In this case, the Bank of Japan is setting a hard price on government loans. Japan is one of the most heavily indebted countries on the planet at over 200% debt-to-GDP. If investors ever lose confidence in Japan to pay back this debt, or do so in its own currency, they will sell the bonds, driving up the yields. The central bank will then have to stand ready to buy up all of these bonds to keep the yield at zero, effectively monetizing its debt.

Losing Credibility

Haruhiko Kuroda, the Governor of the Bank of Japan, in a speech accompanying the new policy announcement, noted their 2% inflation target was obviously not working. The bank’s former plan had been to make a strong verbal commitment to a 2% inflation target, and back it up with the bank’s large asset purchases (their QE), hoping they should then see inflation move towards their goal.

Instead, prices continue to fall in Japan. Mr. Kuroda concluded that the plan is not working, theorizing that consumers base their inflation expectations on past prices and psychology, rather than what central bankers tell them.

Too Late

Unfortunately, rather than admit defeat and recognize the limits of centrally-planned monetary policy, the Bank of Japan will continue to pursue any and all policies, ever bolder and more absurd, until it sees the consumer price inflation it desires.

Japanese currency with the text, YENBut higher consumer prices due to monetary policy will not generate more wealth and economic prosperity for Japan. By the time prices rise above their 2% target, it will likely be too late, because confidence in the central bank’s control and the country’s currency will have already been eroded.

The Bank of Japan has frequently been at the leading edge of new monetary policies and experiments, such as negative interest rates and now direct and blatant manipulation of the yield curve. Expect other central banks to watch closely and to try similar measures soon.

This Time, it IS Different

This Time it IS Different

It's Different

It IS Different

The four most dangerous words in the world of finance, often repeated, are “This time it’s different.” During both of the last two major booms and busts, a common belief was that the new internet age was different (2000) and later, that housing was also different (2008).

However, used to describe our current interest rate environment (particularly negative interest rates), the over-worked phrase actually does ring true.

Financial journalist and observer Jim Grant noted at a recent investment conference that research on interest rates shows that over the past 5,000 years of history, there has never been an instance of negative interest rates… until now.

The ever quick-witted Grant remarked, “If these are the first sub-zero interest rates in 5,000 years, is this not the worst economy since 3,000 B.C.?” Perhaps. Or maybe this is just the first time in history where we have central banks active in monetary policy, attempting to drive interest rates as low as possible.

Record Negative-Yield Debt

The current amount of debt sporting a negative yield continues to grow. In early 2016, there was over $5 trillion in negative yielding debt. This grew to nearly $12 trillion by the end of June, and it is now closer to $13.4 trillion!

Not only has more debt become negative in yield, but it is increasingly happening to longer term debt. Yields on 10-year government bonds have become negative for Germany, Switzerland and Japan.  

Remember that bond yields are an inverse to bond prices. As bond prices get bid up, their yields go down.

What makes this unique is that bonds are a relatively simple financial instrument. Bonds do not have the subjective valuation that applies to stocks, and this makes the math and the logic of bonds fairly straightforward.

A person can buy a stock from another person while thinking it still has the potential to go higher, given higher growth prospects for the company. The price is based on one person’s subjective valuation.

On the other hand, bonds are not as subjective. If you buy a bond at a certain price, with a certain coupon payment, then the yield is a mathematical certainty. It is the yield you will receive per year if you hold the bond to maturity, and if it pays the principal in full without defaulting.

What Bond Buyers are Saying

By stark contrast, today’s current bond buyers are purchasing a security where they know they will lose money if it is held to maturity. For example, if you buy a bond today with a negative 0.5% yield, and it has five years until maturity, then after five years, you will be paid back less than what you originally paid for the bond. Even with the coupon payments you received during the life of the bond, the total payout will be equivalent to getting a minus 0.5% return on your money.

Therefore, we must make one of two different assumptions about current buyers of negative yielding debt. One assumption is they could be anticipating the bonds will continue to go up in price and that they will then sell them for a profit. In other words, the negative yields will become even more negative, and they will sell the bonds before maturity.

Unfortunately, this requires the buyer to believe there will always be a ‘greater fool’ out there who is willing to accept a higher price than what the original buyer paid. It it not unlike those who bought houses before 2007 on the premise they would flip them to a higher bidder. Remember that with bonds, someone must be holding these financial instruments at all times.  

The second assumption is that buyers are perfectly fine accepting a negative yield, and are willing to ‘pay for the privilege’ of lending out their money. This goes against all basic laws of finance. It only makes sense insofar as these buyers have no other place to put their money, and are therefore choosing the lesser evil.

But this is a weak explanation, because they could put their money in cash and get at least a zero percent return. Also, this doesn’t seem to make sense for longer maturity debt, as it means these buyers think negative interest rates are here to stay for at least ten years or more.

Both of these scenarios point out how this time, it is very different, and we are living in a twisted financial world, a world only exists because of the manipulations and distortions of central banks.

It is always precarious to try to make predictions, but it seems that there will come a time in the not too distant future when people will look back at this period and say “What were people thinking?”Secure Your Wealth

Like a frog languishing in a slowly heating pot of water, investors have warmed up to the environment of negative interest rates, not realizing how absurd and dangerous the situation has become. But take time now to assess, and be well prepared for the inevitable.

In this zero/negative interest rate environment, it is stunning to consider that since 2000, the DJIA (Dow Jones Industrial Average) has increased in value 63% while silver has increased in value 289% and gold has increased 380%…. an annualized return of 23.75%!

Cash, anyone? Or gold!

Helicopter Money

Helicopter Throwing money from a piggy Bank. Yen versionPost Brexit jitters have faded away and the market has gone on to crack new highs, partly aided by the rumors swirling of ‘helicopter money’ coming to central banker’s toolboxes around the world, but most notably Japan in the near future.

Once thought of as an imaginative or hypothetical example of what central bankers could do to combat deflation and get economies jump-started, helicopter money is now being seriously talked about. This is further evidence of the central banker’s mindset and why it is important now more than ever to make sure investment portfolios are fortified with a certain allocation of physical gold.

So when will money start dropping from the sky?

Surprisingly, the term helicopter money was first most famously used by the free-market economist Milton Friedman as a simple illustration of how money could be injected into an economy.

Former Federal Reserve Chairman Ben Bernanke then repeatedly used this term to additionally mean injecting money into the economy, but he also advocated for it in terms of central bank purchases of bonds and other financial assets, or to help the government finance fiscal stimulus. This earned him the nickname, Helicopter Ben.

It was therefore not lost on market participants when Helicopter Ben visited Japan a number of days ago and spoke with Prime Minister Shinzo Abe, the father of Abenomics – the grand experiment of trying to boost Japan’s economy by aggressive monetary and fiscal stimulus.

Mr. Bernanke did not specifically mention helicopter money in subsequent interviews, but he did note that Japan has more tools at their disposal to continue monetary easing. Ever since the meeting, market participants have continued speculating that some kind of easing will take place, sending the yen lower and stock markets higher.

Call it what you will, the result will be the same

Central bank actions have taken many forms over the past years since the crisis: lower (or even negative) interest rates, quantitative easing, monetary stimulus, and now helicopter money.

While it is not certain what helicopter money will actually look like if implemented, it would likely be some arrangement whereby the central bank directly finances government spending. In its extreme (and most literal) form, it could involve somehow getting newly printed money into the hands of consumers.

These are all slightly different programs and they work in different ways, but they all have the same thing in common: creating (printing) money and credit and then injecting it into the economy in an effort to try to boost spending, depreciate the domestic currency (thereby boosting exports), stoke inflation, or a combination of all three.

Add gold to your portfolio – now

This highlights why it is so important to be holding some physical gold. Bernanke is right in one sense: there is nothing physically holding back central bankers to continue these programs, and central banks will continue them because efforts thus far have proved unsuccessful.

What was once thought unthinkable and merely a thought experiment is becoming a reality. If in doubt, think of all those who thought negative interest rates were a crazy idea that would never be implemented.

Secure Your WealthMonetary easing, in whatever form, will likely continue until there is a severe depreciation or collapse of currency and correspondingly high inflation. Unfortunately, Japan already learned this lesson in the 1930’s and 1940’s when it embarked on a similar program of using the central bank to directly finance government spending, which unsurprisingly resulted in an inflationary surge.

History is repeating, and the chances of central banks admitting their policies do not work, and ceasing them or reversing course, is slim. Therefore, it is especially prudent at this time to allocate a portion of your investments to physical gold, and that is why we recommend a 10-20% allocation.

Brexit Fears Fade, But Gold Does Not

british gold reservesSome of the dust is starting to settle from the Brexit vote when British citizens surprised the world by voting to exit the European Union. The initial uncertainty caused stocks to sell off sharply and the British pound to plummet while gold rose in price.

Stock markets in the United States have now largely rebounded as fears have subsided, but instead of similarly reversing course, gold has stayed high and has even pushed higher. This recent market action highlights the fragility of political constructs, while underscoring the fact that gold does not depend on such political alliances.

United Kingdom withdrawal from the European UnionWhy Brexit Is A Big Deal

In a sense, Britain’s decision to leave the European Union is not such a major disruption. After all, Britain was never part of the Euro currency, so there will be no changes to its currency system. Further, the process will take at least two years or more while the terms are negotiated; - plenty of time for British citizens and the markets to adjust and plan ahead for any changes.

Yet in another way, it is a very big deal. First, it is an important event because Britain is the first nation to exit the relatively youthful European Union. Imagine if a state of the United States were to exit the union. The first U.S. state to leave would constitute a landmark historical event, even if it was a state that has talked about wanting to exit for a while (I’m looking at you, Texas).

Once one nation has shown that it is possible to leave with a peaceful vote, many other E.U. citizens may want to follow suit. This would be especially powerful if it were a country that was not only part of the Euro currency, but one that was financially healthy, such as Germany.

Britain exiting the European Union and sending the markets into turmoil shows the fragility of political institutions and the tenuous nature of alliances made between high-level politicians and political bodies.

There is nothing inherently strong about such alliances because these agreements depend on the word and bond of each country, backed up by the contracts they each sign. These in turn are only as good as the rule of law governing them, which is also a political arrangement.

Government Currencies Are Mere Political Promises

The Brexit vote gave citizens and investors around the world a harsh wake-up call, reminding them that entities like political unions and countries are merely political constructs, devised by politicians.

While these political institutions can be helpful, citizens can also come to feel they are doing more harm than good, and once they recognize this, they may choose to reject them.

Currencies are no different. There is nothing inherently stable about today’s government fiat currencies, because there is nothing backing them beyond the faith, credit and political promises behind those flimsy pieces of paper.

A national currency – or a multi-national currency like the Euro – may provide some benefit to citizens in terms of facilitating trade. But if citizens begin to perceive that the costs of the political monetary system (such as inflation or value instability) start to outweigh the benefits, they will reject them and look for a better alternative.   Composition with 50 gram gold bar, banknotes and coins

Fortunately, gold is an alternative currency to which one can turn. Rather than a metallic commodity, gold should really be considered as another currency or form of money, but with one major difference: it does not depend on political constructs, promises, or faith in a political system in order to work as a currency.

In fact, gold usually functions as the exact opposite, representing a loss of faith in central banks and governments. This is why it is essential to hold a portion of your wealth and investment portfolio in physical gold.

Here at Anthem Vault, we offer solutions to easily acquire and own physical gold, the best way to quickly and securely diversify a portfolio. We believe a reasonable allocation to gold is 10-20% of your investment portfolio, depending on your level of risk acceptance and other factors. Contrary to the opinion of some, and in-line with historical data and modern portfolio theory, this allocation can greatly lower your portfolio’s risk without sacrificing returns.

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