Tuesday, May 05, 2015

Why are Interest Rates so Low?

That is the question that Ben Bernanke, former US Fed Chairman, tackled in his blog at Brookings. Here are the papers:

To summarize his points, the following are among his concluding statements and charts or table presented.

Part 1: The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns. This helps explain why real interest rates are low throughout the industrialized world, not just in the United States.

Part 2: Does the U.S. economy face secular stagnation? I am skeptical, and the sources of my skepticism go beyond the fact that the U.S. economy looks to be well on the way to full employment today. First… at real interest rates persistently as low as minus 2 percent it’s hard to imagine that there would be a permanent dearth of profitable investment projects.

Part 3: the global savings glut hypothesis remains a useful perspective for understanding recent developments, particularly the low level of global interest rates. Overall, I see the savings glut interpretation of current events as providing a bit more reason for optimism than the stagnationist perspective.

Part 4: Overall, the behavior of term premiums helps explain the generally low level of longer-term interest rates in recent years... in turn reflects a number of factors, including: minimal investor concern about inflation; relatively low uncertainty about the likely future course of interest rates... a strong global demand for safe, liquid assets (for use as international reserves, for example, and to satisfy regulatory requirements); and quantitative easing programs by central banks.

Mr. Bernanke is right  on at least two points: (1) that it is the real economy, not the Fed or central banks, that drive real returns to capital, and (2) credit glut, represented by high current account surplus by many industrialized and emerging economies, not stagnation, is a better explanation for low world interest rates.

Prevailing interest rates are simply the equilibrium points of (global, regional, national) credit supply and demand. Many if not all governments around the world have been too irresponsible and wasteful, living beyond their means, financing their over-spending with endless borrowings.

With such high demand for credit to finance endless wastes and irresponsibility, interest rates should rise. But this did not happen because the increase in credit supply is much larger than the increase in credit demand. Modern capitalism has become more efficient, it can bail out ALL irresponsible governments combined. Even if the US (federal government alone) will borrow $1 trillion a year to finance its over-spending, global interest rates still refuse to rise.

Central planners in the monetary sector can produce various explanations like tinkering with overall money and quasi-money supply, engineer the reserve requirements, etc. as drivers of global and national interest rates. While these are valid explanations,  there is one major factor that they may fail to mention -- that productivity in the private sector keeps rising due to more innovation and competition. So that even if individuals and corporations are over-taxed and over-bureaucratized, there are still huge social surplus. So a flat or declining productivity and usefulness of many in the public sector can still be endured by the private sector, savings and credit can remain high, and so interest rates can remain low.

Many if not all governments of developed economies need to reform and reduce their expensive welfare system instead of printing more money, which only delays belt tightening in the future.

Low world oil prices also significantly contributed to low global inflation. The cost of airlines, shipping lines, bus lines, trucks, taxi and ordinary motorists have significantly declined. Again it is a result of capitalist competition -- shale oil vs. petroleum, OPEC vs non-OPEC producers. Competition among motor companies  result in new models of cars, buses, trucks, airplanes that are more fuel efficient, they can run or fly the same distance at lower oil consumption.

Central governments and central banks tend to specialize in creating inflationary pressures in the economy. What could be cheaper goods and services become expensive because of the various taxes, fees, fines, mandatory contributions, that are passed on by the sellers and manufacturers to the consumers. Then the inflationary pressures of endless borrowings and printing of currency.

The private sector in a competitive environment on the other hand, specialize in deflationary pressure. What used to be a $200 mobile phone last year becomes $150 this year because of harsh mobile phone competition. Productivity keeps rising, companies and workers produce more for the same if not lesser, resources and inputs.

Overall, the latter bails out the former, and the former continues their wicked and wasteful ways while bragging that they are "fighting poverty and inflation."

This situation can continue for as long as productivity growth in the private sector is higher than wastefulness growth in the public sector. If the latter catches up with the  former, then that is the inflection point and interest rates will start rising.

No comments: