Tuesday, June 26, 2012

The Death of Equities?

Buck has been the dean of the SKK Graduate School of Business at Sungkyunkwan University, Seoul, since 2004. SKK GSB is the top MBA program in Korea and one of the top programs in Asia. Previously he was a finance professor and served as associate dean and chair of the finance department at the Indiana University Kelley School of Business. He follows the markets closely as a money manager as well. A version of this article in the Korea Times appeared yesterday, June 25, 2012.

 The Financial Times published an article last May about the end of the cult of equities.  If you are a member of the equities cult, you believe that an investment in equities will provide a superior risk-adjusted return in the long term relative to bonds. Even though risk may be greater, the equity risk premium (equity returns minus bond returns) will more than compensate for the additional risk. Equity returns come from two sources, dividends and capital appreciation. While dividend yields were low by historical standards, investors believed that most equity returns would come from capital appreciation.

Because equities are riskier than investment-grade bonds, for decades dividend yields exceeded bond yields. That all changed in 1956 when 10-year U.S. Treasury bond yields exceeded equity dividend yields for the first time in the U.S. going back a century. Bond yields exceeded dividend yields from 1956 to 2011-2012 when the relationship reversed after more than half a century. Recently the S&P 500 dividend yield was 2.2 percent versus the 10-year bond yield of 1.6 percent.

So the cult of equities started in the 1950s and certainly accelerated in the 1980s and 1990s as equities became the asset class of choice for institutional investors such as pension funds and endowment funds and individual investors through direct ownership of equities or indirectly through mutual funds, which grew rapidly during this period. Individual equity exposure also increased through their pension plans.

What started the cult of equities? One word: performance. From the beginning of 1950 to the end of 1955, equities, as represented by the S&P 500, provided annual returns of 25.2 percent versus 1 percent for long-term corporate and government bonds. As a legacy of WWII, the Federal Reserve, much like today, had suppressed long-term interest rates until 1950. As long-term interest rates rose, bond prices declined and annual returns were minuscule and less than inflation.  As the stock market crash of 1929 and the Great Depression became distant and faded memories, the appetite for equities increased.

Equities continued to outperform bonds from 1956 for the rest of the 20th century, although bonds did as well as equities in the 1970s. From 1956 to the end of 1999, equities provided annual returns of 10.4 percent versus 6.0 percent for long-term corporate and government bonds. Inflation ran about 4.7 percent annually during this period, so real (inflation adjusted) returns were lower.

So what has caused investors to lose their appetite for equities? Again, one word: performance. The first decade of this century experienced two devastating bear markets in which investors lost at least half of their stock market wealth. The first bear market was a result of the dot.com bubble and an overvaluation of stocks in general. The S&P 500 peaked at 1527 in March 2000 and hit bottom at 777 in October 2002, a decline of -49.1 percent. Five years later, the S&P 500 hit a new peak of 1565 before it started a dramatic decline of 56.8 percent to 677 in March 2009. This was the worst bear market since 1929 and the first since then to have been caused by a financial crisis from the collapsing of credit and housing bubbles.

The end result has been an ugly first 11 years in this century for equities. From 2000 to 2010, the S&P 500 had an annual return of only 0.4 percent versus annual returns of 8.0 percent for long-term corporate and government bonds. Given annual inflation of 2.4 percent during this 11-year period, real returns were negative for the first time since the 1970s. Today the S&P 500 is still well below its March 2000 peak.

In addition to mediocre equity returns since 2000, equity volatility has also been at historic highs. The combination of low returns (negative real returns) and higher risk has been the primary factor for increasing investor risk aversion and decreasing appetite for equities. But not the only one. Other factors would include the financial crisis and the Eurozone crisis, increasing economic uncertainty, increased globalization, regulatory reform in the financial sector, tax rules favoring bonds over equities, high-frequency trading and the flash crash in 2010, less liquidity in the market and the growth of government debt and deficits. So institutional and individual investors have reallocated billions of dollars from equities to bonds and other financial assets since the financial crisis of 2008-2009.

In addition to investors losing interest in equities, corporations have also been reducing equity in their capital structure by repurchasing stocks, and raising billions of dollars in the bond markets, whether needed or not, because of historically low interest rates. The implications of the de-equitization of the financial system can be serious. Equity is the risk capital in a financial system and the absorber of economic shocks. Less equity will result in a more volatile economic system. Plus emerging companies usually publicly access the capital markets first in raising equity capital via an Initial Public Offering (IPO). Despite the publicity, good and bad, associated with the Facebook IPO, fewer companies are going public, annual average of 130 since 2001 versus 503 in the 1990s, which could eventually have a major impact on economic  growth. And investors have fewer choices today; the number of publicly traded companies has declined since 2000.

What should equity investors do going forward? If you are a contrarian or value investor, the Financial Times article could be good news. Many remember the BusinessWeek article in 1979 titled “The Death of Equities.” The 1970s were not a good decade for equities or bonds. Nominal equity returns were 5.9 percent annually, similar to long-term bonds, but inflation was 7.4 percent, so real return were negative for both bonds and stocks. The BusinessWeek article was widely quoted and publicized, but after the 1981-82 recession, the stock market enjoyed returns of 18.5 percent annually from 1982-1999, one of the best periods in stock market history. The media have a long history of bad-timing articles, perhaps this time also. A 1950s scenario of raising interest rates may benefit equities relative to bonds.

Investing in equities always involves uncertainty. There have been many unexpected events since 2000 impacting equity returns in a negative way: the dot.com, credit and housing bubbles; two recessions, one severe; the financial crisis; the Eurozone crisis; and acts of terrorism and wars, to mention a few.  Hopefully there will be fewer such events in the future and investors will regain their appetite for equities. Equities are one of the few ways in which investors can participate in the economic growth of companies and countries. A healthy equities market in which investors have confidence is important for the economy.

Old cults never die, they just fade away for a while; maybe the cult of equities is just lying dormant like in the 1970s, ready to spring back to life after a couple of years. Long live equities.

Tuesday, June 19, 2012

Can you kick a cliff down the road? Let’s kiss and make up.

Have we somehow gone beyond rational argument? Have we taken differences beyond a logical extreme? Are we about to self-destruct for no good reason? These are the kinds of things I keep hearing. You have to admit that in the US, the so-called fiscal cliff borders on insanity. The news is that congress wants to kick the cliff down the road. Can you kick a cliff down the road? If Congress decides to simply extend bad policies until well into 2013 will that really be the best we can get out of these goof balls? Remind me please. How much are we paying these guys to jeopardize our futures?

Recall the hitch-hiking scorpion that stings the turtle in mid-steam and they both drown. As he is going under the scorpion admits that he had to sting turtle because that’s what scorpions do. But we are not scorpions. We are people. We have brains. It makes little sense to play games with the fiscal cliff if other options are available.

Obama supporters say that Romney is not good Presidential material. Apparently they think he was a bad governor and a mean businessman. Romney supporters say Obama is not qualified to be president. They point to the dismal state of the economy today.  But please! Argue if you will about their relative successes in life and their specific qualifications. But please, both of these men are running for president. Why waste time with hateful and impertinent allegations? This argument about qualifications has very little to do with solving our immediate issues.

We voters agree on a lot of important things:
·         We agree that too much national debt can cause economic problems. We also agree that tolerating recessionary conditions for too long can be wasteful and unnecessary. 
·         We agree that tax revenues are well below normal. We also know that government spending is decidedly above normal. We know that using one or the other in isolation to solve deficit problems is probably not feasible.  Raising tax rates will surely slow the economy. So will reducing government spending.
·         We know that many poor people have circumstances where government support is the only remaining option. We also know that there are also many people called poor who are not and who could probably live without as much government assistance. We also know there is inefficiency and fraud in many government programs.  
·         We know there are many people who need society’s help with healthcare. We also know that healthcare costs are rising at rapid unsustainable rates and severely impact people of middle incomes.
·         Neither party’s goal is to destroy America. Both want to see the country succeed in economic and non-economic terms.
I could go one with the many more shared beliefs. We also cherish our freedoms, our great cities, our supportive neighbors, or brave soldiers and so much more. In addition, I think most of us believe it is a waste of time, energy, and emotion to argue at a feverish pitch while our problems just seem to get bigger and bigger. Both sides are dug in –come hell or high water.

Instead of acknowledging and emphasizing the validity of all these share beliefs, we seem to delight in picking one side as the winner and spend our time belittling those who chose the other team.  We have fallen to a point where we would rather jump into a heated fight than rationally, creatively, and dispassionately weigh the facts and find ways to accomplish our joint goals. It is fun to scream for your team at a football game.  But the morning after the football game means little to society while the morning after the next election can mean everything? Are we as dumb as the scorpion?

Hopefully I am wrong but it is difficult to see many leaders in either party earnestly trying to solve problems. Most have agreed that nothing can be done before the election.  They spend more time trying to shame their opponents than governing.  Does it make sense to pay them for the coming months as they avoid doing their jobs? How did we get to such a ridiculous position? What is the problem? Here are some very unpleasant realities to chew on…
There are no real solutions to these problems. Society tries but will ultimately fail anyway. It doesn’t matter who leads the country next year – he will fail anyway.
·         There might be a real solution but it is very complicated. This recession is not your Mother’s recession. Americans cannot handle complexity. Americans respond only to colorful and brief sound bites flowing from the mouths of very attractive quasi-experts. 
·         Any solution will definitely create redistributions of income and/or wealth. Those who see this process going against them will fight for their assets regardless of any long-run benefits that might come to them and others.
·         The press earns money by selling advertising. The higher the pitch and the bloodier the fight the more soap gets sold.
·         Professors, consultants, bloggers, and other experts want to sell their time and words but realize that given the above it makes no sense to explain long trains of information and statistics that support complicated centrist positions. It is not easy to differentiate the professors from the 6 pm news.
·         Companies, labor unions, and other recipients of government largess support only simple positions that help them continue to receive targeted assistance.
·         More?

It seems pretty hopeless, except for one fact. If things get bad enough for long enough self-motivated people will begin to see that their own behaviors are self-defeating. Many people will discover a correlation between their own gradual economic demise and things like intellectual laziness, inattentiveness, selfishness, and politicians who seem never concerned about finding real solutions. This hapless recovery is not enough for most of us to see the landmines of our own ways. How much more will this country have to suffer before we get it? What disaster will have to occur before we elect people who will not feed this frenzy of ignorance and selfishness? Divide and conquer makes a lot of people rich but impoverishes the rest of us. That is, until we clearly see the game. Then, maybe we will have a chance and won’t need to kick cans or cliffs down the hill!

Tuesday, June 12, 2012

More “Gooulish” Nonsense about European Fiscal Integration

Austan Goolsby wrote in the WSJ on May 30, “A Fiscal Union won’t fix the Euro Crisis.” I first thought that since he is a professor at the University of Chicago that we might be kindred spirits. But that is not the case. While we agree about the ineptness of a proposed European fiscal union we seem to come at this agreement from very different angles. I dislike the fiscal union because it would create too much pressure towards populist expansionary policies across Europe. He dislikes it because he thinks it won’t do enough to supply a coordinated European government stimulus.  

Here’s his reasoning. First, his data shows that a fiscal union among the 50 US states means that US states routinely subsidize each other.  For example, Minnesotans routinely bail out Mississipians through the magic of a federal government. Goolsby worries that a European fiscal treaty would allow any country to easily veto that kind of inter-state redistribution. Thus in a European fiscal union Goolsby worries the austerity hounds would win. I am concerned about the opposite.

Second, Goolsby blames the woes of Ireland, Greece, Spain and others on the monetary union. He notes that since the monetary union began German’s real wages have grown slower than productivity while the opposite happened in the peripheral countries. Thus, the monetary union – according to Dr. G (how many times can I type Goolsby?) – has made the peripheral countries less competitive. This might not be so bad but the monetary union prevents these countries from overcoming this competitive disadvantage through currency devaluation. Dr. G laments that without an exchange rate the only avenue left for these countries is “moving, inflating, struggling, or subsidizing”. Thus he wants the stronger European countries to either subsidize the weaker ones or he wants them to inflate.

Wow. Can we check the facts please? The US federal experiment succeeds because some states subsidize the rest? That is Dr. G’s main explanation for decades of US growth? The only choice for Europe to improve the lot of Italians and Greeks is inflation/subsidy from Germans and Finns? The implication is that the countries that have benefited from monetary union should be the ones doing the subsidizing and inflating. This is the secret ingredient necessary for EU growth?

From Dr. G’s analysis one should find in the years after 1998 when the monetary union began, the peripheral countries were weakened while Germany and some of the others were strengthened. I found a table of real GDP growth figures for OECD countries (  http://www.oecd.org/document/3/0,3746,en_2649_34109_2483901_1_1_1_1,00.html ) with data for the years from 1987 through 2007). There is little support for Dr. G in a pre- post- comparison of real GDP annual growth around the year 1998:
·         Finland’s growth rate was higher after monetary union (2.2% per year versus 1.7%)       
·         France’s growth rate was about the same in both time periods at about 2.2% per year
·         Germany’s average growth rate fell from 2.6% per year to about 1.6% per year after monetary union
·         Ireland’s growth rate fell very marginally after monetary union from 6.1% to 5.8% per year
·         Italy’s average annual real GDP growth also fell marginally from 1.9% to 1.6%.
·         The Netherlands’ growth was helped by monetary union – from 2.5% to 3.1%
·         Portugal’s growth rate almost halved from 3.4% per year to 1.8%.
·         Spain improved considerably after monetary union – from 2.7% before to 4.6% per year afterward.

Germany and Spain’s performances are just the opposite of G’s conclusion since Germany seems to be weakened while Spain was improved by monetary union. Using data on standardized unemployment rates across these same countries shows that except for Portugal, Eurozone countries were greatly improved by the monetary union. For example, Spain’s unemployment rates averaged well above 15% in the years before 1998. Afterward Spain’s unemployment rates averaged about 10% and fell to 8.3% in 2007. It is true that trade patterns after 1998 changed international competitiveness within the Eurozone – but these changes are not mirrored in overall economic indicators like output and employment.

The most outlandish ghoulish assumption, however, is that somehow economic growth and prosperity has much to do with national stimulus and subsidization. I know of no growth theory that supports such an unwarranted conclusion. Growth is all about marshalling inputs and using them in increasingly productive and innovative and competitive ways.  In today’s cynical and skeptical environment stimulus and subsidy are even less useful. There is a widespread concern about more stimulus since governments are deeply in debt and so little has been accomplished in the way of competitive restructuring of financial, product, and labor markets.

Back to the main point about increased fiscal integration of Europe. Dr. G is right – a tighter fiscal cooperation among the 17 Eurozone countries would not be a good idea for Europe. But the reason for the failure is not that it would bring too little stimulus and subsidy. It is precisely the opposite.  Such a democratic project among the nations of Europe would soon produce a majority for the same kind of populist policy trash that now dominates the US. I wouldn’t wish that on anyone! A fiscal union is not warranted by monetary union nor is it in the best interests of any of these countries. 

Tuesday, June 5, 2012

Will the US Recovery Experience a Fourth Anniversary in 2013?

Two Guest Bloggers this week on the topic of the current US economic recovery. The first is by Tico Moreno (Current Reality is the precise Result of Current Policies). Directly following is the contribution by Buck Klemkosky (Happy third Anniversary).

 by Tico Moreno

“Tico Moreno is the owner/manager of a coffee service company that operates in Ft. Myers and Naples, FL. Prior to moving to Sanibel Island FL he worked in Venezuela where he was a promoter and president of a 1,500 Ha. shrimp farm, was involved in planning and logistics in the banking and beer sectors, and was a professor of management at a University. He has a PhD in Engineering Management from Clemson University.”

The May employment figures released by The Labor Department were disappointing. From January 2009 to May 2012 the civilian non-institutional population 16 years or older has increased from 234 million to 243 million, an increase of 9 million, but the number of people employed has remained the same at 142 million. If the same % of the population that was employed in January 2009 were employed in May 2012, the total number employed would be 147 million, so we have a net of 5 million missing jobs. This weak employment scenario is precisely the one to be expected as a consequence of the policies being applied over the last three years. Let’s see:

Monetary policy has been to artificially keep interest rates low. Artificial application of tools will bring about artificial results. We are familiar with the recent experience of what happens when we artificially keep the price of money under what the market rate would be, given our propensity to save. Production beyond what people would purchase is stimulated. Last time around it was production of housing. No telling what bubble is being stimulated this time. Last time the market reacted very efficiently to the carrots and sticks of the time and produced housing in extraordinary numbers. Had the Fed not made available the cheap fuel, bankers would have not been able to make as many housing loans. This time, so far as we know, what has increased is the cost of food and energy, but there is no substantive growth.

Fiscal policy has been Keynesian: increase spending by the Federal Government in the hope that that spending will stimulate the economy. But the government is no magician that can create prosperity; it can only redistribute it. For it to spend one dollar the government has to subtract that dollar from somewhere, a move that has the effect of reducing growth somewhere else. The net effect is no growth and deficits. An alternative approach is a supply-side oriented one: make the economy grow by reducing tax rates and regulations. This approach may increase the deficit initially, but in the end the induced economic growth brings about more revenue to the government. The choice between Keynesian and supply-side economics is not only theoretical. The evidence of the real world abundantly supports the success of the supply side approach and the failure of the Keynesian approach. Witness the Kennedy and Reagan supply-side induced growths, and the Hoover-FDR Keynesian failure to get the economy going in over 14 years of trying. In fact even now, the paltry growth we are experiencing only started after the certainty that the so called Bush-tax-cuts would be extended, a supply-side move.

We are currently experiencing the exact effect caused by the current economic policies.

 by Buck Klemkosky

Buck has been the dean of the SKK Graduate School of Business at Sungkyunkwan University, Seoul, since 2004. SKK GSB is the top MBA program in Korea and one of the top programs in Asia. Previously he was a finance professor and served as associate dean and chair of the finance department at the Indiana University Kelley School of Business. He follows the markets closely as a money manager as well. A version of this article in the Korea Times appeared yesterday, June 4, 2012.

June 2012 marks the third anniversary of the end of the Great Recession, the most severe of the 11 U.S. recessions since WWII – although the 1981-82 recession was comparable. Conventional wisdom is that the strength of a recovery is related to the depth of the recession. That has not happened three years into the U.S. recovery.

How bad has it been? The growth in real (inflation adjusted) Gross Domestic Product (GDP) has been 2.4 percent since the start of the recovery in July 2009, about half of what real GDP growth would normally be three years into a recovery. The growth rate also lags the long-term (1997-2007) U.S. GDP growth rate of 3.4 percent.

The unemployment statistics appear to be better than GDP growth, but they are deceiving. During the Great Recession, 8.8 million jobs were lost and 4.5 million jobs created thus far during the recovery, so there are fewer jobs in the U.S. today than in December 2007 when the recession started. Even though employment is still several million below its peak, the unemployment rate has dropped from a peak of 10.1 percent to 8.1 percent today.

Why the significant drop in the unemployment rate? The big reason is the drop in the civilian labor participation rate which measures the number of people (16 years of age and older) who are working or looking for work versus the number in the total population. The labor participation rate has dropped from a peak of 67.3 percent in 2000 to the current rate of 63.6 percent, the lowest since 1981-82. The continued decline is unusual in an economic recovery because more people usually seek employment as the economy improves.  Since the recession ended, the rate has fallen from 65.7 percent to the current 63.6 percent, thus the lower unemployment rate.

While the potential number of workers has increased during the recovery, the number leaving the workforce has increased even more, taking down the unemployment rate. So where have all the workers gone? Some of the baby boomers (those born between 1946 and 1964) may be retiring early, marginal workers may not have entered the workforce because of slow job growth and stagnant wages, and more are opting for government subsidies. Medicaid spending, disability payments and food stamp usage have all risen sharply under the Obama administration. The bottom line is that no one has a good grasp of the numbers and why people are leaving the workforce.

There are numerous reasons why the U.S. economic recovery continues below average. First, the Great Recession was caused by the severe financial crisis of 2007-2008. As a result, households have had to pay down debt, and banks have had to increase their capital base by extending less credit. Evidence shows that recoveries from financial-caused recessions are slower than other recessions because of the deleveraging that has to occur. It may take more time for this to work its way through the system, so slow economic growth may be the norm in the U.S. and Europe for several more years.

As the experience of Japan has demonstrated, asset bubbles such as in housing can impede an economic recovery. U.S. home prices have fallen about one-third from their 2006 peak because of the speculative bubble in housing prices and over supply of houses. Usually construction, housing and commercial, leads an economy out of a recession, but not this time. Construction jobs are still 25 percent below their 2007 peak in the U.S. So until housing prices stabilize and the excess capacity is worked down, this important segment will be a drag on the economy.

The U.S. corporate sector is sitting on more than $2 trillion in cash and cash equivalents. They are investing less in plant and equipment than normal in a recovery. Why the reluctance to invest? The main reason is economic uncertainty caused by the problems in the Eurozone, a slowdown in China, regulatory reform, healthcare costs (including Obamacare), the so-called fiscal cliff facing the U.S. in 2013 when the Bush tax cuts expire and mandatory spending cuts to the U.S. budget take place, and escalating public-sector debt. Because of below-normal corporate investment and gains in productivity, manufacturing jobs in the U.S. are still 15 percent below their 2007 peak.

What can be done to stimulate the U.S. economy? Probably not much. Monetary policy has pretty much been played out with historically low interest rates, several rounds of quantitative easing, excessive bank reserves, and massive amounts of liquidity. Fiscal policy also is constrained. The U.S. has already borrowed more than $5 trillion to cover fiscal deficits since the start of the Great Recession. Some may argue that there has not been enough stimulus, but $5 trillion has resulted in GDP growth of less than $1 trillion. The bond markets are also closely monitoring public-sector debt and will quickly raise bond yields if government debt and deficits appear unreasonable.

What the U.S. economy needs more than anything is confidence. Confidence that government can  control spending and deficits, that consumers can spend but also not take on too much debt, that banks can provide credit again but also manage risk, and that regulatory reform is reasonable and not anti-business. Otherwise, it is difficult to see what will get the U.S. economy back to a normal growth rate. The worst economic recovery since WWII may continue on its present path. Or worse, it may result in another recession, and there may not be a fourth anniversary of the recovery to write about. Time will tell.

Sunday, June 3, 2012

Negative Real Interest Rates Cannot Exist. Or can they?

Imagine going into a bank to borrow some money for a new car. The banker tells you that the interest rate is -3%. You look around the room for the Candid Camera camera and Alan Funt and then ask the banker to repeat what he said. So he speaks slowly so you will understand. If you borrow $10,000 from the bank today and pay the loan off in full at the end of the year – the bank will give you $300.

You immediately get very skeptical. Usually a car loan is quoted at something more like a +10% interest rate and will require that you pay back the $10,000 plus another $1,000 in interest. As such negative interest rates are not part of your usual experience and therefore require a second look.

There are two dimensions to every credit transaction. If in the above case the borrower is getting rewarded for borrowing then the creditor is getting a penalty. So right off let’s agree that negative interest rates tend to favor or incent the borrower – but do the opposite for lenders. So if this was a rugby match the side with jerseys marked borrower would be cheering. The lender side would be weeping in their Fosters.
But before going on to that excitement, we need to make a distinction between market and real interest rates. Right now, most market interest rates are not negative though some are. However it is true that many real interest rates are negative.  

First, market interest rates. How can some market interest rates be negative? Most banks are not quoting negative market rates on loans or deposits. But bonds also offer interest rates. A bond has a rate written on it – it says that if you hold this bond on such and such a date then you will receive the coupon return. So if you buy a $100 bond (you lend $100 to the borrowing company or government) with a coupon return of 4% then you would receive $4 per year. If this bond matures in one year then you will have received $104 back for your $100 investment. That sounds pretty cool. But if you sell that bond on a day when not many people want to buy you might accept $95 for it. In that case Buck, who bought this one-year bond, paid $95 for a security that will give him $104 at year’s end. He expects to earn 9.5% on his $95 investment.  A week later Buck sells the same bond on a day when the market is crazy for bonds. Myra buys the bond for $105 that day. At the end of the year she expects to get $104 back for her $105 investment. Way to go Myra! You get a -1% return on your $105 investment.  

Why would Myra or anyone else buy a bond with a negative return? One reason is that she likes the color of the print on the bond. A more important reason is that Myra looked around and noticed that most stocks, bonds, and real estate were very risky investments. While -1% doesn’t look very good in historical terms, it might look great compared to what she might get back from an investment today in a bank in Greece.

At this moment we don’t see too many cases of negative market returns. What we see more of is negative real interest rates. On Friday the market closed with the following market rates for US Treasuries – 1-year at 0.17%; 10 year 1.45%, 30-year 2.52%.  These are very low market rates. But for all these cases the real returns are negative. Why? Because a real return states the return in terms of purchasing power over goods and services. To obtain a real rate we subtract the expected future expected inflation rate from the market interest rate. How much annual inflation do you expect in the prices of goods and services in the next year? 10 years? 30 years? We could quibble but let’s just say that it seems reasonable that over any of those time periods the prices of goods and services will rise by at least 2.52%. If so, then as of last Friday there was a very negative real rate on 1-year bonds; at least a -1% real return on 10-year treasuries; and a wash for the 30-year bonds.

What is the upshot?
·         This is a time of great global financial risk and US Treasuries are the go-to asset
·         Market and real interest rates have gone so low recently because of market forces – not because the Fed drove them down.
·         This leaves very little for Fed policy to do now. Would it really help if the Fed drove these rates even lower?
·         Meanwhile borrowers are pretty happy and creditors are not.