April 09, 2015

An Implausible (But True?) Interest Rate Scenario

Patrick Marren

Interesting stuff from Brad DeLong​, possibly explaining much of the last decade of economic weirdness:

"You may say: A 10-year nominal Treasury bond rate no higher than inflation is supposed to be the current value of the natural interest-rate? Good God! That is absurd! Something is wrong with our economy, and wrong at a much deeper level than a simple shortage relative to demand of the supply of safe-and-liquid-store-of-value assets that can be hoarded! It makes no sense that real capital assets must be at such a premium valuation in order to induce wealthholders not to hoard but rather to invest in the future! And if you were to say that, you would be Larry Summers.

"You may say: In the mid-2000s, it was all because wealthholders in China had this extraordinary and not-entirely-rational demand, and today it is because wealthholders in Germany have an analogous extraordinary and not-entirely-rational demand for the safe-and-liquid-store-of-value assets by the US government. And if you were to say that, you would be Ben Bernanke.

"And you may say: Those extraordinary foreign demands for dollar assets as safe-and-liquid-stores-of-value are, today, reflections of insane austerity and secular stagnation in Europe, and were, last decade, reflections of the global imbalances caused by China's rapid development and potential political instability. And if you were to say that, you would be Paul Krugman.

"And, of course, all three are right."

And of course, the sequence of different foreigners eager to hold our bonds due to regional political risk or secular stagnation may not find a successor once the Chinese and Europeans feel less frightened. Which means as always that past performance may not imply lengthy future continuation of low rates, or perhaps that when rate increases come, they might come quicker and more sharply than expected...

Comments  | 

Robert Avila
Or you could ask what type of investments most benefit from long rates this low and who is it that decides to make such investments. We know that it is not high technology where product life cycles longer than three years are unheard of and no end of bizarre investment projects are currently indulged in to soak up excess cash. Real estate development certainly soaks up a great deal of long-term money but China appears to have decided that there is a limit to the number of Empty Cities it needs and one suspects that Russian Oligarchs may be reaching a similar conclusion about empty apartments in major cities. Another big user of long-term money is raw material and heavy industry but now that China’s building boom is ending there is excess capacity in everything from aluminum to copper to petroleum to steel to zirconium. There is of course one area of investment that can soak up vast quantities of long-term money, infrastructure. In addition, much of the existing infrastructure is particularly antiquated in two of the largest economic blocks in the world: Western Europe and North America. Infrastructure is, however, a politically based rather than market based form of investment. So, if the search is on for the timid investors who despite unprecedentedly low long rates refuse to make profitable investments look to the lords of fiscal responsibility and the masters of austerity: if there is one sector of the global economy hoarding cash in the face of endless investment opportunity it is the public sector.
Here at home in the U.S., the infrastructure deficit is estimated to be northward of $3 trillion, which if addressed could absorb a lot of the steel, cement, copper and other materials now reportedly piling up as China and much of the developing world wind down their respective building campaigns. But as Robert Avila points out, even infrastructure spending as a national issue has become politicized beyond remedy. The New York Times recently featured a range of opinions on various public-private options for infrastructure repair/development. We'll be hearing more about these in the presidential campaign fast approaching. http://www.nytimes.com/roomfordebate/2015/04/08/does-the-public-benefit-from-private-infrastructure-investment