First with Financial Comment from Arabia

Higher global interest rates both inevitable and essential

with 5 comments

Federal Reserve chairman Ben Bernanke yesterday made the statement that financial markets have long been dreading and said the US central bank will soon have to raise interest rates and remove cash from the system as a start to unwinding the unprecedented stimulus given to the US economy to stem the recent global financial crisis. Stocks immediately fell.

Indeed, the implications for all asset classes are enormous. Current valuations mirror the very low or zero returns on bank deposits. As interest rates rise then the yields on other asset classes also have to rise to stay competitive, and that is achieved by lower valuations.

Yield arbitrage

For example, if the rent on a house produces a three per cent return and a bank deposit pays five per cent then in order for the rental yield to match the return from a passive bank deposit the value of the house has to fall 40 per cent.

The same crude calculation can be applied to equities and their yields, currently at a very dangerous historic low. But this is an inevitable and necessary process.

To keep interest rates artificially low indefinitely would eventually result in runaway inflation of asset prices and with them general price levels. For with money costing nothing the urge to speculate on rising asset prices would be irresistible.

It is always then going to be a question of when and not if interest rates go back up. Bernanke’s statement ought to be a warning to investors in many asset classes that the writing is on the wall: interest rates are too low to fall any further, and the only way is up. And when interest rates go up asset prices fall.

‘Although at present the US economy continues to require the support of highly accommodative monetary policies, at some point the Federal Reserve will need to tighten financial conditions,’ said the Fed chairman, not wanting to scare the socks of investors.

Rising rates, falling assets

But every reader of ArabianMoney needs to think what rising interest rates will mean for their investments. It will be very bad news for stocks, property and bonds.

That will only leave cash, particularly the US dollar as the global reserve currency, short-dated treasury bonds and precious metals. The performance of gold and silver will be especially interesting if a bond market crash sends trillions of dollars into precious metals.

This is certainly going to be a nasty wake-up call for readers whose faith in Mr. Bernanke’s ability to solve all their problems is frankly ridiculous. His Fed is the same institution that caused the credit explosion that caused the global financial crisis in the first place. These are not good credentials to tackle the problems that lie ahead.


Written by Peter Cooper

February 11, 2010 at 9:05 am

5 Responses

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  1. Let’s see if I understand this global debt bomb correctly:

    1. The FED is the principal cause of the global financial crisis and the credit implosion (as Peter has stated)

    2. 2010 is an election year in the USA.

    3. The public can not trust what Bernanke says.

    4. The FED is in a really, really “tight spot”; they’ve painted themselves into a corner by their QE and other insane tricks (i.e. fatally flawed Keynesian economics here!). They were clueless in 2008, in 2009, and even now. They’re now scared to death.

    5. The FED made a huge gamble on their Keynesian experiment, hoping it would work. It didn’t work, for a variety of reasons, most significant of which is this: “a government can’t solve the country’s debt problems merely by printing money!” These actions just “kick the can down the road” for another year or two.

    6. Given the tight spot that the FED is in, there is no way on earth that the FED can raise interest rates in 2010, in spite of his statements, and in spite of what the “controlled” news media says.

    To Sum Up, Using Peter’s Words:
    “The performance of gold and silver will be especially interesting” . . . yep! Even with JP Morgan’s aggressive, daily shorts of the gold and silver price on the fraudulent COMEX (they are acting as the government’s agent here!), gold and silver will have good years ahead.


    February 12, 2010 at 11:10 pm

  2. WOW! Bloomberg TV USA just reported that Societe Generale just said that the euro is headed for a break-up. Such a bold statement makes me wonder if they have some inside government information, or if they are just trying to scare the PIIGS into austerity. I’ll let you big thinkers figure out the implications, if it actually happens.

    Bill Simpson in Slidell

    February 12, 2010 at 9:18 pm

  3. If he is foolish enough to start raising rates anytime soon, the US economy will go right back into recession. Millions of baby boomers will sell stocks and put their money into FDIC guaranteed bank CDs. A relative of mine is waiting for the stock market to go up just a little more, before he sells everything (six figures) and puts the money into bank CDs. I think Ben is all talk.
    If you like the horror genre, go to the website and read the latest article by Paul b. Farrell, ‘How to Invest for the (global) Debt Bomb Explosion.’ Feb. 9, 2010. It’s scary. No, it’s very, very scary.

    Bill Simpson in Slidell

    February 12, 2010 at 1:23 am

  4. “For with money costing nothing the urge to speculate on rising asset prices would be irresistible.”

    The issue is that the credit channel is broken. Broad credit supply has stagnated, bank loans are contracting not expanding; in the EZ broad credit is actually contracting.

    So the banks only have one place to put the money, US treasury securities. Hence, speculators essentially have no access to the ZIRP money, it’s just a mirage. All this if anything argues for higher bond prices, not lower.


    February 11, 2010 at 1:53 pm

  5. Peter, I would add short positions to your list of options for investors seeking to prepare themselves for these inevitable rate hikes. I would think a violent sell-off in long-dated US Treasuries would do wonders for the share price of the US Treasury short ETF “TBT,” no?


    February 11, 2010 at 12:07 pm

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