On Friday night, I dropped my daughter off at Wezz in Donnybrook for the first time. This is a traumatic experience, but one which many thousands of Dublin fathers have either gone through, or will have to go through in years to come. Indeed, I myself went to Wezz – a teenage disco – when it was called Wesley and we, the boys and girls, went on the bus. These days, that has changed.
Rather than getting the bus, today’s Wezz teenage girls go to each other’s houses to get made up. This, apparently, is half the fun (let’s hope so!). Young teenage girls cake on loads of slap, giving them that unmistakable ”bewildered raccoon” look.
Seeing the transformational effect that a Mac palette and a massive brush can have on the girls got me thinking about the similar impact of low interest rates on companies. The teenage girls put on make-up to look older and more mature; their mothers use similar stuff to look younger and more girlish – but the net effect is to change them.
Low interest rates do a similar thing. They make a bad company look good and a fairly decent company look better. In short, low interest rates flatter to deceive.
Now that interest rates are rising unambiguously in the US – the benchmark for the rest of the world – what is likely to be the economic effect?
Long-term US rates will probably hit 4 per cent by the end of the year. This doesn’t seem too significant, until you realise that this time six months ago they were at 1.5 per cent. Given that inflation was about the same level, real interest rates in the US were zero. Long-term rates have more than doubled in less than half a year. This American move may or may not have an impact on European short-term rates, but it will affect the amount of liquidity sloshing around the world. This will mean that, in time, the financial markets will once again refocus on the sustainability of certain countries and companies.
During periods of excess liquidity, stock markets rise rapidly, but do the underlying companies in the stock markets change in a fundamental way? Not really. In fact, they are probably run by the same people, doing the same business, making the same sales. So why are they worth so much more?
They are made more profitable by the subterranean interest rates that allow the companies to borrow at historically low levels on interest. This cheap money allows companies to refinance expensive existing debt, lowering interest expenses and thereby pushing up net profit margins.
They can also use the cheap money to buy back their own shares, raising their share prices – and making them look more profitable and more attractive.
When people expect interest rates to rise, the first thing they do is sell risky assets because they know that the interest rate balm is giving an unfair picture of what is really happening. This process lasts until they sell other assets and in the same way as when the credit was plentiful everything looks hunky-dory, when liquidity dries up, it will expose some of the flaws.
The same thing happens in countries. When interest rates are extremely low, even heavily indebted countries can look quite sensible. In fact, growth rates may turn positive and the debt burden may actually look manageable.
However, if countries don’t take the opportunity when things are calm and when rates are low to materially reduce their debt burdens, they will get hammered when rates rises again – as they eventually will do.
For the past few years, as European and obviously Irish interest rates have been extremely low, the mainstream economic view has contended that the cure to all this debt is austerity. If we could cut back on public and private debt and pay off debt as quickly as possible, the period of low interest rates will be the background noise to a successful reduction of overall debt levels.
Well it turns out (as argued here in the column until I have become blue in the face) that that hasn’t been the case at all.Not only have Irish (and European) debt levels not fallen relative to income, but they have in fact risen. This is because incomes have fallen faster than people can pay off debt, so debt relative to income goes up, not down.
All across Europe, countries – particularly after five years of austerity – still have too much debt, public debt and, in some countries, private debt. Austerity, by hitting growth, actually makes debt ratios worse because the policy can reduce income faster than debts can be repaid – meaning that the afflicted country actually ends up with more debt, rather than less, after a period of austerity which was supposed to reduce it.
If you don’t believe me, look at the chart. Lo and behold, which is the most delinquent of all the European debtors? Why, it’s the one which followed austerity to the letter. This is exactly what this column predicted all along: the country with the highest debt and the most dramatic austerity will end up still the country with the highest debt.
It turns out that the country that has come out of the bailout quickest is the one with the most public and private debt.
Now, how could this be? How could the underlying figures be so stark while the skin-deep spin be so believable? It is because of our old friend, very low interest rates. In the same way that low interest rates can make companies look extremely profitable, they can also make indebted countries look almost solvent.
So what should you do when interest rates are low? You should cut your debt burden, so that it doesn’t cut you to shreds when rates rise.
On Friday, the IMF released a paper written by Harvard professors Carmen Reinhart and Kenneth Rogoff, which claimed that European debts were too high and should be addressed not by austerity and deflation, but by the opposite: debt restructuring and inflation. It warned – as we have done here on many occasions – that the alternative was 1930s-style debt defaults.
Does it not seem logical for our government to use the next few months, when rates remain low, to figure out a way of reducing our debt burden, negotiate it now and prevent a financial meltdown when rates rise? The data doesn’t lie: we are only looking good because rates are so low. Now is the time to be courageous.
They are already on the way up in the US. If we wait till interest rates rise, it will be carnage, with yet more panic and we will be back to square one.
Have you ever been at a teenage disco and received the shock of your life when the lights came on suddenly, and the brightness did what brightness does late at night?
Think about it.
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Countries reduce their debt burden through inflation. They always have. They always will. This is really basic economics, as
the US and UK know, and they didn’t hesitate – as soon as the crisis hit, they started printing money hand over fist. They were completely baffled when the Eurozone didn’t do the same. Apparently, the Eurozone “experts” know less about economics than an average 1st year economics undergrad, and that really is depressing.
Couldn’t agrre with you more Mc Goo. Best D
Although for now. the EU is not following the US in long term interest rate adjustments, the writing is on the wall, this will be the final nail in the coffin of distressed Irish homeowners and my biggest fear.
With Enda & Co washing their hands of the mortgage crisis leaving the cleanup to the Bank’s and we all know their attitude, life for tens of thousands of Irish families is going to get much much worse. I truly dismay at this forecast.
The IMF paper went into the various means debt burdens can be reduced and it’s an awful lot more than simply ditching austerity. Here are the methods of debt reduction suggested 1)” Economic growth.” (This is the one Enda and the boys are banking on.) 2) “Fiscal adjustment-austerity.” ( No mention of ditching it.) 2) “Explicit default or restructuring.” (Bring it on. This what should have been done at the start) 4)” Inflation surprise.” (Be careful what you wish for as hyperinflation was a big surprise to the people of Zimbabwe and countless other countries who tried this one.) 5)… Read more »
Constantin Gurdgiev in yesterday’s Sunday Times concurs.
His 2014 Irish prediction, economy = no change, employment = no change, debt = no change, interest rates = rise, anywhere from 3% to 9%.
Ouch!
The IMF, while referring to FDR and “gold” in 1933, has apparently a flighty teenager attitude to Glass-Steagall, the decisive adult economic intervention that successfully brought the US out of the Depression. Maine Editor Says “Sen. King Can Lead On Glass-Steagall Restoration” The monetarist makeup-cake of the IMF recipes should by now not fool anyone. Staring into the blaring financial lights and missing entirely the oncoming 16-wheeler is a really daft way teach economics, whether at undergrad or expert level. “Fortunately, for King and other supporters, the issue is clear enough to build a real groundswell of public support. Unlike… Read more »
The real inflation rate is 8% not less than 2%. Interest rates on the 10 year US bond at 3% nominal rate is negative 5%. a negative 5% rate on money loaned is inflationary , that is the investment climate for cash is so bad that people will park it in a bond or bank to have it worth less in spending power every day. Why are the nominal interest rates so low. Because the central banks have to have them there or their Ponzi scheme blows up. Why are the long term rates rising? Because nobody wants to invest… Read more »
“So what should you do when interest rates are low? You should cut your debt burden, so that it doesn’t cut you to shreds when rates rise.” Six months ago you were suggesting people should go out and spend to maintain the cash flow. “your spending is my income” you said or words to that effect. Savers were hoarders it was suggested. The frugal were the problem. Spend , spend, spend you said. Now you say people should cut their debt burden. Isn’t that what a lot are trying to do. The problem is they waited too long. Their job… Read more »
Indo editorial presents 5 reasons to be wary about the eurozone’s stability in the coming year. Top of their list significantly is the German Constitutional Court – if Karlsruhe “did take the nuclear option, the bond market could declare open season on the currency bloc’s weaker members once more, pushing it back into crisis.”
http://www.independent.ie/business/world/eurozone-five-reasons-to-be-wary-in-2014-29891893.html
Everyone is more broke than they admit. One thing that would immediately crush the dollar and send dollar-gold to the stratosphere is the following, by Richard Russell: Richard’s Latest Remarks I offered the thought that the US could unilaterally re-set the price of gold to a much higher number and overnight re-liquefy the system and minimize the pressure of our enormous debt. The price of gold has been re-set twice before by the US, so why not now? Yet nobody in DC has even broached this idea. Why? Then the full horror of the situation struck me. The reason raising… Read more »
Too big to jail. Market manipulation transparent yet allowed. —————————————————————- 2013 – The Year of JPMorgan Theodore Butler | January 3, 2014 – 10:22am Probably owing to the dramatic decline in the price of gold and silver, I’ve read scores of year end metal reviews, more than I have ever read previously. Like most of you, I read in order to learn. Therefore, I approach every year end review and outlook with an eye towards understanding just what caused the prices of silver and gold to decline as much as they have and what that portends for the New Year.… Read more »
I’m sure, if pressed, the CME could come up with some cockamamie excuse why JPMorgan was allowed to hold and take delivery of so many gold and silver contracts in one month, but the real reason is that JPMorgan is above all rules and law. The CFTC backed down on policing JPMorgan and it would be foolish to think the CME would restrict its most important client in any way. Far from a band of brothers, this is a brotherhood of criminals. Besides, rules are for the little people, not JPMorgan. – Silver analyst Ted Butler, Butler Research, January 3,… Read more »
For the goldbugs, German Bundesbank is one of the the top losers apparently, of the 2013 gold-crash. Total losses for all central banks $457 billion.
http://www.welt.de/finanzen/geldanlage/article123602726/Notenbanken-verlieren-mit-Gold-457-Milliarden-Dollar.html
http://blog.milesfranklin.com/the-great-disconnect
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The great lie leads to the great disconnect, the huge misallocation, the biggest crash is on the way.
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“Another area that makes no sense are interest rates. Why are interest rates at historical lows (though doubled off their bottoms) if financial and debt ratios are as poor as they are. Actually “poor as they are” is the wrong term…I should say worse than they have EVER been. Why would rates be low if “risk” is at all-time highs? Another disconnect?
Bill Holter
This has to take the biscuit ! New York FED Chief Dudley Displays His Brilliant Economic Insight “Fed economists confront a major “riddle.” They don’t know whether or not the unemployment rate will continue to fall as the economy improves, because possibly millions of frustrated workers will now begin to return the labor force — which could lead to a rise in unemployment!” What Dudley is hinting is s that the only reason the official US unemployment rate has fallen recently, is that millions of actually unemployed Americans have simply been dropped from the labor force, as EIR and LaRouchePAC… Read more »
Their is too much debt Their is no incentive or bravery to address this issue. Govt debt is climbing even with austerity…interest payments on National Debt are climbing with a falling income. Next month at Davos,Business leaders will be discussing how to get more growth whilst ignoring the massive debt Mountain growing…..Cheap interest rates are fueling mini credit bubbles in the States where the amount of automobile debt at the end of 2012 outstanding was $1 trillion U.S.The growing interest rates are going to cause a shitstorm..but rather then address the issue of too much debt..the Fed or E.C.B [… Read more »
I know from personal experience managing businesses, that a successful CEO must strive to keep ALL debt down while growing company income, no matter what the available interest rate. So must a state government. Boosting income by incurring debt, for which David is making the case, is fraught with danger. He believes that debt is necessary to achieve income and growth. That is not the case. Long-term debt should always be confined to income-producing capital items. Even then great care must be taken not to overestimate the future income that will amortize the debt. Many companies fail by making this… Read more »
I heard a numpty from one of the Stockbroking Firms here in Dublin on Newstalk this evening congratulating the NTMA on the impending 10 year Bond issuance, his words of wisdom were ” we should take on as much Debt as we can while interest rates are low”!!! Not a word about how will we repay it! Am I missing something here?? Is this not what our illusrious leader Enda castigated the people of Ireland for at Davos “losing the run of ourselves”….at least with wages as they were in 2007 most people could afford to repay their loans, in… Read more »
David argues against austerity based on his misleading assertion that “austerity reduces income faster than debts can be repaid”. He does not distinguish between absolute debt and relative debt. Nor does he establish a cause and effect relationship between fiscal austerity and reduced national income. As I pointed out in the utility company example above, it is perfectly possible to produce more income from less consumption. Economists like David need to stop thinking that more borrowing and more spending will create more income and that the reverse, which they have dubbed “austerity” will automatically reduce income. Austerity and the Euro… Read more »
So if you use austerity as a tool to reduce debt you in turn reduce income. But you need income to pay off debt. Since no-one is spending then the debt not only remains but will become a bigger millstone when the price of money rises and our lads are going to get caught with their pantyhose down. Why is this do you think?
Why would they deny the advice of people who know better than a bunch of glorified county councillors?
http://blog.milesfranklin.com/japanese-hyperinflation-coming-right-up
Will Japan be the Black Swan
I think there are a number of differences that we should pick up on here between how interest rates and lending markets differ in Europe and the US. (1) In the US people have been able to refi / take on debt over the past number of years at low locked in rates for terms of 10/20/30 years, this provides stimulous and enables them to be cushioned against rising long term rates. (2) US currency should rise strongly against euro over next 3/4 years due to substanatial interest rate differential – rates will not be rising in Europe anytime soon… Read more »
Not to alarm you DMW but allot more that dancing goes on at Wesley the sex acts that go on there don’t make it into “respectable porn” SO I AM TOLD. Allot more than raccoon headlight makeup goes on in the bedroom it’s not just water in those bottles. I guess that economics is the same, the USA and Brits have now cornered the Afghanistan poppy market, yields are up way beyond the Taliban years – they were not slaves to the west war was inevitable. The balance of wealth towards the east is a form of equality, china and… Read more »
It is my imagination or do certain posts disappear in to thin air?
Many have been deceived by the low rates to want to lock in billions of cash. Will interest rates rise and make this a poor investment??? with all the manipulation I would not go near the bond market!!! Ireland: Ireland hopes to raise €5B with 10-year bond sale: The Irish Examiner reported on yesterday’s announcement from the NTMA that unveiled the first Irish bond sale since it exited the EU/IMF bailout programme late last year. It noted that market sources suggest the NTMA will look to raise €3B, but could raise at much as €5B as demand is likely to… Read more »
“The Golden Eye” Here is a thought posted on http://www.lemetrolecafe.com for the all knowing all seeing CON-stitutional references Bill: It’s rather amazing to me how uninformed so many folks on your site are relative to the reality behind our so-called CON-stitution. They have apparently all been brain-washed into believing the illusion that it actually pertains to them and that they actually are the “de jure” jurisdiction in this land who has unfortunately become the victims of a usurping power elite. Give me a break! What hogwash! They are a victim for one reason and one reason only—–THEY CHOOSE TO BE… Read more »
Yet another point of view to what’s coming
http://www.roadtoroota.com/public/642.cfm?awt_l=EhK2R&awt_m=3iHZ3fLf_aAZ85B
Monkey business
http://blog.milesfranklin.com/monkey-business
‘Labour’ are circling the Latrine… can’t happen quick enough.
http://www.independent.ie/irish-news/politics/new-blow-for-labour-party-as-south-dublin-mayor-resigns-29896555.html
Guy obviously caught a waft of what the approaching wind’s carried.
25 councillors have now left Labour since 2011…
http://www.youtube.com/watch?v=n4RjJKxsamQ
This is the only posting I can say should not be ignored. Within is an extraordinary commentary of economic trends.
It ignores the mainstream economists BS predictions and gives a clear unadulterated look at the real position of economies world wide.
http://blog.milesfranklin.com/wide-world-of-horrible-headlines
flash crash $35 in less than a second.
http://truthingold.blogspot.ca/2014/01/the-price-of-gold-feds-60-seconds-of.html
Interesting economic comments on energy.
Russia emerging as a super power again
http://www.caseyresearch.com/cdd/how-putin-conquered-south-africa
Low rates should be no rates
An “interesting” article on why money should bear no interest.
http://www.wakingtimes.com/2013/04/15/usury-the-root-of-all-evil/
As pleaded many times Our money must be issued from treasury at no interest and not be an IOU as it currently is. This must be or there is no salvation of the economy possible.
Make Ireland into the Shanghai of Europe. A refuge from government, bureaucracy, and Euro
http://www.thedailybell.com/editorials/34905/Richard-Ebeling-Shanghais-History-a-Tale-of-Successful-Capitalism/
WOW…. That early in the year? Hahaha!
Really, I must say, I did not expect the most ridiculous headline of the year 2014 to appear less than 200 hours into the new year, but there you are… ROFLMAO… Hahahaha! :)
http://www.independent.ie/business/irish/kudos-as-michael-noonan-named-european-finance-minister-of-year-29899294.html
For those caught between the Scylla of budget cuts on the one side, and the Charybdis of tax increases on the other, The Third Option There is a third option that doesn’t involve issuing carbon taxes, increasing the retirement age, reducing healtcare benefits, cutting unemployment benefits, or cutting agriculture subsidies, and it is Franklin D. Roosevelt’s Reconstruction Finance Corporation and Alexander Hamilton’s National Bank, starting with Glass-Steagall. Firms hoard capital, Banks are bloated with QE etc, so do as FDR best expressed this in his 1940 budget address, saying the United States alleviated the Depression “by borrowing idle funds to… Read more »
British Labour MP: Glass-Steagall Worked, Everything Else Doesn’t
Noonan, getting his belly scratched by FT’s “The Banker”, may have a different idea of “what works” or “what scratches”. All dogginess aside, being bankers poodles does not work.
Hi David McWilliams, I am a fan of yours since you first hosted a current affairs programme on TV3 in Ireland. And, I have been reading this blog avidly for some 7 years. A wandering Hibernian I am now, forlorn from my native shore that has treated me cruelly ; And, I only trying to enhance the nations lot I was so I was. Exiled as I am but concerned for the innocents of my kin, & those who are likewise of decent heart among newly arrivals there,- I purposely explored the web to see your internet response when “the… Read more »
88 year old ex SS soldier charged in connection with wartime massacre in French village of Oradour-sur-Glane. http://www.independent.ie/world-news/former-ss-soldier-88-charged-over-wwii-massacre-29899775.html French and German President’s meet in solidarity in the ghost town “in a visit aimed at underscoring French-German postwar reconciliation.” It makes good PR to haul a grunt over the coals even after 70+ years. O’bama leaves this guy in the ha’penny place. How about dragging his scraggy derriere before the ICC?? The European project is hurtling down a similar path to a couple of generations hence. Only difference is the foot isn’t as firmly down on the accelerator. This alliance will… Read more »
http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2014/1/8_Rick_Rule_-_Silver_Shorts_About_To_Have_A_Religious_Experience.html