Every Measure of Real Interest Rates Shows the Fed is Out of Control

$blankman

4 years ago

When I was a homeowner, I calculated my own (crude)
estimated rent equivalent. I estimated a mortgage payment (since we actually
paid cash) and accounted for such as property taxes, homeowner’s insurance, maintenance
expenses and improvements, etc. While it seems to me that something like the OER (effective in 1983) makes some sense, it may well underestimate costs
in an economy where more than 2/3rds of households are homeowners. It
seems that it surely also discounts shocks—as if they are not important in the
near term. Costs of homeownership could, for example, drive more people into
the renter market. Which will have consequences for both markets down the road.

There is also the assumption that private homes are
not consumption items, but investment items. If the OER excludes purchase and
finance costs on that assumption (as I believe it does), it surely
underestimates inflation. Mish’s adjustment seems to be an attempt (laudable)
to overcome such shortcomings in the official inflation measures.

Mish, a lazy question: Would the GDP deflator (which
does have the disadvantage of excluding imports) be a generally better (as well
as broader) measure of inflation?

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LostNOregon

4 years ago

Mish, have you read this Politico article about Thomas Hoenig (former Fed Reserve Bank President in KC)? He really thinks the Fed has screwed the pooch.

https://www.google.com/amp/s/www.politico.com/amp/news/magazine/2021/12/28/inflation-interest-rates-thomas-hoenig-federal-reserve-526177

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Maximus_Minimus

4 years ago

Reply to LostNOregon

“Ben Bernanke, who was widely regarded as a hero for the ambitious rescue plans he designed and oversaw.”

Great humor, these articles peddle.

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Jackula

4 years ago

Reply to LostNOregon

Great article, was surprised to see it in Politico. More like jaw dropping. I think this time with the kinds of crazy narrative control we have today things are really gonna blow financially before any policy reforms are implemented. Putting an algorithm in change of the money creation as in the case of bitcoin is looking smarter every day. While I think bitcoin is a pos from many standpoints including technical the concept is very clever.

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Bam_Man

4 years ago

USA = “Venezuela-Lite”.

Venezuela 2021 Inflation Rate = 2,700%

Venezuela Overnight Benchmark Rate = 54.00%

Fake, (near) worthless “Money” does not and cannot EARN interest.

Get it?

Coming soon to a Banana-less Banana Republic near you.

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RonJ

4 years ago

“Rates are at or near record negative levels.”

How much longer can Scottie maintain warp 9?

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Doug78

4 years ago

It’s all
about priorities. This inflation was the cost of bailing out Main Street along
with the banks this time around. Would you prefer to have just bailed out the
banks this time as we did back in 2008? Instead of a slow anemic recovery that
took years, albeit with very low inflation, what we have is a sharp snapback of
the economy and low employment. Sure there is more inflation than we like but
if the Fed had done a replay of 2008 then we would now be in a very bad place. I
don’t like inflation but I accept it in order to get the economy rolling again.
The Build Back Better plan is too much stimulation and is not needed now so the
lone Democrat in Congress with some brains left did the right thing and killed
it. The middle of a pandemic is not the time for fiscal discipline. That will
have to be brought back in towards the end and that is starting to happen now. A
couple of years of high inflation won’t kill us and the labor market is tight
enough to give workers some bargaining power offsetting the inflation somewhat.
We will get though as long as the radical wing of the Democrats is contained
and ideally pushed down to reasonable levels.

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BowserB46

4 years ago

Reply to Doug78

I’m not sure the “slow anemic recovery” isn’t better. It’s based on real economic principles and not a big Fed-inflated balloon. Look at what the stimulus and bonus unemployment did. It created a whole class of former workers who now just want money–and they elected a class of socialist representatives who are happy to provide it. Right now, the GOP senators and one Democrat Manchin are all that stands between a slow but sure recovery and runaway 1970’s inflation. My friend, when inflation gets started, the psychology of inflation won’t let it stop.

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Doug78

4 years ago

Reply to BowserB46

I did not like how the post 2008 recovery went. It caused legions of people to lose their jobs and homes and crushed a generation of young adults while enriching the class that brought the crisis about. The only good thing was low inflation but that was because demand was weak and employees had no bargaining power. If the Fed and the government at the time was truly interested in real economic principles then they wouldn’t have bailed out the banks but they did. The consequent economic and especially social damage was immense. This time I am happy that they didn’t make the same mistake. The bailouts were also in Main Street this time as well. I remember the 1970’s inflation because I lived through it. We had energy quadruple, a bit like now, and wage-push inflation also like we have now but we are not as far gone into it as then. We can cool it down easier this time.

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Captain Ahab

4 years ago

Reply to Doug78

There should’ve been NO bailouts in 2008. The phrase, ‘too big to fail’, was a misrepresentation of greedy banks, making poor decisions. The same banks still exist, more greedy, still making poor decisions, and dependent on handouts if the economy is not strong.

The net result of 2008 was not a proper and intelligent consideration of risk-return in investment and operational decisions, but an invitation to a feeding frenzy on Fed largess.

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Eddie_T

4 years ago

Reply to Doug78

Agree completely.

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Jackula

4 years ago

Reply to Doug78

A couple years of high inflation will be real hard on the ascendant generations and the savers, the retirees on fixed income, and those that don’t own assets, ie the poorer among us. The younger folks are getting pretty restive and political instability will rise further yet. Inflationary thinking has already taken control in the asset markets, I think its already too late and will take serious interest rate hikes to contain.

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StukiMoi

4 years ago

Reply to Doug78

No “Main Street” gets “bailed out” by paying more for the same exact thing.

All “Main Street” paying more contributes to, is making more money available to bail out the same Wall Street Welfare Queens as before. None of whom have ever created a penny of value whatsoever. Yet somehow still are the ones who, thanks to The Fed and bailouts, have been handed the means to spend ever more of the value others have created.

There are no such thing as “good,” as opposed to hypothetically “bad,” bailouts. Bailouts are pure theft, period. There is no “good” theft. Never was, never will be. It’s just theft. The rest is nothing but excuses aimed at fooling the stupid and easily fooled.

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Zardoz

4 years ago

Was that little crash last year actually the ka of the ka-poom?

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ColoradoAccountant

4 years ago

The Fed can’t let silver go back to $50 an ounce, or gold break $2,000 an ounce and keep on rising. That makes inflation too obvious to everyone, and would represent the end of the no asset backed monetary system. Unless, that is what they want to happen?

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TexasTim65

4 years ago

Reply to ColoradoAccountant

Your comment reads as: ‘Whatever happens with silver and gold prices is exactly what the Fed wants to happen’.

I’m sure you didn’t mean for it to read that way, but that’s how it reads. It’s sort of like the running joke Mish makes whenever the Fed makes a statement to the effect of ‘what’s happening in the economy right now is exactly what we wanted to happen’ in order to placate people into thinking everything is under control.

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ColoradoAccountant

4 years ago

Reply to TexasTim65

Your interpretation is correct.

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TechLover1

4 years ago

Everyone is pretending to do something about inflation. The problem is that inflation (and most economic phenomenon) are psychological in nature.

Once inflation starts and takes hold, it is very difficult to tame down.

There is no chance that FED will increase short term rates anywhere near what would be needed to tame inflation to the 2% target.

So negative real rates are for future for a while.

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BowserB46

4 years ago

Reply to TechLover1

TechLover, you sound like me. I lived as a working adult through the 1970’s inflation, and clearly the psychology of inflation exacerbates the problem more than most economists want to admit. It even became part of the tax code, when businesses could use LIFO (Last In First Out) accounting for inventory. That maximized their Cost of Sales and minimized gross profit, and it essentially understated inventory value at the end of the year, which could also help in places where you paid property tax on inventory. Oops sorry for the digression.

Anyway people bought today with financing to beat price increases tomorrow. At the extreme end of the buy today was houses. And I was part of that. The deal worked like this. Home prices increased with every new home, so most home builders would sell you at one price and give you a contract at a higher price with a a side deal reflecting a phantom down payment. That way you could get a home loan for 100% of the real purchase price. No, we really couldn’t quite afford the payments, but I knew I’d get a substantial raise at the end of the year, and then the payments would be affordable. Three years later, home prices were up, we sold our house for 65% more than we paid and bought a bigger house we couldn’t afford until the next raise.

That psychology of buy today what you can afford next year continued for maybe hundreds of thousands of people right up to the crash, aka the end of inflation. Like a game of financial musical chairs the people who just bought suddenly were upside down in their mortgages, no raise or in some cases no job. Our household was lucky, as we were relatively conservative and didn’t continuously “trade up” to bigger and bigger houses, although we were probably close to the next “upgrade.” That’s when I became a financial conservative. Our most recent house we bought for cash, even before our last house was sold (long story…too much stuff in the house to show it–we lived there 26 years–so we moved first.)

Real bottom line is in the CPI 1970 to 1980. CPI up 100%. DJIA up a NET of 3.5%, largely I think due to high interest rates. Why risk buying stocks if you can get a one year bank CD paying 12%? And THAT is why I believe the Fed is 100% under control of Wall Street.

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TechLover1

4 years ago

Reply to BowserB46

Thank you for the thoughtful response.

I am not sure if inflation has taken a strong foothold yet. If it is above 6% for another six months, it will take a life of its own and long term negative rates will be there as long as FED will get the stomach to accept a heavy loss in all risk assets. I don’t know if we will get political leadership that can stomach such a loss. That means inflation runs hot for as long as it by itself causes a recession. We are some time away from that to happen.

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TexasTim65

4 years ago

Reply to TechLover1

The other big issue with persistent long term inflation (ie 10ish year) is it destroys the ability to teach kids and young adults how to ‘save’. If you have to race to spend your money as fast as possible before it loses too much value then you never learn how to save for anything long term.

That leads to life long problems for people (and nations) as no one learns the value of saving for tomorrow.

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TechLover1

4 years ago

Reply to TexasTim65

Thanks for your perspective.

I am more worried about what such a run of negative interest rate does teach kids and young adults: that speculation in risky assets pays off big! The wilder the better.

Just take a look at young adults “investing” in crypto, meme stocks, options and such and you get the idea. This will hurt them real bad when the risk off mode comes. Then they might become super conservative (and not have the capital as well) at the very time they need to take risk and will miss out on the upside. It seems we humans need to learn the same lessons in every generation.

They might shy away from risk assets for a long time and it will only worsen their share of the assets/economy over the long term. Eventually, they will inherit all the wealth in the nation but I feel there is a big difference between self made wealth and inherited wealth.

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Eddie_T

4 years ago

You have to do something to protect your wealth, if you intend to have any to live off of in your old age. Imho, tangible assets and shares in companies with claims on tangible assets are the best way to doe that. Not to say that doing that doesn’t involve risk, in a time when we have the Chinese behemoth slowing down, and numerous other deflationary forces in play. But it’s time to go back to looking for real value instead of chasing stocks with insane P/E multiples and fairy-tale tech stocks.

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Gator Break

4 years ago

Reply to Eddie_T

Eddie, what are some of your favorite companies in the asset field?

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Eddie_T

4 years ago

Reply to Gator Break

I like oil companies, midstream pipeline companies, and Canadian junior explorers, many of which have very attractive P/FCF’s. I also like uranium, but that’s more of a lottery ticket in the short term for a variety of reasons. The most under-loved of all, and my favorites, are the midstream pipeline MLP’s, which pay out large dividends…..SHP, WES,BPMP,EPD (and several other good ones). MLP’s have different tax issues than stocks, which makes them attractive to me as a high-income professional, but there is more to deal with at tax time. Not advice, do your own DD.

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Eddie_T

4 years ago

Reply to Eddie_T

I also own a few diversified miners, some of which are really beat down. SBSW, EXK,,BHP, PLG. Hopefully at or near bottoms, but no guarantees.

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BowserB46

4 years ago

Reply to Eddie_T

Good point. And is that not exactly what the Chinese are doing here? Chinese ownership of American Agriculture is out of control. WE need to own our means of feeding ourselves, and that may be where our investment money should be. What do you think?

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TexasTim65

4 years ago

Reply to BowserB46

Why worry about Chinese ownership of American agriculture?

If push comes to shove (ie a food shortage), the president would simply sign an executive order banning exporting of food. They do this all the time with Oil.

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Doug78

4 years ago

Reply to Eddie_T

Have you ever looked into gravel pits?

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Eddie_T

4 years ago

Reply to Doug78

No. Is that a serious suggestion or in fun?

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Doug78

4 years ago

Reply to Eddie_T

Peter Lynch talked about gravel pits in the 1980’s. He used them as an example of a type of investments that are moated from competition, has a quasi or real monopoly and is in private hands because they are too lucrative to quote on the market. No reason to share the real money-makers. Many years ago the French state decided to privatize its highways and they sold them to a large building group. To give a fig leaf to the regulators a small part of the shares were set aside for the public. I bought all I could. The company “rationalized” the highways and cashflow took off. Two years later the company staged what is called a “squeeze out” which is where the major shareholder can force small shareholders to sell them their shares for a “fair price” determined in this case by Goldman Sachs and merge the small quoted company into the larger one. It turned into a cashflow monster afterwards but that was hidden the larger company’s accounts. That was their “gravel pit” and companies never sell their gravel pits.

Gravel is the same everywhere and the cost to extract is low but the cost of transport is high so a gravel pit has a monopoly in the area surrounding it. It is also low tech so no hotshot tech startup is going to look for ways to disrupt the gravel market. If you own one your margins are really good and as long as build you make money.

I actually did look into gravel pits here but they are all owned and no way to get in. Maybe you can find one in Texas.

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Maximus_Minimus

4 years ago

Reply to Doug78

I am often puzzled watching French movies. I was of the impression, health care was government funded, but in the movies, they directly pay the doctor.

If the state privatized the highways to a single entity, who guarantees the quality of service?

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Doug78

4 years ago

Reply to Maximus_Minimus

Heath care is publicly funded but their are private clinics too and some doctors who have a very good expertise can chose to be outside the payment system and can charge whatever they want. In any case when you go to a doctor you have to pay him naturally usually by credit card. You also have a health card with all your history on it. You plug it in and it appears on the doctor’s screen. Most things are close to 100% paid for by the social security and if you get something bad you don’t pay at all. No need to sell the house if you get cancer or whatever. At the pharmacy it’s the same thing. It’s got its’ problems though but generally it’s pretty good.

For the highways by contract they have to keep up decent service and also all rates rises have to be authorized and they usually are. They rake the money in.

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whirlaway

4 years ago

And yet, the algorithms bring down gold and gold stocks every time inflation numbers are shown to be getting worse! Apparently, the idea is that the Fed would increase interest rates (a la 1981-82!) to bring down inflation. LOL.

If the Fed even gets to 1% short-term interest rates, it would still be a real interest rate of -5.7% or thereabouts.

Yeah, that would bring down inflation! More likely it would completely collapse the insanely overleveraged asset markets, and we will be back on the QE Express again.

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Eddie_T

4 years ago

Reply to whirlaway

Yep.

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Captain Ahab

4 years ago

Great article! However, the bigger issue IMHO is what prolonged negative real rates can, and will eventually do to an economy. To my mind, artificially low real i-rates represent a massive wealth transfer to the investing class. They contort the risk-return tradeoff, resulting in miss-priced investments/assets relative to risk, The potential impact on pensions etc should be distressing. Low i-rates/yields position those assets, whose prices benefited from low yields, for a huge price shock when it is no longer possible to keep yields so low.

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Maximus_Minimus

4 years ago

Reply to Captain Ahab

The pension funds are in a pickle. No longer can they count on 5+ returns to keep them solvent. They pile into the stock market to get those returns. Additionally, all pile into just a few stocks like GOOG driving them still out in the phantasysphere. When the epic correction comes, all will be running naked.

The cretins with fake credentials, who created the conditions, and it wasn’t natural, are responsible for what’s comming.

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BowserB46

4 years ago

Reply to Maximus_Minimus

And are the biggest pension funds not local and state governments? People here in Texas have talked about the pension time bomb for years and its potential effect on taxes–Texas lives off property tax with no individual income tax. Increased property taxes to fund city and state pensions could put a couple million retired Texans out of their homes. (Not technically, as the Texas law allows you to stop paying at a certain point and instead owe out of your estate with the taxes accruing interest at some usurious rate.)

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Every Measure of Real Interest Rates Shows the Fed is Out of Control

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