Ed Note: One of Michael Campbell’s favorites, Donald Coxe has 35 years of institutional investing and money management experience in the United States and Canada, and a unique background in North American and global capital markets.
The Highs and Lows of Zero Rates
Zero is a seemingly small number, but it is demonstrating its power to change the world. We have seen many examples in individual countries of The Power of One: this is that kind of power on global scale. We are regularly told that we should expect a roaring recovery Reagan-style.
But if Reagan were alive, and Margaret Thatcher were in good health, they would be astounded at how their two nations’ economies are struggling at a time of zero interest rates—when they had to launch recoveries at a time of record-high rates. (Ed Note: 18% Fed Funds)
The US and British economies are performing at roughly the level they were during the late stages of the 1981-82 recession—when corporations’ and consumers borrowing costs’ were inﬁnitely higher. That inﬂation could be in the zero range would also astonish them, even though the biggest factor in their ﬁrst election victories was the runaway inﬂation of the Carter and Callaghan era—when “malaise” was the Presidential euphemism for the spreading despair.
So why shouldn’t the economic recovery be at least as strong as Reagan’s—if not even more robust? It’s because those Zero rates tell us that the ﬁnancial system’s problems that triggered the economic collapse aren’t going away quickly—and could even be getting worse.
Reagan and Thatcher didn’t have to deal with serious demographic problems that meant housing prices could not—for the ﬁrst time since World War II—leap in response to plunging interest rates. Reagan and Thatcher didn’t have to mortgage their nations’s futures to bail out bad banks, which, upon being rescued, diverted the succor they were given to rebuild their devastated capital to speculation and bonuses, thereby making their saviors—politicians and taxpayers—look like suckers.
Nor did they have to face the certainty that interest rates and inﬂation would have to go up sometime—and that could be very inconvenient for both the politicians and the economic recovery.
US interest rates and inﬂation could remain at current levels, were America to mimic Japan’s experience from 1990 to Koizumi’s election. But those early years of Japan’s Triple Waterfall Crash occurred at a time of rapid global growth that meant Japan’s trade surpluses grew robustly, and the immense levels of domestic savings were adequate to ﬁ nance Tokyo’s endless ﬁscal deﬁcits. (Currently, Japanese investors are not quite able to absorb all the debt coming from record deﬁcits, but they’re certainly embarrassing their American counterparts: they’re absorbing 94% of new government debt offerings.) In contrast, America’s trade deﬁcits are a permanent feature of the US economy, and even the current uptick in US household savings is no match for the fast-growing ﬂ ow of new Treasurys, which means the US becomes more dependent on foreign bond-buyers by the month.
The Administration’s forecast through 2019 assumes that foreign creditors’ appetites for Treasurys will grow at least as fast as the national debt. It predicts sustained real GDP growth of 3% per year, with no recessions, no increases in taxpayer cost for health care, and—despite sustained deﬁ cits and a doubling of the national debt-to-GDP ratio (excluding Fannie and Freddie debt) from 41% to 82%—long Treasury yields will not rise more than 1%. (We spoke at a Canadian ﬁ nancial conference last month at which Niall Ferguson was the star. He ﬂashed that forecast up on the screen and said, “Those aren’t real forecasts: they’re Mickey Mouse numbers.”)
Despite the current deﬁcit of 12% of GDP, and despite increasing grumbling about Washington’s willingness to incur huge deﬁ cits in bad times and good, the foreign support of the dollar by buying Treasurys continues. There has been one little-remarked change in the investment strategy of America’s Sugar Daddy #1: in recent months, China has been rolling over its maturing Treasury notes into T-Bills. It thereby chooses to forgo interest of 2%–3.4% in favor of near-Zero yields. What power, one wonders, does Beijing think, comes from a Zero return in a weakening currency? And why is that putative power growing so relentlessly?
Published by Coxe Advisors LLC
Distributed by BMO Capital Markets
A monthly publication of opinions, estimates and projections prepared by Donald Coxe of Harris Investment Management, Inc. (HIM) and BMO Harris Investment Management Inc. (BMO HIMI). Basic Points is available exclusively to clients of BMO Nesbitt Burns, BMO Harris Private Banking (Canada), Harris Private Bank (U.S.) and BMO Capital Markets.
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