Sunday, September 16, 2012

Low Interest Rates Make No Cents

The economy is doing just great. If you are retired, your savings are generating just gobs of interest--right! Figure a million dollars in the bank is generating about $10,000 a year. Remember when interest rates were about 8% and your return would be more like $80,000 a year?

If you are into buying bonds, there is no reason to buy any further out than 5 years at these interest rates. They can’t go much lower, and if they do, why even buy them? Do you want to hold a 100K 3% 30 year bond if interest rates double. Can you wait 30 years to redeem them? Or take a 50% haircut when you redeem them early?

The interest carry costs for futures are warped out of place. For a futures contract, 100 oz of gold one year out, a majority of the option cost is figured as interest on the actual amount of money tied up in the contract till delivery, plus storage fees and a volatility premium. So the commodities game right now is in play, with very low interest rates. It’s not rocket science to figure out that borrowing the money to buy gold futures is a money making proposition, the interest costs are negligible. Sounds a little like the housing boom doesn’t it?

Your health care and auto insurance companies invest the premiums received, into the financial markets to get an additional return. These returns allow them to reduce premiums charged on policies. This nice little cost cutter has gone to hell.

Retirement plans like CalPERS have assumed that the return on investment would be around 8.5%%. Guess what, it is not even close. Figure 100% of all state government plans are in some form of denial, “This can’t be happening.” If they were marked to market and held to realistic return rates, a lot more money would have to be ponied up by the states. Naturally the legislatures hope that this problem will just go away given enough time—Translation: After they are dead and gone.

Real Estate loans, you want to buy a home? Fannie and Freddie still offer nothing down loans at competitive low interest rates. If your credit rating isn’t up to par, that will not stop you from getting the loan. The aggravating thing, is that if the government got out of real estate financing, the sale prices would be a hell of a lot lower than what Fannie and Freddie are offering with government financing. To compound matters, there is no one out there to buy 30 year paper at these interest rates. By no one, I mean the banks, investment firms, and anything else you can think of. This is why Mr. Bernanke has decided to go with a 40 billion dollar a month re-purchase of mortgage securities.

The question has to be asked, who really benefits? The government can still borrow at ridiculously low rates. The interest on the national debt remains lower than normal, and Congress can spend more than it takes in in taxes and kick this can further down the road.

The big thing to understand here is that the current interest rate keeps the government debt manageable. Plus it facilitates the borrowing of more money. Why not borrow instead of tax the constituents? The concept of borrowing and putting it on the national debt has no real tie to the world most people live in. The national debt is just a place where we park debt we have no plans of ever repaying.

Americans are led to believe that the Arab crisis is the reason for the doubling of gasoline prices, when in reality; it is due to the massive printing of dollars. The US government is going to tax everyone with a savings account 50%. You have the same amount of dollars in the bank, but it only buys half as much. Bank depositors need to ask one question, why keep your money in the bank at these rates, where is the reward?

Our government has borrowed 17 trillion dollars. As long as interest rates are artificially low Congress will have no problems, but the minute they rise, we as a nation are in serious trouble. The funny thing is, the money they borrowed, was from people preparing for retirement, the silver foxes were going to live off of the interest. It’s a little like having retirees stand on a chair with a rope around their necks. They bought the rope and the chair and now the government wants the chair. Their savings were their lifeline to comfort in retirement. But by God, the government will not fiddle with your Social Security, all $1,200 a month of it. They are going to fiddle with the million you have in the bank. You’ll now get $800 instead of the $6,600 a month in interest; you had counted on for your golden years.

Ben has to buy all paper presented in order to keep interest rates low. If he doesn’t, you'll get more interest on your savings, and we can’t have that, can we? Risk has been taken out of the financial markets. Government guarantees for everyone, drinks on the house. What ever happen to plain old common sense?

Romney says he'll replace Ben if elected, so we do know when the party ends--- November 6th. At that point the movie is over and reality sets in---Got Food Stamps? Looking on the bright side, the Sunday paper is now cheaper than a roll of toilet paper and goes further if cut right.

Copyright 2012 by Jim Brubaker


Anonymous said...

why not join the party and buy some real assets with your cash?
instead of waiting for the world to revolve around you, you might want to start revolving around the world.
i used to think like you but after decades of being proven wrong, i now know that what i think doesn't matter, it's what is happening that matters.
thus, ride the current, don't swim against it.

Jim in San Marcos said...

Hi Anon

Everyone is traveling from point A to point B. Point B being some sort of success or satisfaction with life. There are many different ways to get to point B.

Everyone can be right, the only problem is, we can't all be right at the same point in time.

I bought gold in 1985 and got laughed at for years. Nobody's laughing now. My blog attacked the housing bubble in 2006, and I was considered wrong and it didn't bother me.

The words "right" and "wrong" are words for fools. Many a war has been fought over them.

I recommend reading a book called "The Tyranny of Words" by Stuart Chase written in 1938. You'll never lose another argument and realize self defeating phrases like; "I can't do anything right" or "after many decades of being proven wrong."

Your attitude in life can be influenced by how you interpret the feedback from your surroundings.

As a side note, housing prices have dropped considerably, and we may buy one.. The 600K homes are now going for 300K. And since no one is buying lower priced starter homes, it gives all appearances that housing prices are rising if you look at the averages.

Anonymous said...

Buying assets with cash? That really depends on what assets. As stated on the Drudge Report, we are 100 days off from the highest tax increase in history. This tends to imply lower asset pricing, for next year. This month may turn out to be the worst month to buy 'assets'. zero interest rates are already factored in. dollar devaluation is already factored in. Who are you going to sell your assets to, during the next year? who will have more funds to purchase whaf you have invested in ?

Anonymous said...

Calpers can buy California city bonds like Poway that pay 7 1/4% interest annually not payable for twenty years. In 20 years Poway pays Calpers $100M cash for the
$10M borrowed today and avoids paying the interest annually that Poway cannot afford. New schools with no tax increases. Calpers almost makes its return and Poway gets free money for 20 years. Win win. What could go wrong?

Jim in San Marcos said...

HI Anon 1:53

Actually the deal is even worse than that, I'm not sure who underwrote the loan or the interest rate, but Poway borrowed 105 million and has to pay back 982 million starting in 20 years for the next 20 years.

The neat thing about this financial arrangement, is that it jacks up property taxes about $800 per home per year 20 years in the future.

How this is deal is legal, is beyond me.

Anonymous said...

this is anon 3:58

makes sense but what i was trying to say is that when the game is rigged, like 0% interest rates, it's hard to make logical sense out of things. your(blogs) analysis is spot on and logical, but unfortunately we don't live in a world that follows logic.

Anonymous said...

Harry Dent says that the amount of existing debt and demographics are the two reality factors that can't be ignored. There is nothing that central banks and governments can do about this. It's gonna be deflation just like Japan has been unsuccessfully fighting for the last two decades. We are going that route here in the USA as well. So altho the savers might not be getting any return on their cash, they still may wind up the winners in the end since cash is always king in deflationary times.

Jim in San Marcos said...

Hi Anon 3:58

Your are quite definitely right, there is no rhyme or reason to the logic for how things are now.

Apple and Google pay no dividend and yet prices keep going up.

I think we are at a point in time where being absurd is the accepted norm.

I tend to picture the economic markets a a balloon that is being squeezed. Markets move away from the pressure.

Zero interest rates will eventually kill the financial markets. There isn't any risk reflected in the markets. Why loan money for free?

Somewhere in the near future, the market will snap back into reality, and no one is going to like it.

Jim in San Marcos said...

Hi Anon 8:08

I see it a bit different. If you have a ton of product and no money, you have deflation. Cut the price until it sells.

If you print a ton of money and grow no extra crops, there is less supply and more money. I call that inflation.

Deflation is where there is plenty of product and no buyers, cash is scarce. Inflation is where, there is limited supply and many buyers. We have limited resources and the federal government is printing consumption dollars, I see absolutly no deflation.

Of course it is an election year, so I guess we bend with the wind.

Anonymous said...

Nope. The reason Bernanke is printing so much is because of deflation. His fear of deflation. His recognition that it is there, hidden underneath all of the bailouts, propping up and printing that the government has done and will frantically continue to do. If the central bank and government didn't intervene with insane fiscal and monetary policy we'd be in a deflationary depression. That is what is underneath all of this. And it will happen because they will never be able to print enough money and issue enough credit to turn this around. A crash is inevitable.
The structure of our economy, our condition, our debt, our demographics will not allow a "recovery". It has got to be all washed away and starting with a fresh clean slate. Everyone is being fooled and setting things up for inflation when it is going to be the opposite.

Jim in San Marcos said...

Hi Anon 7:27

In the 1930's depression, the banking collapse took 90 percent of Americas wealth, it went up in smoke. So if you wanted to eat something and had no money, you starved. There was plenty to consume, farmers were even dumping milk on the highways because they couldn't get a decent price for it. That to me is deflation.

In 2008 we had another financial collapse, no one lost a dime. Plus now there is food stamps. Food prices have tripled. There is a shortage of beef at the old prices, thats not what I define as deflation. We don't have an oversupply of anything except bureaucracy.

Anonymous said...


I thought you would find this interesting, esp the conclusion

Jim in San Marcos said...

Hi Anon 7:34

Thank you for the link.

There is a lot of good material there.

It might surprise you, that my next post takes the opposite view of what is about to happen in the near future. Long term, this article will be right if Bernanke keeps printing currency.