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Srikant Krishna is a financial technologist and quantitative trader. He has a background in biophysics, software development, and the capital markets. He has lived in Brooklyn, NY, Staten Island, NY, Holmdel, New Jersey, Piscataway, NJ, New York City, Boston, MA and currently resides in... More
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Srikant Krishna
  • Why Interest Rates Will Asymptotically Approach Zero Forever (Part 1, Background) 0 comments
    Feb 7, 2013 12:58 AM

    There has been much discussion and chattering in the financial and mainstream media regarding the possibility that interest rates may increase because of reduced action by th FED. Across the Atlantic, investors have been mystified how countries experiencing upwards of 50% youth unemployment can retain low sovereign debt yields simply due to the actions of a one Mr. Draghi. Across the Pacific, a large number of investors will shortly lose their shirts betting on higher JGB yields.

    Low interest rates are a necessary and predictable consequence of the massive credit-fueled bubble conceived on August 15th, 1973 when the dollar was no longer constrained by a gold standard, even on an international basis. Since that era, the wizardry, nay sophistry, that is finance has allowed credit (a more polite expression of debt) to be created at an unprecedented rate. But the miracle of finance relies on one fundamental principle: debt is borrowing the future. So, relatively quickly individuals began to finance their vehicles over several years, students accrued student debt to be paid back over their lifetimes, and households suddenly began to procure homes through 30-year loans. This is the essence of credit: the borrower trades their future production for current consumption.

    The availability of cheap credit elicited an enormous growth in asset prices across the board during the past forty years. Wall Street fared the best, with a stock market that seemingly was to return 8% or more in perpetuity. In fact, many annuity policies and pension plans were structured on this flawed assumption. In prior decades, stocks an bonds were reserved for the affluent. The tremendous growth in the availability of credit, in combination with the inception of the IRA, drew a large swath of the population into investments in financial instruments that they never would otherwise done. The money instead would have saved at the local bank, which would have lent to the local community businesses and so forth. Instead, the sudden infusion of cash flowed straight into the so-called money center banks, which then proceeded to use the proceeds to engage in more sophisticated casino games known as derivatives and structured products.

    But just as both individuals and corporations were prone to very fundamental long-term errors due to the availability of easy credit, governments also fell prey to deceptively simple borrowing. Balanced budgets became an extinct creature, and slowly but surely, Washington, Tokyo, Madrid, and corresponding state and local governments expanded in size and scope. Furthermore, pension plans for government workers were established based on defined-benefit pink-unicorn 8% per annum asset growth projections. Cheap credit enabled the West, which had extremely efficient credit generation and distribution systems in place, to eventually win the Cold War against a system in which borrowing the future was no simple task, and one that would have been regarded as mystical to not-well-connected.

    And the cracks were starting show early onwards. The constant pressure imposed by leverage and borrowing began to take its toll in the 1990s, with issues such as wage arbitrage and NAFTA being the explosive economic choices that corporations and countries had to grapple with. After all, when the bills started coming in, the only way the maintain an identical lifestyle was to reduce costs. And so foreign manufacturing and services quickly began to transform the workforces of so-called developed economies into systems that relied on the exchange of capital rather the production or real goods or services. Simon Johnson, in his May 2009 article in The Atlantic, "The Quiet Coup" summarizes this process in great detail and with an excellent use of the English language.

    It was a singular and revolutionary innovation that postponed the end of the debt bubble and produced real and measurable economic growth: the Internet. This technological revolution extended the "good years" for another decade, until the early 2000s. But there was a problem with the new era ushered in by this advancement: it made global wage and price arbitrage much easier to accomplish. Whereby before computer code may have had to been transmitted by satellite using proprietary protocols, fiber optics and ethernet changed the picture. An order for factory goods no longer required faxes or snail mail. It became trivial to communicate with anyone, anywhere, anytime around the globe.

    And there lies the basis of the dilemma. In a world where everyone is on near equal footing, how can there be justification for one country or region to afford a better lifestyle than any other? The short answer is that there is none, and Generation X, Y and the millennials are feeling the impact of not having to compete with the two hundred students in a high school graduating class, but rather two hundred million students from around the world of the same age who are a simple air flight away from attending the same university or obtaining the same job.

    So, against this painful backdrop for developed economies, the crows are suddenly coming home in droves to roost. In the second part of this article, I will describe in detail why it follows that interest rates will remain low forever.

    Copyright © 2013, Srikant Krishna

    Srikant Krishna is a financial technologist and quantitative trader. He has a background in biophysics, software development, and the capital markets. He grew up in Holmdel, New Jersey, New York City, Boston, and currently resides in Stamford, CT

    You can follow him on Twitter @SrikantKrishna, and on LinkedIn at http://www.linkedin.com/in/srikantkrishna/, or e-mail him at sri@srikantkrishna.com.

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