In the past years low interest rates have been seen as THE remedy against crisis in financial markets and as a consequence out of it in the economy. Main arguments are cheaper refinancing for companies and the provision of cheap money for private consumption. If people spend money on consumer goods and companies provide more jobs a positive spiral of events is created. Especially under Mr Greenspan this strategy seems to have worked.
But will it work out this time again?
Looking at Japan one can easy get doubts about it, nearly 20 years of zero interest rate policy and they still complain about a bad economy. Why should Europe and the US fare better?
In all cases asset bubbles have been preceding in financial and property markets and - always little bit in the background – massive structural problems in economic policy (Japan: unusual extreme coziness among the big industrial players to the disadvantage of shareholders and the public; US: moving nearly the complete manufacturing sector – except for guns and cigarettes - into countries with cheap labor and a way too large share of services and sales in the economy on the whole; Europe: too rigid market conditions, too high taxes and the fetish like graving to implement utopian economic concepts with a Marxist background by politicians of all ideological directions; additionally in all regions timid and partly handicapped regulation in credits and investment vehicles). The sad thing is, nothing has been really changed yet.
Only a global liberal economy, void of any socialist fantasies, with a strong government as the ultimate referee and controlling guardian to stop economic crimes and monopolies, and as the resource of elemental social help for the needy ones and the provider of necessary state infrastructure can be the solution. Low interests alone are too little.
Right the opposite, as mentioned in a Bloomberg article http://www.bloomberg.com/news/2010-08-22/bernanke-must-raise-benchmark-2-points-in-prescient-rajan-s-latest-warning.html , there is an imminent danger of further bubbles and financial imbalances if interest rates are so absolutely low. Main reason for low rates is to provide cash strapped banks with money after money markets suffered a breakdown because of credit confidence. But if one may believe media reports, there is too much money going around nowadays. Since consumer and corporate credits are rather restricted, primarily out of fear, asset liability management teams in banks (have to) invest in Bunds and Treasuries, after being burnt by stocks and hedgefunds. Better to invest at 2,25% or 3 % than with an overnight deposit. Hence a new bubble is created. Nobody with a normal salary could have escaped the rising prices in gas, rent or service in the last 10 years. In other words inflation is alive and kicking, despite phony statistics or the everlasting propaganda of bank analysts. Additionally it seems that every part of the economy is growing again, well except for financial industries and car makers.
So what happens if central banks raise interest rates by two percent?
The consumer, according to analysts the battleship of the economy, will probably continue buying cars, food and movie tickets. Credit rates would grow only marginally, since credit margins are already high. For companies 2% more in interest rates are likely to be the least of their costs. And banks with a serious saving and loan business will even make more business with a better range of their credit margin.
Banks with too little core business and a surplus of “heroes of the universe“ (Tom Wolfe) will suffer. In general lacking the brainpower of institutions like Goldman or BoA, they will be hurt and crippled by their greed in gobbling up ridiculous bond yields. The question remains who will really have pity with them ? Same goes for phony investment vehicles, which will not have any real chances against a yield of 5 % for 10 years.
Of course this cannot be done by tomorrow. But it would be fine for a start when central banks start teaching politicians about economy and finally prick this bubble before the Big Bang.
What does this mean for the investor?
Keep mum, or take a long term credit if you can afford it. Because of the ongoing weakness in stocks, yields will go down further. But finally stocks and other assets will find a reasonable level, corresponding with economic reality and the retirement celebration of Mr Bernanke .