Friday, June 10, 2011

What's going on with interest rates?

I'm an amateur economist and investor with a lot of questions.  Here's one: What on Earth is happening with interest rates?  Why is the bond market driving US Treasury rates lower when the Federal Reserve is about to stop buying Treasury notes at the end of this month?  Wouldn't that dry up the money supply and force rates UP?

This is challenging my long-held view that US economic policy has been reckless and hyper-inflationary.  Is it possible that Ben Bernanke is right and without Quantitative Easing we would be in a deflationary spiral?  I know (and you know) that Bernanke knows a lot more about economics than most people, but come on - isn't there something nefarious going on inside that Federal building?

I am reminded that inflation is an oversimplification of a lot of different monetary forces at work.  There's a lot of difference between food inflation and rising home prices.  Rising prices of energy can suppress economic activity and reduce demand for all sorts of other things, and the net effect could be "no inflation".  And how it affects you may be totally different than how it affects me.

So let's focus on what those Federal Reserve bankers care about.  Remember this - when you can't understand something, look for a profit motive.  Most of the big banks are in trouble with the real estate market and stand to lose a lot of money and maybe collapse if their real estate loans aren't collateralized.  So one thing they will never do while they can stop it, is allow real estate prices nationwide to continue to spiral downward.

All that QE managed to do was to slow down the house price declines and drive up prices for a lot of other stuff (including stock prices).  Now that QE looks like it's completely out of favor and the new Tea Party mandate will probably suppress another round of easing, we SHOULD be seeing long-term rates (eg. mortgage rates) climbing and asset price declines accelerating.  Right?

Well, all that could happen tomorrow, or not.  But I have to consider that Mr. Market (who consistently proves to be smarter than even the likes of Mr. Bernanke) may be telling us that economic weakness and deflation is a real possibility.  I also have to think that there are more and more of you who would like to pay less for pizza and rent, and less of you that care about your shrinking or non-existent home equity and 401Ks.  Well you probably won't like the next few years anyway - house prices will continue to decline and food prices will continue to rise because of all that foolish economic policy in the past.  Until the home/hamburger ratio returns to what it was before the Keynesian Economists went wild, and until average people can afford average homes without fraudulent loans at artificially low rates.  That could be a long time from now.