I begin by thanking everyone for their overwhelming outpourings to the 20th Anniversary of the 10 Best Songs to Trade To. I particularly appreciate all the suggestions for incremental inclusion and want to assure my readers that I am taking them under consideration. But no, recent events notwithstanding, and tempting though it may be, I will not be adding anything from the Coldplay catalogue to the list.
However, we’ve other matters with which to tend. Some pleasing, some frustrating. Let’s begin with the former, shall we?
I’m delighted to learn that CBS has shitcanned The Late Show – once a crackling center of wit, creative energy and modern sensibility, the show should’ve died with the departure of its visionary creator: David Letterman. They instead replaced him with that petulant hack Steven Colbert, whose one joke seems to be to utter sardonic witticisms, in tortoise-like cadence (so that those deemed obtuse will understand what he’s saying), issued at the expense of anyone who fails to rise to his level of hip sensibility. He generally lets us in on the gag, inviting everyone who comprehends how things really are (i.e. those that agree with him) to be part of his exclusive circle, while rudely dismissing anyone who doesn’t.
I don’t really care that he’s a liberal from Central Casting. So is John Stewart, who at least manages to bring some joyful self-deprecation into his scoldings.
With fitting verisimilitude, and though the network denies any linkage, the decision comes on the heels of Colbert’s pithy criticism of parent Company Paramount’s $16M out-of-court settlement with Trumpy Bear – the reality that The Late Show loses ~$50M each year notwithstanding.
In an even happier (and predicted in this space) turn of events, the Banks have all reported blowout earnings, and this always brings the waterworks to mine eyes. Who, after all is more deserving of these riches than our friends on buttoned-down Wall Street? I was a bit worried about them, what, with all that market carnage in April and all. But wouldn’t you know it? April was the best month of the three.
And Goldman Sachs – a company for which anybody who fails to root can truly be said to possess neither heart nor soul – clocked in with record revenues.
Meantime, it’s on. The information is flowing in fast and furious. Inflation statistics? A mixed bag. Further consolidation in the Energy Patch. Epstein. Jumbotron Gotchas.
At least it’s quiet – on a relative basis – in the Middle East.
But what’s really on my mind is all this monkeyshine talk about the need for interest rate cuts. Drives me crazy. Trump thinks the Fed Funds Rate should be at 1% (its current lower bound is 4.25%), and, in his spare time, plays with the market like an overly sadistic cat, toying with a crippled mouse, about firing Chair Pow.
Early this past week, it looked like he might do just that; the infallible PolyMarket was displaying a jump to a 40% probability of same, before he issued a trademark “just kidding”, sending the chances back to just below 20:
These are bad, terrible, ideas. First the significant lowering of Fed Rates and second the premature dispatching of our beleaguered Fed Chair. Now, I’m not gonna holler much if the Fed decides to throw the wolves a bone and lob in a modest cut. But the material slashing of yields is plain bad economics.
Before I school y’all as to why, a couple of disclaimers are in order. First, I am firmly in the camp of those who prefer borrowing costs to reside at the upper end of appropriate ranges — so as to maintain as much dry powder as is possible for cuts when they are actually needed.
They are not. Needed, that is. Midway through Q3, the Fed is projecting real growth of ~2.5%. Risk assets are priced at an all-time high. We enjoy full employment.
Meantime, Interest Rates while above levels prevalent after the three significant crises we’ve endured this young century, are, particularly at the longer end of the curve, well within levels of familiarity and comfort:
If we were to obliterate them now, we would likely face the following annoyances:
Rising Inflation. Must I really bust out an IS/LM curve here to show you? Easier money means more borrowing, which, if you hadn’t noticed, is a major aphrodisiac for our unchecked consumption orgy. At lower rates, individuals and organizations will borrow more, and, having borrowed more, will spend more.
It is doubtful that increased supply can keep pace, so stuff will cost more.
Increased Indebtedness. Did I mention that economic agents will borrow more at lower rates? I hope so because they do. Institutions, Individuals, Corporations, Municipalities, States, Sovereign Nations – All God’s Children – beef up their liabilities. And this against a backdrop of global indebtedness many orders of magnitude greater than that which has ever prevailed – including the interval leading up to the 2008 crash. Many – including, arguably, the U.S. Government — owe amounts which they cannot hope to repay by conventional means.
I hardly think, under the circumstances, that new borrowing inducements are warranted. Indebtedness is likely to expand under all circumstances; we cannot resist gorging ourselves upon it. But someday it must either be paid back or otherwise disposed of. And that, my friends, is unlikely to be a pleasant affair. In the meanwhile, the concept of turbocharging it by jamming down rates strikes me as being a less-than-optimal selection among our alternatives.
It Crushes Savers. Answer me this: what on earth do policymakers have against us wretches that keep large portions of our wealth in liquid, interest-bearing accounts? I mean, first, we cram down rates at the slightest whiff of a pretext to do so, and then we tax the meager proceeds as ordinary income. And, after years of pre-tax returns in the 0% to 2% range, we were finally getting some relief. One could, and still can approach, the purchase of a CD that yields the princely sum of 5% (pre-tax). But if Trump gets his way, we’re back to zero.
The well-worn platitude (attributed to, but never uttered by, Benjamin Franklin): “a penny saved is a penny earned” is still around. But you wouldn’t know this from economic policy, and if the low-rate crowd gets its way, they just might toe-tag it altogether.
Misallocation of Capital. OK, pay attention, because this here is the big one. When rates are suppressed, economic agents make bad decisions: borrow too much and allocate proceeds in the wrong places. With unfortunate outcomes, sooner or later, ensuing.
Let’s begin by setting the stage. In textbook economics, there’s a tiresome but important concept known as real interest rates. It is defined as the nominal interest rate, less the rate of Inflation. For illustrative purposes (and though I think that the statistics understate the reality on the ground), let’s assume that the latter is 2.5%. Set the nominal rate at 1.0%, and it implies a negative real rate of 1.5%. Creating a construct under which borrowers are the actual recipients, rather than the burden bearers, of the cost of money.
Who wouldn’t borrow to beat The Band under these circumstances. Not borrowing means you’re losing money.
So, what happens? Companies issue credit and allocate to projects unworthy of underwriting. Enterprises that should be shut down refinance, or, if private, go public. Governments rejigger their financials to show lower interest repayment expense. And borrow more. Banks, which may or may not pass on the reductions to their borrowing clients, book wider spreads. And lend more. Many borrowers will default, causing untold upheaval. But bonuses will have been banked by then, and it will be someone else’s problem.
And the poor consumer? Well, we face the worst fate of all. You’d think we would have learned something about this during the Great Financial Crisis, but, apparently, we didn’t.
Credit card and other forms of Consumer Borrowing are at an all-time high:
Of course, the Lion’s Share of this is in the form of mortgages. And, while there were many contributors to the last crash, I believe mortgage debt was the Head of the Dragon. Bad behavior prevailed across the entire transactions chain. Aspiring homeowners reached too high, as empowered and enabled by unscrupulous mortgage brokers. Banks gobbled up this paper, knowing in advance that they could bundle it and sell it to greedy, ill-informed investors. It was great while it lasted, but then it all went kapoof, producing abandoned dwellings and empty offices everywhere one cared to look. And bankers pounding the pavement.
At present, the cost of home ownership is at record levels, and glib analysis places the blame on high mortgage rates. Fair enough. I get that folks refinanced when the refinancing was good and are thus kinda stuck in terms of mobility. But if we unleash the hounds of lower mortgage rates, it’s a sure bet that the same bad behavior witnessed 20 years ago will resurrect itself. Mortgage bucket shops will multiply like hobgoblins and sell their wares to unsuspecting homeownership aspirants. They will comfortably pay the first few installments, and, unable to meet balloon payments, will hand the keys back to the bank, walking away from all those swell new appliances that they purchased on their credit cards, which charge 16% rather than 18%.
The Party line suggests that this will simply catalyze a surge in building, thereby divinely increasing supply. But here, it pays to remember that we have recently implemented a tariff of 15% on the Canadian Lumber that comprises 30% of the cost involved in the construction of houses in Lower 48. And there’s talk of taking this level to 25%. At which point, the incremental homebuilding expense will rise comfortably into the double digits.
I could go on, but hopefully I need not. Meantime, Conservative rate policy, as I have demonstrated, holds Inflation in check, serves as a guardrail against the acceleration of already excessive borrowing, and offers a salve to misanthropic savers such as myself.
Most importantly, the cost of money at appropriately sober levels forces economic agents into sounder decision-making. Because the cost of being wrong becomes more acute.
There’s not much space left in this here column to protest the concept of firing Chair Pow. But we’ve covered this before. Suffice, meantime, to state that Jerome H. Powell is not Steven Colbert. And for this, at any rate, we can and should be thankful.
I’m not sure any of this means much for the markets. Until it does. At which point, it will mean a lot. Rates are probably going down, near-term, and this will help goose already-lofty risk asset valuations.
A reckoning may be coming, but whose to say when?
TIMSHEL