The interest rate bears …

by John Quiggin on March 14, 2006

… of whom I am one, are starting to growl again.

The cenral tenet of interest rate bearishness is that if interest rates are low enough to generate negative savings, as is the case in the US and Australia, they are too low to be sustained. The counterargument, put most forcefully by Ben Bernanke is that someone must be willing to lend at these low interest rates, and this lending must reflect a “global savings glut”. Bears respond that the supposed glut does not reflect savings by households or business, but is really a liquidity glut created by expansionary monetary policy around the world, which must eventually come to an end, or be dissipated in inflation.

Exhibit A for the bears is Japan where the central bank has not only held interest rates at zero for years, but has pumped vast amounts of money into the system. But Japan is now emerging from the long period of depressed activity that followed the collapse of the property and stock market bubble in 1991. Over the next year or two, we can expect to see liquidity being sucked out of the system and, eventually a return to positive interest rates.

Europe is similarly tightening policy. Again, there’s been a long period of macroeconomic depression, this time associated with the merger of East and West Germany also in the 1990s.

It’s probably premature to make too much of this, but over the last few weeks, the US 10-year bond rate seems finally to be drifting up towards 5 per cent. If the bears are right, it has a long way further to go.



Bob B 03.14.06 at 7:23 am

The conjunction of ample liquidity slopping around the world, high oil and commodity prices, and wars in far away places is beginning to look like a replay of the 1970s. Is this another case of deja vu all over again?


Steve 03.14.06 at 7:32 am

The cenral tenet of interest rate bearishness is that if interest rates are low enough to generate negative savings, as is the case in the US and Australia, they are too low to be sustained.

But nothing is ever sustained. Interest rates constantly change, unemployment rates constantly change, every measure of anything is unsustainable. Why should low interest rates be any different?



Tom T. 03.14.06 at 9:21 am

But if low interest rates generate negative savings, why haven’t Japan’s very low interest rates generated highly negative savings there?


mkl 03.14.06 at 9:29 am

Then let’s get prescriptive on this. Get out today and borrow all you can at long term fixed rates, best by mortgaging your house to the roofpeak. Sell any bonds you hold. Put the proceeds into gold, or money-market accounts whose yields will go up with interest rates. You’ll be steadily losing cash near-term, but look mighty smart when rates soar.

/oh, heck, it’s no fun putting your money where your mouth is posts are.


P O'Neill 03.14.06 at 10:06 am

How long have you been an interest rate bear? I’ve been one for about 10 years and still waiting for the stopped clock to be right even once.


Thales 03.14.06 at 10:15 am

In answer to Tom T., doesn’t Japan, along with many other Asian countries have a mandatory savings rate?


paul 03.14.06 at 10:25 am

Just one little bit regarding 4: money-market yields go up when other rates do, but the capital value of the account can in fact decline at such times. So nope. (The money-market funds typically hold a variety of instruments with maturities out to 30 or even 60 or 90 days; during periods of particularly fast interest-rate change, even those short maturities will see changes in underlying value that swamp a week’s interest or more.)

Of course, if interest rates have the effect on demand they stereotypically do, no holding of a commodity will help much either. I think I’ll go for the bottle caps.


Dan Simon 03.14.06 at 2:01 pm

I’ve seen it suggested that the US savings rate has been depressed by (1) the wealth effect of the real estate bubble and (2) the energy-related inflation spike of the past year. To the extent that these are temporary effects, their subsidence may allow savings to return to positive territory without much more interest rate adjustment.

On the other hand, there’s the worldwide trend towards higher interest rates, which may force American rates higher to prevent a dollar collapse (since the only thing holding up the dollar in the face of the huge US C/A deficit is massive foreign investment attracted by higher US interest rates).

My guess, though, is that even modestly higher rates in the US should be able to choke off growth sufficiently that the dollar can be allowed to fall without much inflation risk.


a 03.15.06 at 1:22 am

An interest rate bear will always eventually be right – at some point interest rates will go up, just as eventually interest rates will go down. The important point about bears is how wrong they have been for so long.

Timing is everything.


John Quiggin 03.15.06 at 2:40 am

Part of the problem is that you can be substantively right (not just in the stopped-clock sense) but still have to wait so long for the correction that it makes no sense to back your judgement financially. I wrote a piece saying the NASDAQ was overvalued at 2500, and watched it promptly rise to 5000. Am I glad I didn’t go short?


a 03.15.06 at 3:24 am

“I wrote a piece saying the NASDAQ was overvalued at 2500, and watched it promptly rise to 5000. Am I glad I didn’t go short?”

Writing “Nasdaq is overvalued” is pretty much meaningless; it sounds like you are making a prediction when you’re not. Basically it’s the same thing in finance that an untestable hypothesis is in physics. Writing “the Nasdaq will be lower next year than it is today” has sense. Mind you, at any given time it probably has around 40% probability of being right, so it hardly qualifies as a brave prediction. “Next year the value of the Nasdaq will be at least 30% lower than it is now” has more meat to it.

So, if you want to make an interesting prediction about interest rates, you need to make precise what term you are talking about (10 year, 30 year, 1 year?), what currency (I guess this is the dollar?), what future point you wish to predict about. Then it’s interesting if the current probability of the prediction is significantly less than 50%.

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