This so called bubble isn't tech at all. This is the everything bubble caused by excessively low interest rates, held down by the government for inappropriately long periods of times. Sure, 0% may have been justified in the wake of the 2008 crash, for maybe a year or two, but not 10+ years!!
People shouldn't be surprised that SOOO much money is sloshing around looking for increasingly risky returns when interest rates have been 0 for so long. And here we are, at barely 2.5% (far below where it should be) and the fed is already considering rate cuts even though we're in the biggest bull market. This article is doing the world a great disservice by trying to blame the tech industry without even once mentioning the real reason: excessively low interest rates forced on us by the Fed. And it's not just the Fed, other 1st world countries are doing the same thing. They're all following the call of Keynesian economics: Keep the party drunk as long as you can by refilling the punch bowl. By creating every incentive in the world to separate people from their money as quickly as possible in a hopeless attempt to spur money flow, ultimately resulting in increasingly risky investments.
The Fed doesn't have a target interest rate, they have a target inflation rate -- and the current policy has not been causing inflation -- so by all measures they've been successful at doing exactly what they're supposed to be doing: helping the economy grow without creating high inflation.
I notice that goldbugs in particular get very upset about low interest rates -- as if there is something "natural" or "normal" about 7% vs 3%. But there is no magical number -- if you can create wealth without inflation, you should obviously continue to create wealth.
Also, the government doesn't owe you a risk-free return of 7%. In theory, the risk-free return should be equal to the rate of inflation -- nothing ventured nothing gained.
Yes, if you measure inflation as a basket of consumer goods, you can pat yourself on the back doubly for having an asset bubble at the same time as "low" inflation. Nice that the population can still afford bread and eggs, not so nice that the prices of property, artwork and the like disappear into the stratosphere far beyond their reach.
Upvoted for the point that how inflation is measured matters a good deal to any discussion of whether fed policies of managing it are good for society as a whole.
But... a picture of specific problems with the measure the fed uses (PCE, apparently) would be better than vaguely implying it's bad. Apparently it does include housing expenses, medical care, education, and even recreation, so it's not clear it's just "a basket of consumer goods."
Looking at housing costs without considering current price e.g. ( rental equivalent ) is a tricky business as it will lag current conditions by decades as a relatively small portion of the population pays current prices.
The vast majority of people live in, and the vast majority of economic activity takes place in, major urban areas. So yeah, housing inflation is very relevant.
considering the fact that in all metro areas housing prices have almost doubled, I'm curious in which parts of the country the housing prices decreased by half to reach the 13% average increase
Also keep in mind that housing prices in those areas are not forced up by oversupply of capital. Those areas have the highest demand for housing in the world, and draconian zoning laws that ensure supply will never be able to keep up. The Fed would have to be insane to set interest rates tailored to SF housing prices.
I'm 10-15 minutes outside of Raleigh. I have a 22-35 minute commute (depending on time of day and traffic). I bought a house for something like 300-350% of a junior dev's annual salary in 2013, and from what I can tell, could do the same today (both house prices and junior salaries have increased).
(Note: I am in Garner, which is a less affluent town, but hardly a bad place to live).
Thanks - appreciate the data point. I just bought a house for about 0.8x a mid-career dev's annual salary, but worked really hard to find it (I'll be about 1.2x once I get it finished and rethatched, which is part of why it was cheap)
But I work remote and it's a risk to leave the city - growing up in northern California the idea of owning a home without an enormous amount of debt (and thereby meaning I had to decide to maximize income whether it meant doing what I wanted) was foreign.
How do you define a "decent" job? If you're a nurse you can probably find a decent job most anywhere. If you're a software developer then your options may be more limited.
Property is an investment, not a consumer expense. Outside of a few limited areas there is plenty of rental housing available, and rents are fully included in the CPI calculation.
The effect that is being suppressed is the natural deflation of manufactured and technological goods. A new manufacturer, or really any new vendor, wins marketshare by doing more for less. And computing power gets cheaper analogously to Moore's law (as we all instinctively know). So in a steady state economy (no resource shocks/depletion, etc), we should expect to see continuous natural deflation due to the progress that we are all working to create. But yet the Fed insists on targeting price inflation, to keep workers from directly seeing those gains!
This played out quite nastily in regards to consumer goods. Walmart et al came to town, promising low prices based on foreign production and domestic economies of scale. But they destroyed local towns' commercial economies, putting many people out of stable living-wage work. Economic orthodoxy would expect the remaining local economy to cope by providing the still-employed more purchasing power (say, dual income families being able to drop to single income, now-richer still-employed people hiring household help, etc). But any lower prices were only temporary due to that policy of forced inflation, and everybody kept needing the same level of income. So the net result of that innovation ended up being to lower the standard of living with lower income and poorer quality goods. (Then along came heroin from Afghanistan, but I digress).
The problem is that we're not leaving ourselves options for when things inevitably go bad. We need to unwind the balance sheet while it's possible, because otherwise we won't be able to deal with another 2008 the way we did.
The balance sheet is (slowly) normalizing though. It's being reduced by about half a trillion a year, and that program will continue, regardless of interest rate changes.
This is incorrect. The fed announced a halt of their divestment when signs of instability began showing over the end of '18 into '19. [0] (Edit: I wanted to reconcile why your chart was still trending down; the halt starts in September. [2])
The lowering of rates now coupled with balance sheet stabilization, during the longest expansion, prior to any REAL sign of economic turmoil (backed by Powell's own statements earlier this year when he was advocating "patience", the fundamentals have not changed substantially since then although his tune has) is to many a bad sign that the fed is being driven by political/wall street forces to keep the party going despite losing leverage down the road and promoting asset inflation. (Housing is often discussed but to avoid the inevitable rebuttals to that, I'd also cite the average PE ratio [1] being far above the historical average.)
The issue is, government is subsidizing Risk with Tax paying dollars. By handing out money for free (0% interest rates), they're increasing systemic risk. If something terrible happens like it did in 2008, tax payers are on the hook, to the tune of trillions of dollars.
> In theory, the risk-free return should be equal to the rate of inflation -- nothing ventured nothing gained.
The rate of return is the opportunity cost of capital. As long as you have economic growth there will be an interest rate.
When the government puts an interest rate below the natural rate it is making the machine work harder, but not necessarily better. It gives people that have access to the natural rate of return an above-natural return.
"the fed is already considering rate cuts even though we're in the biggest bull market"
Inflation is extremely low, so the Fed should consider cutting rates. Lower rates means lower unemployment, which should eventually lead to higher wages. As a model for what the Fed rate should be, assume that it should always be 0% plus whatever amount is needed to limit inflation. Since inflation has been low and stable, the rate should remain close to 0%. After all, we should want a world where unemployment goes low enough that wages eventually go up. And, it is important to notice, in today's world, even an unemployment rate of 3.6% has not been low enough to cause the kinds of wage gains that were normal for most of the 20th Century. If wages aren't rising and if inflation is low, then the Fed should be pushing the rate back toward 0%. The lower the rate, the easier it is for entrepreneurs to get money, to build a business, and thus to stimulate economic activity, and if enough entrepreneurs do so, then presumably unemployment will eventually go down to whatever level is needed to raise wages.
A price inflation measure like CPI is a summary statistic, so it does not capture the underlying dispersion of costs as various people experience them. It is true that imported, mass-manufactured goods remain cheap, such as TV’s. At the same time, domestic resources like housing, health care, and education are difficult for many to afford. It turns out those things are vital to a good life, more so than TV’s.
A monetary supply inflation measure like M1 shows a remarkable rise since 2008. The central bank added lots of money by financing the US government debt, and that has indirectly bid up financial assets, VC, etc. If you owned US financial assets over the last decade you are flush; if you didn’t you are wondering why important things in life are so expensive.
Education is more accessible now than ever. It's amazing that anyone anywhere in the world can watch Feynmann and Leonard Susskind's lectures on General Relativity without giving a penny to CalTech/Stanford. There is also plenty of cheap housing in the US, just not in large cities and highly desirable areas. If you do decide to live in a low-cost area, there are more options for remote work than ever before.
Over the last 20 years, humans have really mastered cooperation on a global rather than a national scale. IMO, the economy as a whole has expanded as a result.
Is this a joke? I mean, I understand the sentiment, and agree with it, but (probably unfortunately) the current value of education is more highly correlated with the ability to _prove_ that one is educated than education itself - the "piece of paper" if you will. Coursera is moving toward a model where affordable certification is possible for topics normally restricted to an advanced traditional post-secondary education in the US, but the reality that the value/cost ratio of post-secondary education for the average American has decreased significantly over the past 50 years.
Note: I'm doing this calculation under the assumption that the value of an undergraduate degree has remained constant, while the average price of tuition has increased significantly. Some might even argue that the value of a degree has even decreased due to looser lending practices enabling more people to obtain degrees, further increasing this disparity.
> Over the last 20 years, humans have really mastered cooperation on a global rather than a national scale.
There may have been improvements, but mastered? I guess a lack of global scale cooperation has nothing to do with our failure to address global warming....
It is being addressed. Not at the level of governmental cooperation, but some of the things that really matter are being done in spite of that.
Solar cell prices have decreased by 300x over the last 40 years and continue to do so. Similarly, solar production capacity and installations have increased very significantly.
There are also more electric car companies and models than ever before.
> Lower rates means lower unemployment, which should eventually lead to higher wages
> And, it is important to notice, in today's world, even an unemployment rate of 3.6% has not been low enough to cause the kinds of wage gains that were normal for most of the 20th Century.
You're talking about the Phillips curve (https://en.wikipedia.org/wiki/Phillips_curve). I wonder if it's not dead. We've got the lowest unemployment rate in decades but no very little increase in AHE (average hourly earnings). It seems like while a lot of people are competing for jobs, companies still aren't willing to pay more.
Just search for "is the Phillips curve dead" just to find bunch of them. It is a head scratcher for me, but of course, I'm not sure who's right (and I don't think anyone does)
I think part of it is that there are large swaths of the labor force that are basically replaceable (retail, food service are examples), so there's no real need to pay someone more. Just get someone new.
My ignorant gut would be that greater portions of the workforce are replaceable with capital nowadays than in previous times.
You want to hand manufacture more widgets, you need to hire more people.
I'd be curious if there's also a de facto inflection point, whereby decreasing requirements for broadly available labor limit wage gains, which stunts demand, which stunts additional labor and hiring.
Essentially: in a bifurcated economy demand and unemployment become less tightly coupled.
> greater portions of the workforce are replaceable with capital nowadays
I totally agree. I think this is even something they intended. And the workforce parts that aren't capital are more serving the capital (running expensive machines) rather than the machines helping workers be more productive. People's jobs have been tailored around becoming replaceable widgets, where you want to be able to replace someone as fast as possible (with minimal training).
But all this is basically saying the Phillips curve is dead. In that, lower unemployment doesn't lead to higher wages.
You are mistaken. The Phillips Curve suggests that low unemployment leads to higher inflation, whereas I wrote that low unemployment leads to higher wages. What I wrote is a simple assertion of supply and demand: if labor is in more demand, then the price of labor should go up. The Phillips Curve suggests a different relationship, and is unrelated to what I wrote.
I don't believe I'm mistaken. From the first few sentences of the page I linked to, it says exactly what you said:
Wikipedia:
> Stated simply, decreased unemployment, (i.e., increased levels of employment) in an economy will correlate with higher rates of wage rises.[1] Phillips did not himself state there was any relationship between employment and inflation; this notion was a trivial deduction from his statistical findings.
You:
> whereas I wrote that low unemployment leads to higher wages
I made the "trivial deduction":
If low unemployment leads to higher wages, it means that the prices for the things those people are producing (with higher wages), are going up, or inflating. That, or profit margins for the company are decreasing, if prices are kept stable.
with so much money in equities and real estate, there is a huge inflation risk ahead of us. Just think what would happen if people actually started to sell off that equity and start spending it (such as those retiring baby boomers).
Furthermore, the fed is supposed to be smoothing out the economic cycles. If it keeps feeding the bull market with lower interest rates, it won't be able to do anything once we hit a recession. The result is much larger booms and much larger recessions: the exact opposite of what the fed is supposed to do.
Yep, the fed should be removing the punch bowl before the peak of the party. Start a decline in a slow manner as opposed to an eventual panic and crash. Also gives the fed something to do in the future.
Mostly agree with your thesis that inflation isn't extremely low, but wouldn't boomers selling off assets (housing, stocks) actually be deflationary not inflationary? They'd be selling the house to pay for longterm care which means they're going into cash.
Asset prices of equities aren't figured into the inflation calculations. So, when equities get sold off, all that money comes flooding into the money supply.
Median rents went up by 30% between 2007 and 2017: https://images.app.goo.gl/m9SwrkpQYhuNBMeaA. That’s 2.6% per year, somewhat higher than the 2% inflation target, but not much.
Housing is hard to gauge because the same house moves up market as areas develop. When I was a kid, Reston (where Google has a big office), was a solidly middle, even lower middle class suburb with old housing stock. Now it’s got a Metro station, tons of new shopping, tons of tech jobs. Reston is, now, what Clarendon was when was a kid. Rents have gone way up in Reston, but that’s not inflation. It’s paying more for a more in-demand, premium product.
(The same thing happens with cars by the way. The Toyota Corolla was once Toyota’s low-end model. Now, it’s a mainstream sedan, with whole nameplate, Scion, filling the market segment previously targeted by the Corolla.)
I lived in Reston for a few years. For being a quiet far-away bedroom community, it was funny to see how rents exploded, especially once the metro arrived. Apartments in the awful town center area were asking Dupont Circle prices with the 2 hour x 2 commute and $20/day parking and $10/day tolls it would cost to actually work in Dupont.
DC is becoming an awful place unless you absolutely know where you'll be working for the next 20 years and can buy a home close to the office. Otherwise, you're not going to enjoy the 2.5 hour commute and $12 in tolls when client site location moves from Tysons to Silver Spring, MD. It's so crowded, though, because a lot of government workers and contractors who'd be making $50K in Anywhere, America can earn 6 figures after a bit of seniority in the gov.
I'm planning on bailing for good. I could now only barely afford one of those tiny condos with a $500/month HOA nowhere near a metro in NOVA, but I'd never get to enjoy it as I'd be spending the majority of my day sitting in traffic. And wages in DC for techies aren't really that good compared to SV or NYC, since it's mostly set by government. Maybe Amazon will force the contractors to pay more.
Rent isn't paid with debt, so is very different. You don't get to make magic money out of nothing to pay rent. But with the way the Fed is running things, almost anyone can create magic money out of nothing and buy a house. The money the bank lends you did not exist(save for the reserve requirement) before the loan was created.
Also, inflation requires increasing demand for it to occur. The existence of increasing demand does not mean it's not inflation. That's why goods/services with no increasing demand do not inflate in an inflationary economy. Inflation has always been an uneven phenomenon.
Housing and health insurance are the largest portion of many family budgets but for some reason don't seem to significantly enter into the inflation calculations.
And they use BS games to minimize the increases - things like equivalency pricing. My health insurance hasn't gone up that much in the last 5 years on per month basic. The difference is instead of the $10 copay on day 1 that I used to have, I now have a $3K deductible and my in-network choices have been cut in half.
I'm guessing there are similar games done with housing. For example, prices for condos in a lot of areas have probably kept pace with inflation, but meanwhile the HOAs have gone up from $200/month 10 years ago to $400/month now, and I suspect it's because government services have been cut. I doubt the fed takes into consideration things like my area is now so crowded, I pay $100/month to park whereas 10 years ago it was free. Same with tolls - the once free interstates have all been converted to toll roads in my area that cost $40/week to get to work.
I will forever fail to understand why commenters on hacker news ask questions for which the answer is public and readily available. I think it's because they think that the answer to the question will favor them and the idea is that astute readers will do research and thus be convinced of the commenter's point.
Unfortunately, in this case, an astute reader would do research and conclude that the point you are trying to make is completely mythical. Housing (total, rent + everything else) accounts for 42% of the CPI calculation, and the 'owners equivalent of rent' (i.e. how much you would have to pay to rent your home) makes up ~24%: https://www.bls.gov/cpi/tables/relative-importance/2016.pdf
That captures rent renters pay as well, since for apartment buildings, the owner's equivalent rent is the rent being paid.
In PCE (Personal Consumption Expenditures), it's weighted half as much. Is the median person really paying only 12.9% (or 15.3%) of their income for rent? Seems like it's usually closer to 30-40%, and sometimes higher for the working class. (12.9%-15.3% of median household income is only ~$7740-9180 which would be only $645-765/mo.)
That one at least weights medical care at 22.3% ($13380) vs the 6.2% ($3700) in CPI, although that might be realistic if the median person simply doesn't get medical care because they can't afford it.
Consumer price inflation is low. Given the scale of money creation, it is likely that 'real' non-consumer prices are not completely real and are actually experiencing inflation, but for some reason the people claiming the money are competing for financial assets rather than consumer resources.
In addition to the consumer price index being on target, the producer price index is also at 2%[1]. In general low interest rates do mean higher prices for investments but when Amazon's market cap goes from a hundred billion to two hundred billion that doesn't mean that it has absorbed a hundred billion dollars from the economy. The buyers of the stock lose money but the sellers of the stock gain money and it isn't removed from the larger economy.
The producer price index should be roughly capped by consumer prices, if it were rising faster than CPI mid-long term then all the businesses would obviously go bust. The money is going into financial assets.
> when Amazon's market cap goes from a hundred billion to two hundred billion that doesn't mean that it has absorbed a hundred billion dollars from the economy
Totally on board with that, but it does mean ~100 billion dollars of control have been transferred from persons unknown to someone who knows how to borrow money; because lending is the mechanism for creating new money.
I consider myself an asset owner. This is all great for me short term, I'm getting wealthier relative to many of my peers because I own assets and they do not. I'm just completely mystified why anyone thinks this is a good outcome, because obviously in the long term economic control is going to transfer from capitalists who know how to make things work to financiers who found their way in front of the money hose.
I don't want the reward structure to favour giving control to entities who borrow vast sums of money, I want the reward structure to favour people who manage capital responsibly. The current reward structure is obviously going to cause crises and crashes. And I don't see it as responsible for creating real wealth, so I don't think it is a good system.
I mean, I understand why we do it. But that understanding hinges on the assumption that people don't trust the ability of numbers and incentives to predict the future.
Isn't an unemployment rate of 3.6% effectively full employment? It seems I can recall in the past that 5% unemployment was considered effectively full employment.
The core rate of inflation may be low by the government's accounting, but there are problems with the way we calculate inflation, it seems, given how much rents and medical expenses have risen even during what was considered slow economic growth.
Full employment is "the condition in which virtually all who are able and willing to work are employed."
Arguably, because the commonly cited U3 unemployment rate is the percentage of people who are able to and actively looking for work and unable to find it, any unemployment rate above zero means that you're not at full employment.
That said, because even in the "best" economies that we've ever actually experienced there is always at least some level of job loss and it's always going to take at least some amount of time to find a new job, many people / economists tend to view full employment as something more like "the lowest level that we can realistically expect unemployment to reach given some unavoidable level of job churn". This is why you see statements like "4% unemployment is full employment".
Personally, I don't agree with this redefinition because I think it is at least _theoretically_ possible to get to a state where those who lose their jobs due to layoffs etc. are employed again extremely rapidly and the rate ends up being much closer to zero.
> Personally, I don't agree with this redefinition because I think it is at least _theoretically_ possible to get to a state where those who lose their jobs due to layoffs etc. are employed again extremely rapidly and the rate ends up being much closer to zero.
This has never happened though.
U3 being the Official Rate appears to because it's the metric comprised of orthogonal data points. The U4-6 rates are linearly related to the U3 rate; when the U3 doubles, so does the U5 and U6, likewise when the U3 halves. Which makes reporting the U4+ pointless for trending, it doesn't matter if you pick the rate that goes from 4% to 8% or the one from 7% to 14%.
The U1 & 2 rates do not demonstrate this correlation. The U1 can remain flat while the U2 spikes because they represent different pools of people.
So while we intuitively think that including discouraged workers make since, from an analytical perspective, including them doesn't give us any more predictive power than we had before. Calling sub-5% U3 unemployment "full employment" is more of an empirical definition than a logical one; it just happens to be the lowest point we've ever measured.
You're not remembering incorrectly. If you compare old job reports to more recent ones, they now talk a lot more about the "labor force participation rate". Basically, the unemployment rate is distorted by the character of the job loss in the Great Recession so you can't really decide on a full recovery from looking at that one number.
Well, by the standard that economists used to use, yes, U3 being 3.6% should be associated with high inflation because it should be much better than full employment.
Congresswoman Ocasio-Cortez asked Fed Chair Powell about this at a recent hearing, and Powell said that it meant that the economists (including him) were wrong about the relationship between unemployment and inflation. That has led many to wonder if "full employment" (something economists technically call NAIRU- non-accelerating inflation rate of unemployment, meaning that full employment was the lowest unemployment consistent with stable prices) is a real thing or not, if that was another thing that is no longer operative in our current economy.
Last time this concept was popular I read the Wikipedia article on "Non-Accelerating Rate of Unemployment" NARU. This is the (lowish) level of unemployment that doesn't cause huge wage inflation. Folks were worried where that level was in the 90's.
Yep I've been stuck on less than inflation level raises at my job for the last 5 years, partially because I started at a really high salary and partially because I'm a wimp* when it comes to pushing for raises; I do like my job and company though.
Regardless, I keep stats, and I'm doing worse than I was 5 years ago. My rent has gone up about $300 a month (16%), health insurance about 30%, my daily coffee at Starbucks 18%, the toll road costs 33%, and various services like Netflix, cable, phone, etc. are up about 12%-15%. I just priced what it will cost to replace my car with the equivalent I bought in 2013, and it, too, looks like both the car and insurance will end up being about 15% higher.
I'm a single guy who makes good money and has few expenses, plus half my earnings end up in the stock market which has done well, so I can't complain. But I still don't understand how my coworkers - the guys with 2 kids, a wife who works part-time, and an average priced $600K house - do it year after year, especially when the biggest increase in prices seem to be things they spend far more on (health insurance, daycare, housing, education, etc).
* After five years of no raises, I just took matters into my own hands by moving, without asking, to a much more inexpensive city 120 miles away where housing is 1/2 the cost. I worked remote mostly anyway, and now only come back for important meetings about 1-2x a month. If they need me, I'm always on Slack or teleconference on Skype. My employer hasn't said a word, either. Guess we're both bad with confrontation. ;)
> Regardless, I keep stats, and I'm doing worse than I was years ago. My rent has gone up about $300 a month (16%)
I have to hand it to you, this is one of the most insidious ways to misrepresent the true rate of inflation. If it was intentional, kudos to you; you almost tricked me. If it was not intentional, then a quick math nitpick:
If your coffee has increased 16% in price from five years ago, the average inflation rate (which almost always means per-year rate, and certainly means per-year given the stats cited above) is actually 16/5 = 3.2%.
Indeed, it's the 5th root of 1.16, or 3.0%. Doesn't make much difference, though - paying a greater proportion of income to maintain the status quo is a pain in the ass.
Could you explain this a bit more, or link to something that does? I'm don't know much about the Fed or the effect of bond interest rates. In particular:
1. The idea that interest rates should be high to prevent other, riskier investments, reads rather like we have to bribe investors into not gambling too much.
2. How do low interest rates 'refill the punch bowl', as you said?
3. How do they incentivize separating people from their money? The interest on those bonds is ultimately paid out of taxes, no? So wouldn't high interest rates be separating people from their money, making things better now at the cost of having to repay more later?
4. The bonds the government issues basically act as a loan the govt. takes from whoever buys the bonds, no? So shouldn't the interest rate be set as low as possible while there are still willing buyers?
Honestly none of this makes sense, and I'm pretty sure I'm missing something major.
When interest rates go down, it means safer investments become less attractive. For example, lets say you have 1 million dollars in the bank account. if the bank pays you 0% then you're not very likely to keep your money there. You're much more likely to put it in the stock market, a hedge fund, a high yield muni bond or anywhere else. What all those "anywhere else" have in common, is that they're all higher risk. So, collectively by reducing interest rates you are incentivizing risky behavior.
And it's not just individual players. Think about all those pension funds and insurance company funds that need to make returns to fund people's retirements. Collectively they have trillions of dollars on the line, and no choice but to invest in increasingly risky funds. Once you understand the connection between low interest rates and risk, as a follow up, watch this: https://www.youtube.com/watch?v=k9_bWbrYPKg Brian Reynolds has a ton of experience working in the pension industry and this is an extremely fascinating interview (though a bit advanced, but you can still understand some of it)
So literally pay investors so they can get richer without risk?
"A legal mandate requires these funds to generate 7.5% returns, and when they fail to do so, taxpayers foot the bill." - it sounds like it would be much cheaper for taxpayers to pay pension funds directly, instead of paying all investors, and hoping some of that money finds its way to pensions.
Actually, let me get back to "by reducing interest rates you are incentivizing risky behavior". Phrased this way, it sounds obvious that 'of course you should try to reduce risky behavior'. But risky behavior of what? Is a car manufacturer going to take more risks because of low interest rates? No - they make a profit from selling cars. Same for farming, mining, pharma, advertising... literally every industry, except the purely financial ones. So... are we just paying tax money to bankers, and getting nothing in return? Because they convinced us that if their profits were any lower, they'd start taking so many risks banking would collapse (instead of more prudent banks emerging)?
> So literally pay investors so they can get richer without risk?
No. it's exactly the opposite. When government steps in and offers 0% interest rates, it's subsidizing the money lending by handing out cash like it's free candy. It's preventing the natural lending that would have occurred if it didn't step in. Hence offering 0% interest uses the power of government to force people into riskier assets.
If government paper has a return of 0% while private market marginal safe and liquid assets returns are in the negative (which can easily happen) 0% is an above market rate and a subsidy to people holding on to government paper instead of investing in the real economy.
If you look at long term history, negative real returns on stores of value were the norm. Before financial systems existed, almost all investments had negative returns if you didn’t put work and energy into them. To store value, you had to accumulate stuff, buildings or land. Most options either had high maintenance costs, were subject to risk of damage from natural causes and theft, were very volatile or required hard labor to get production out of.
Even in societies with financial systems, getting low risk, hassle free, liquid, positive real returns has been difficult for most of history. This just reflects the natural laws of thermodynamics that tell us that everything tends to decay without a constant supply of work and energy. In general, most things require maintenance to keep their worth.
The 20th century was probably the most notable exception. Because of unprecedented demographic and technological growth, positive risk free real returns were easy to find. The recency effect probably explains some of the confusion people have about this. It is possible that under favorable conditions, wealth can have positive returns and even compound into very good long run returns but it is not a guarantee and there is nothing natural about it. It may not continue forever, particularly amidst an aging and retiring population in a world no longer as rich in easy to exploit natural resources.
While people are used to get negative returns on very short term purchases, you buy fresh vegetables at the supermarket, even if they degrade over time, many can’t seem to accept the normalcy of negative returns on longer term assets. In nature, squirrels’ nut caches have a certain percentage of losses from theft and spoilage. Real returns tending towards the negative is natural even if they can seem unusual for humans just out of the 20th century.
How are 0% interest rates 'handing out cash'? I thought bonds worked in the following way: Buy bond at N% interest. When it matures, government pays you original price + N%. So 0% would be bond buyers handing cash to the government, no?
Fed interbank interest rates aren't the same thing as treasury bond interest rates. Yes, when money is cheap bonds become almost worthless, that can be seen in the market right now. However the cash party isn't for people buying bonds, it's for people with access to the inside track of low-interest money.
Yes, that's the interest rate that impacts the money supply (along with other factors) by greasing bank's balance sheets. Treasury interest rates are set by the market, they are whatever they have to be to get people to buy government debt.
The Fed operates on a shorter time scale than T-bond maturities.
Basically, every night banks are required to make loans to each other to ensure that they meet the reserve requirements on deposits. If they made more loans than they took in deposits, they must borrow on the open market to settle. If they took in more deposits, they can lend. All of these transactions are for extremely short-duration securities (when people talk about repos and money market accounts, they usually mean this). The security itself is simply an agreement to repay $X + interest in the near future, usually the next day. And just like the stock market, there's a market for these: banks with excess deposits offer repos at a variety of interest rates, and banks with excess loans take the best available interest rate, and eventually the market converges on a particular market-clearing rate (the "Fed Funds Rate").
The Fed is a participant in this market. But unlike a normal bank, they aren't subject to reserve requirements. They have an effectively infinite balance sheet consisting of the T-bills etc. that back all the other repo agreements. So when they say that they're setting a Fed Funds Rate of 2.35%, what they really mean is that if banks are fearful that day and want a market-clearing interest rate of 4%, they will sell enough securities in the overnight market that the interest rate goes down to 2.35%. And if banks are greedy and are willing to sell securities at 0%, the Fed will buy enough of them to push the rate back up to 2.35%. This serves to anchor the rate, because if you know that it's going to be in that vicinity, there's no incentive to try and push it higher and lower.
It's very much like a stablecoin in the crypto markets. When Facebook pegs the Libra to a basket of currencies or Bitfinex pegs the Tether to $1, they are effectively trying to become a central bank. Decentralized stablecoins like Dai try to distribute that power among a number of ordinary people: the holders of MKR collectively act as a central bank for Dai, with their collateral being ETH rather than T-bills.
When you have 0% interest rates, it basically means that banks can borrow as much as they want for free. So it literally is "handing out cash". The actual bonds backing them are held on the Federal Reserve's balance sheet, which is why you might've heard about the Fed's ballooning balance sheet in the last 10 years. The Fed's under no obligation to pay these back, though: its mandate is to keep employment high and inflation low, and so its job is to release just enough of those securities as to soak up inflation.
* And just like the stock market, there's a market for these: banks with excess deposits offer repos at a variety of interest rates, and banks with excess loans take the best available interest rate, and eventually the market converges on a particular market-clearing rate (the "Fed Funds Rate").*
With the small and pedantic correction that the Fed Funds rate doesn't measure repos, because it measures unsecured lending, and repos are secured. It's the Secured Overnight Financing Rate that measures repos.
But yes, when the Fed wants to push the Fed Funds rate around, it does it by getting involved in repos - because if banks can borrow from the Fed at 2.4% through a repo, they aren't going to borrow from other banks at 2.41%. You'd think there would be a bit of a spread between the rates, because banks don't have to put up collateral for unsecured borrowing, but in practice there doesn't seem to be.
deogeo wrote:
> Is a car manufacturer going to take more risks because of low interest rates?
It seems possible. Vehicles change every year. The amount and ways they change must be affected by available funding, perceived risk, and probably lots of other factors. A lower interest loan could make a risky prototyping project more attractive.
Even if car companies were really stuck doing one thing, shareholders are not. If car companies produce a slow, steady profit, and other investments are producing higher profits on average, chaotically, people will divest from cars and invest in a diverse portfolio of chaos.
I agree with what seems like your point, though. I don't understand propping up markets and businesses in order to help people, when we could just help people.
This is exactly why defined benefit pension plans need to be eliminated. They're just too risky for everyone concerned and create a huge moral hazard. Defined contribution plans like 401(k) with named individual accounts are much safer.
They're only a moral hazard if the plan is permitted to make promises without requiring the promisee to deposit enough funds. And that can only happen for government employee pension plans; private employee pension plans are required by Federal law to follow strict accounting rules which keep the pension fully funded--at any point in time the future expected liabilities must be backed by deposited funds sufficient to cover the liabilities according to a moderately conservative rate of return (e.g. 5-6%).
Private pension plans can and have failed, but that's because corporations sometimes devise clever ways to drain funds. They usually have to do this quickly, though, so it often occurs during mergers and acquisitions where the CFO can shift funds and pay them out as dividends, stock buybacks, or bonuses. Then when the Feds come knocking on the door six months later the CFO moans and cries to the regulators and shareholders[1] about how their pension liabilities are a crippling burden, which is total B.S. because if they hadn't played games the pensions should represent a $0 liability at any point in time. Actually, because of the way the market works--long runs of above average returns followed by sharp below average returns--CFOs just as often claim that their pension funds represent idle money. Of course it's not idle, it's invested in the market, and while those funds are nominally controlled by the employer in reality they're an expenditure no different than the paycheck the cut their employees every other week.
Public pensions, however, aren't required to be fully funded. Politicians are happy to promise huge pensions to placate employee unions without giving a second thought to how they might actually fund those future liabilities today. (Notably, unlike state-government employee pension plans, Federal employee pension plans are kept fully funded as required by separate Federal law, notwithstanding the USPS, which has a complex, unique story of its own.)
A defined-benefit pension is basically just an annuity, and any economist will tell you that annuities are one of the most rational and efficient retirement devices around. The real retirement crisis that we'll see (and which we got a glimpse of during 2008-2010) is when people realize how risky and poorly funded their 401(k) plans are, especially during economic downturns. It's going to be epic particularly because most people only invest 4-5% of their wages into a 401(k) at best, whereas for somewhat historic reasons defined-benefit pension contributions usually represent 20-30% of compensation. Things are going to get nasty....
What we should be doing is incentivizing pension plans, not disincentivizing them. Pension plans should be the dominate retirement strategy. But because the potential for moral hazard is significant when governments make these promises (there's no higher authority to ensure promises are backed by commensurate present funding), we can't rely on government to do this directly. Social Security is very similar to a defined-benefit plan in the sense that there's a set formula for benefits based on wages, and it's a very important safety net we should strive to maintain. But it's just a safety net and we shouldn't expect anything more of it.
A great book explaining the history of pensions and the shift to 401(k)s is "Retirement Heist: How Companies Plunder and Profit from the Nest Eggs of American Workers", https://www.amazon.com/Retirement-Heist-Companies-Plunder-Am.... The author was an investigative journalist for the Wall Street Journal, and the book explains in interesting and somewhat technical detail the legal and financial machinations of defined-benefit (pension) and defined-contribution (401(k)) plans.
[1] Investors who conveniently forgot or had no interest in understanding where that windfall they received 6 months earlier came from.
That's a terrible idea. We've seen many cases where companies failed and pensioners had to rely on reduced payments from the PBGC. Sometimes pension liabilities even drive otherwise viable businesses into bankruptcy, which benefits no one. Pension funds also usually assume unrealistic rates of return.
By contrast 401(k) plans are very safe. Once the money is in my account it's mine and can't be taken away without a court order. Even if my employer or the brokerage holding my account go bankrupt I won't lose anything.
You hear about pension failures but you rarely hear about the retirement failures of 401(k)s because it's a distributed problem. There were plenty of these stories during the Great Recession, but you mostly heard about pension crises even though pensions by their nature are designed to and in fact did weather the storm much better.
Plus, as you point out pensions are insured by the PBGC, primarily funded by premiums paid by pensions. Where's the insurance for your 401(k)? There are a lot of problems with the PBGC, some of which relate to the Republican strategy since the 1970s of killing the system of private employee pensions through neglect, but it's still there.
There are many problems with pensions we could identify, but these are fixable problems using the type of technocratic, regulatory work we know how to do well and are still perfectly capable of doing, even in our bitterly divisive society. And in any event the system doesn't need to be perfect, just better than the alternative. Leaving everybody to fend for themselves isn't an actual alternative--it's an ideological position that denies that a problem exists instead of addressing it.
A 401(k) may be the best choice for you, but the social problem we face isn't figuring out how to maximize nradov's retirement wealth, it's how to maximize population wide outcomes.
As I said, annuities are one of the best vehicles for a secure retirement. It's becoming increasingly common for people to invest in variable annuities through their 401(k)s, but these aren't the same thing. For one thing they don't offer the same security as a fixed annuity. For another their payouts will be lower because healthier, long-lived people will self-select into annuities while other people will live shorter, harsher lives than they otherwise would have. It's a collective action problem--everybody is worse off.
Much like with health insurance, in the aggregate and over time (everybody is an outlying insurance risk at some point) people are better off purchasing insurance and annuities through group plans. Well, that's exactly what a pension is--a group fixed annuity!
To be clear, my point is that pensions are misrepresented; that they're not only useful but desirable. What I'm not saying that we should only have pensions or that 401(k) and other investment schemes don't have a place--they're just a very poor mechanism to provide minimum retirement security at scale as compared to defined-benefit schemes.
Low unemployment doesn't imply strength if it's due to a decline in labor force participation, which has barely budged from historic lows set in 2015 (1). Rising asset prices aren't worth much to those who own little.
> 0% may have been justified in the wake of the 2008 crash, for maybe a year or two, but not 10+ years!!
And yesterday someone in the Financial Times's opinion page was asking the ECB to start going into negative figures with their lending rate. Very crazy times indeed.
> without even once mentioning the real reason: excessively low interest rates forced on us by the Fed.
No. The real reason is that interest (usury) exists in the first place. It is prohibited in Islam, Christianity, and Judaism for a reason. And I wouldn't be surprised if it were also prohibited in other religions.
An economic system that relies on usury is exploitative and predatory. The rich get reacher with basically no risk on their part, and the poor are left to struggle. Eventually the cycle completes and the entire system crashes as we've seen it happen many times now.
Mostly agree, though tech has been one of the bigger recipients of all that money sloshing around. Another being housing (again) which is a big part of why housing is so expensive now.
At this point in the recovery cycle and with a strong economy (which we supposedly have) the fed rate should be closer to 4-4.5% - we shouldn't be talking about lowering rates. But both ends of the political spectrum seem to be pushing for 0% - the progressives with MMT and of course Trump keeps bullying the Fed to lower (not only because he thinks it'll help his re-election prospects, but because he's a real estate guy and would benefit greatly from 0% rates).
What's amazing is that despite all the money sloshing around, the great filter of high private interest rates and rent-seeking makes sure that it never benefits the majority of people. This can be seen by higher levels of inequality.
> People shouldn't be surprised that SOOO much money is sloshing around looking for increasingly risky returns
Surely investors demand an interest rate that is higher than the risk. Gross simplification: their actual expected return is the difference between the sticker rate and the risk e.g. if risk of default is 2%, that sets lower limit on interest rate. If investor seeks return of 5% return then interest rate needs to be 7% (simplification).
So saying investors are seeking more risk has no meaning to me. Saying investors are willing to accept lower returns for the same risk makes sense.
Can someone with investment experience say that more clearly?
The Fed is implicitly causing venture capitalists and other capital holders to subsidize the labor market and grow yhe economy. All the gig economy with money-losing companies is basically a private sector jobs program. To assume there is a bubble in assets is assuming things will go back to a high interest-rate environment. That may never happen. We'll just get lower lows, even negative interest rates if there are no money making opportunities.
People shouldn't be surprised that SOOO much money is sloshing around looking for increasingly risky returns when interest rates have been 0 for so long. And here we are, at barely 2.5% (far below where it should be) and the fed is already considering rate cuts even though we're in the biggest bull market. This article is doing the world a great disservice by trying to blame the tech industry without even once mentioning the real reason: excessively low interest rates forced on us by the Fed. And it's not just the Fed, other 1st world countries are doing the same thing. They're all following the call of Keynesian economics: Keep the party drunk as long as you can by refilling the punch bowl. By creating every incentive in the world to separate people from their money as quickly as possible in a hopeless attempt to spur money flow, ultimately resulting in increasingly risky investments.