Sex 'n' Drugs 'n' ZIRP

cells

padington wrote: »

What are the plausible reasons interest rates might need to go up in the next five or ten years ?

My theory is that the quantity of debt determines the rate of interest (rather than the normal view that the rate of interest determines the quantity of debt)

if at all correct, for rates to go back up we would need a mass net destruction of debt/savings. currently the opposite is happening total debt/credit is rising

brit1234

cells wrote: »

I dont think they need to 'go back up'

my view is that as an economy develops and builds its infrastructure the interest rates in that economy will go down and down towards zero.

I think this is the new normal, zero rates for the most deemed risk free debt (governments) and maybe 2% more for mortals like house buyers to take into account admin, profit, and regulation limits.

We are coming to the crunch time, what do you do when the next economic meltdown happens?

Basically rates got cut to prevent the dot com bubble taking down the economy. Then again after 9/11 and the credit crunch. Over the last 20 years cheaper and cheaper credit has been used to stave off recession. As money got cheaper debt got greater, we haven't faced our demons

padington

brit1234 wrote: »

We are coming to the crunch time, what do you do when the next economic meltdown happens?

As money got cheaper debt got greater

... or as debt got greater, debt got cheaper....

cells

Generali wrote: »

The logic of that position is that people are indifferent between saving and consumption. I have my doubts quite honestly.

in its most fundamental basic concept money and banking is a service to make debt contracts between parties far far simpler and far far more fluid.

If you have a house you wish to sell for £200k and I want to buy it. If banks did not exist we have two choices.

Either you sell the house to me for whatever I can give to you right now (cash gold property or a cart full of potatoes whatever we agree on...)

or you and I enter into a contract, just as an example the contract might be that I the buyer pays you the seller a sum of £1,333 per month for 25 years.

This is effectively a 25 year fixed rate mortgage between you and me at the agreed £1,333 per month (in this example the interest rate works out to ~5%). Of course the rate we agree will depend on many factors (more on this further down)

of course we could potentially do that today. but there are many downsides to both parties and many risks. Instead you and I and everyone else goes through a bank. This bank creates a £200k debt account and hands it to me to pay off, and a £200k savings account and hands it to you to do as you like. Instead of you and I agreeing for 5% interest in the above example private contract, this bank might charge me 6% and give you 4% interest. The difference of 2% is for it to pay for its business and profit in offering this service

This is fundamentally what the banking system is.
Instead of parties writing contracts between themselves a bank acts as the middle man

In fact the old system still exists. Corporations write their own paper and sell it off into the markets avoiding banks altogether. This is possible for them as a traded market exists and the overheads of issuing £100M of corporate paper is probably a lot less than a thousand individuals issuing their own paper to buy houses.



So I would say forget banks and interest rates, just look at fundamentally what they are which is a way to allow debt contracts between parties to be much much much simpler.

In which case what are interest rates?
How do you and I in the above example of setting up a private "mortgage" between ourselves set the interest rate of the contract?

cells

cells wrote: »

In which case what are interest rates?
How do you and I in the above example of setting up a private "mortgage" between ourselves set the interest rate of the contract?

Continuing with that post.....

I and you want to buy and sell a £200k house between us an avoid a bank because...lets pretend they don't exist.

We agree to set up a 20 year payment plan between us. I will pay £50k upfront and X a month for 20 years after which the house is mine fully.

This is effectively a mortgage between ourselves with no banks

The amount we agree for X will depend on many things.

Who I am (the banks already do this, with income tax return savings and credit and age checks). Thats easy

The nation we live in and its rules and regs and strength of contract laws. If it is easy for me to default you will want a larger figure for X to take into account the risk.

The safety of our nation. If there is a war now or imminent you will want a much higher X to account for the risk of that (IMO one of the main reasons interest rates fell post 1990 is the fall of Russia and the reprieved increased safety post cold war)

Your lifespan. if you are older you will want a bigger figure for X to take into account the risk of you dieing before the 20 year contract

A debt market. If a debt market exists where these contracts can be bought and sold you are more likely to accept a lower X figure as you can sell at any time the contract for a lump sum and that is more valuable than having to stick to a 20 year deal

Other. im sure i missed a few

---

So after we both think this through we agree to a figure of X which represents a figure of 6% interest. We have set a benchmark!


Over the last 20 years everything that can help X go down has happened. The world has got safer. Countries have become more stable. Contract and property laws have gotten better. Debt markets are far larger and more fluid and lower cost. Competition has lowered margins. Computers and the internet have lowered costs etc etc. And the result has been 20 years of falling interest rates and these things are largely a one way movement.




PS if you think of it, governments and big corporations bypass banks all together and issue their own contracts (IOUs). Individuals are too small to do this in an economic way so they go through banks for basically the same thing.

Generali

It's interesting stuff cells but doesn't address the problem with interest rates at zero as anything other than an emergency measure: it implies that people are indifferent between spending money today and spending money tomorrow.

If people prefer spending money today, in order to save they will need to receive a rate of interest to compensate them for not spending.

cells

Generali wrote: »

It's interesting stuff cells but doesn't address the problem with interest rates at zero as anything other than an emergency measure: it implies that people are indifferent between spending money today and spending money tomorrow.

If people prefer spending money today, in order to save they will need to receive a rate of interest to compensate them for not spending.

Firstly interest rates were falling for 15 years before the recession its not new

Also people don't need to receive interest to compensate them for not spending. Mr squrille buries his nuts with no expectation that there will be 5% more nuts in the winter. He still values and needs the nut savings which yield zero interest.

But most importantly most of our heavy capital intensive industry is already built out or is much cheaper to build now.

for example we have all the power stations we need. If the BOE cuts interest rates from 5% to 0.5% we will not go out and build more. And even if we have to we would build a £0.5B gas power station instead of a £3B coal station like in the past so spending is down in that sector whatever the interest rate.


also the biggest infrastructure spending of all is housing and clearly there is no link to house building and interest rates going up or down.


so I understand that on paper higher interest rates should lead to less demand and lower interest rstes to more demand but in practise the impact of interest rate is dwarfed magnitudes by other factors so much so that the five biggest capital spends have absolutely no link to interest rates. House building. Commercial building. Industrial building. Transport (roads rail ports airports). All are virtually totally independent of interest rates (at swings likely to happen). They get built (or not) depending on other factors

cells

Fundamentally I think going forward real interest rates will be zero in real terms (plus or minus 2%) indefinitely. We have been close to that for a decade now

I don't think interest rate movements up or down a few points will impact CPI inflation much at all but will impact asset prices a little but not a lot

jamesd

cells wrote: »

I don't think interest rate movements up or down a few points will impact CPI inflation much at all but will impact asset prices a little but not a lot

You may find it useful to work out what change in capital value of a ten year term remaining bond it takes to increase its interest rate for a buyer from 0.5% to 3.5%.

michaels

Generali wrote: »

It's interesting stuff cells but doesn't address the problem with interest rates at zero as anything other than an emergency measure: it implies that people are indifferent between spending money today and spending money tomorrow.

If people prefer spending money today, in order to save they will need to receive a rate of interest to compensate them for not spending.

But with an aging population perhaps people prefer spending tomorrow to today, particuarly with increased income inequality those with spare income would rather consume in the future than today. Don't forget we have seen another huge shift in the economy, a massive increase in life expectancy in retirement.