The Link Between Inflation & Interest Rates
QUESTION:
Hi Marty,
The reason central banks like to have inflation, is because they get to reduce the effective value of their respective national debts over time. I do not know why there is a link between inflation and interest rates, which is assumed in BB’s remarks. Is there any basis for that ?
Regards
D
Regards
D
ANSWER: The link between interest rates and inflation is fundamental. If the inflation rate is 20%, you would never lend money at 10% for that would effectively be the same as a negative interest rate. The level of interest rates must be ABOVE the inflation rate to make it profitable to lend.
This has been my argument all along; no particular interest rate level will cause the markets to decline or boom. The 2% inflation rate has been seen as necessary to keep money flowing. The missing ingredient here is CONFIDENCE. Simple correlation studies show that the economy and stock market have never peaked twice with the same level of interest rates, and they have never bottomed with the same level on the downside.
We have now crossed the one-year anniversary of the ECB introduction of negative interest rates. What happened? Still no inflation. Their next trick is to go even more negative, but to accomplish that they must eliminate physical money. In Italy, I still saw retail stores selling gold bullion coins. In Spain, there were none, but Spain had the closure of the Bank of Madrid with many people unable to get their cash out for nearly two months.
Governments are raising taxes, aggressively confiscating assets and cash, and increasing tax enforcement. That is deflationary and wears down the CONFIDENCE about the future. They wonder why people are starting to hoard money out of banks. Without CONFIDENCE, the people will not borrow at 1% if they cannot see how they will make 1%. Even Keynes said there were times you had to lower taxation to stimulate the economy. Announce that everyone who starts a business and hires people will enjoy tax-free status for 5 years. Watch how many people run out and find a business to create, hiring people to accomplish that goal. Oh sorry, that would be anti-socialism.
The central banks do not worry about the national debts because that is not their department. Even the ECB has no control over the debts of member states, but they are in charge of trying to manage the economy as they see it, and that is something they are not qualified to accomplish with only one side of the coin.
Global Warming Stopped 16 Years Ago
The Daily Mail released the numbers, showing all along that this idea of global warming has been just a natural cycle. London used to be horrible to live in during the summer, when the buses spewed out black exhaust. Today all the buses run on electric or natural gas, and to a large extent, the improved air quality has restored the city. However, that is distinctly different from actually altering the entire planet.
Traveling around Europe on this tour, I personally packed summer clothes but found myself needing to buy warmer things to wear, and should have brought a coat. It was unseasonably cool and did not become warm until I hit Spain. We are moving back toward colder weather, not hotter. The Daily Mail Wrote:
The world stopped getting warmer almost 16 years ago, according to new data released last week. The figures, which have triggered debate among climate scientists, reveal that from the beginning of 1997 until August 2012, there was no discernible rise in aggregate global temperatures.This means that the ‘plateau’ or ‘pause’ in global warming has now lasted for about the same time as the previous period when temperatures rose, 1980 to 1996. Before that, temperatures had been stable or declining for about 40 years.
Why Negative Interest Rates Invite a Dark Age
The quest to eliminate cash is all about Negative Interest Rates for as long as cash exists, people would withdraw their money from banks and stuff it in a shoe-box. They use Japan as the argument that virtual zero interest rates for 20 years failed to produce inflation. Hence, their reasoning is you must go NEGATIVE to force people to spend but they cannot grasp that this is a losing battle.
At a March 20, 2013 press conference, Ben Bernanke explained why the Fed target always includes 2% inflation:
- So historically, the argument for having inflation greater than zero — we define price stability as 2% inflation, as do most central banks around the world. One might ask, “Well, price stability should be zero inflation. Why do you choose 2% instead of zero?” The answer to the question you’re raising is that if you have zero inflation, you’re very close to the deflation zone, and nominal interest rates will be so low that it would be very difficult to respond fully to recessions.
- There is research, for example, which asks the question, “How often do you tend to hit the zero lower bound?” And our belief a few years ago was that it was a very rare event and now it has become more common.
Many central banks are up against the zero lower bound in macroeconomic situation, indicating output less than the natural level. Japan has kept rates at effectively zero for nearly 20 years without creating inflation. This has led to the idea that they must eliminate the zero lower boundary and the only way to do that is to eliminate cash to prevent people from hoarding money at home and withdrawing their cash from banks.
This Age of New Economics is all about manipulating society to achieve optimal monetary policy, which is to keep the economy at the natural level of output. This is where inflation comes into play. Inflation data only gradually reveals where the natural level of output is over time. The general belief is that low enough negative short-term interest rates will work in forcing people to spend and will create inflation, regardless of what people believe about the future, which typically causes them to spend if they believe it will cost more tomorrow. Negative interest rates are seen as the magic bullet that will compel people to spend and therein lies the reasoning to eliminate physical money to prevent people from hoarding.
This is an interesting theory, but money can also return to a barter system, where people do not trust the stability of banks or the system converting the money to practical tangible objects. This is one of the reasons they are also attacking gold.
Japan lost its ability to issue state money because they effectively imposed a form of negative interest rates. Each new emperor devalued the outstanding supply of coinage and his new coins were valued at 10x that of the previous emperor. The people turned to using bags of rice and Chinese coins. The Japanese government was forced to stop issuing coins altogether for 600 years.
Hillary’s Donors Receive $165 Billion in Arms That She Approved
As Secretary of State, most people think it is only diplomatic. The Secretary of State is also in charge of selling arms to foreign governments. Hillary Clinton was in charge of rejecting or approving weapons deals. It is no coincidence that her department approved $165 billion worth of commercial arms sales; the countries she approved were Clinton Foundation donors. The amount of arms sales she approved were twice the value of arms sales to those same countries during the George W. Bush’s second term. She is the Queen of CORRUPTION.
Velocity of Money
The decline in the VELOCITY of money is rather alarming. On the one hand, it reflects the declining liquidity within the marketplace from the rising trend of hoarding money from banks (DEFLATION), as well as the overall socialistic trend as government consumes a greater proportion of the economy GDP. Velocity = GDP / Money Supply, if the Money Supply increases far more rapidly than economic growth (GDP), then VELOCITY will also decline. However, while this should reflect inflation, it also implies a declining GDP relative to the money supply.
There is no question that the investment strategy has been shifting more towards the short-term. This is why we see selling the 10-year paper moving to the short-term, even at negative rates. It is possible that the VELOCITY of money will decline during periods of excessive money supply expansion, as in hyperinflation with a contraction in GDP in real terms. This does not appear to be the case presently for we are in a deflationary mode rather than inflation. We do see asset inflation in the high end real estate, art, and collectibles, with interest earnings collapsing, yet the cost of living outside of taxes has not risen overall on the same level of assets.
Money supply, also referred to as money stock, classifies the total amount of monetary assets available in an economy at a specific point in time. The definition of M1 money supply is a measure that includes all physical currency, such as cash and checking deposits, and offers the most liquidity. M2 money supply is a measure that includes cash and checking deposits (M1) in addition to “near money”. Near money includes savings deposits, money market mutual funds, and other time deposits that are less liquid than M1 and are not as suitable as exchange mediums, but can be quickly converted into cash or checking deposits.
The collapse in the VELOCITY of money is being contributed to by the decline in GDP failing to keep pace with the money supply.
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