Tuesday, 23 September 2008

The Truth About Interest Rates

I'm a little tired to hear around me this nonsense with regards to interest rates comparison to the late 80's.

Lots of economists, journalists have been saying that todays interest rates are way different than in the 80's when they were at around 9.5%.

These groups are clearly misleading people on main street, and are giving a false and dangerous sense that todays interest rates are fine.

I looked at the interest rates for the period 1982-1991, and what I want to highlight is the variation not the level of interest rates. Because what hurts is the change of level not the level itself.

So the change of interest rates between 1987 and 1991 is similar to the one from 2003 to 2008, exactely similar. Indeed the debt servicing level has been multiplied by the magical number x 2.75.

The incredible similarities goes beyond that. Let me show you:

From 1981 (13%), interest rates kept falling until 1987 (3.5%). They were divided by 3.75

From 1991 (9.5%), interest rates kept falling until 2003 (2%)- They were divided by 4.75

In reality, household overstretch themselves even more that in the late 80's, they borrowed for a much longer period and took much higher leverage.

So it's unsustainable. Whatever metrics you are taking, it shows that a change is operating, and we are currently seeing an huge inflection point- in term of debt deleveraging, in term of population ageing, in term of shift of global power.

The world has never been so vulnerable. We are not only talking about financial stability but as well societies stability if geopolitical tensions were to deteriorate (Russia, Iran, Pakistan, Venezuela, Basque Country etc...).

People will say, you are quite gloomy. It's certainly that their reference of stability were the boom years where growth speed and appreciation were just irrational...

If you have a contrarian view, please expose your arguments, I will be more than happy to investigate and publish them.


Andrew said...

I am 53. I cannot agree that the world has never looked so vulnerable. It can indeed be argued that intergovernmental cooperation is now better than it has ever been.

On the other hand our world is so impossibly complex that nobody can predict what will happen.

I am not an economist. I am just a person waiting for the right moment to invest and carry on living. I am in limbo now. Unpleasantly so.

Possibly there are factors now that are very posative for Finland. One being that Russia is recovering and its decline was related to very cheap oil. If Iran and Pakistan and these other far away placed are ingulfed in conflict it might actually be posative for finland because Russia could potentially benefit because it is so enormously resource rich. The Finnish government have been very wise and skillful in dealing with Russia recently.

Russia seems very exposed to the financial crisis in the USA with money apparently leaving Russia en masse in recent weeks?

Even so you can argue that the USA has created a distortion of its economy with the deficit does not matter mantra of the last three or more decades. This seemingly irrational mantra could be actually true if China as savers are prepared to return dollars to invest in the debt of the USA as consumers. Many countries in the world need US consumption to continue and they will do what they can to cooperate. The USA though has to be less arrogant and maybe Russia can allowed to be a bit more arrogant?

What you notice today is that governments want to cooperate with the USA rather than isolate it and create further problems for themselves. The US can then be allowed to go thru an adjustment. Bank of Finland censured YLE yesterday for reporting what happened in the spring because Finland with its wise heads knows it is "easier to rock a boat then steady it".

So how vulnerable are we?

I recall back in the late 70's while war jets were practising overhead in the UK, and Iran was undergoing a revolution that the world looked terrifyingly vulnerable. My boss told me the world was exactly the same as it always had been.

HousingFinland said...

"If Iran and Pakistan and these other far away placed are ingulfed in conflict it might actually be posative for finland because Russia could potentially benefit because it is so enormously resource rich."

If there were to be a conflict with Iran, petrol price will go balistic, maybe 300 or 500 dollar/baril and the global economy willgo into depression.

That is the vulnerability of todays world. Everything is interlinked.

Russia could be good or bad for Finland. We have already seen the impact of the forest industry. Russia doesn't need Finland but Finlad will need Russia at some point...so it's clear that the card on the Russian end. Now we donät know when this will happen, 5, 10, 50 years to come??

Russia was a victim of deleveraging and risk reduction. People are bringing back their investment as they need it to shore up capital loss. Having said that, i think it's worth to invest in Russian stock market but with a long term view. As Petrol will become a scarce resource, Russia could become rich especially if they develop internal consumption...it's a massive country...

I think unbalance need to be corrected in the U.S., the American consumer will have to save more, as banks are now pulling the plug on easy credit.

"Bank of Finland censured YLE yesterday"

What did they censure?

Andrew said...


Coming back to the interest rate topic. The relationships you presented were interesting. Interesting also that when the 1987 stock market crash happened that rates were lowered for about 6 months but then fairly sharply increased.

I was thinking that rates increasing now was an unusual event related to the degree to which a recession is being avoided by central banks but maybe it is not unusual? I know you are expecting rates to fall. Do you have some charts that support that kind of view?