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Much Ado About Nothing

08/25/2016

It is hard to defend an obsession, any obsession.  Wall Street is obsessed with the Fed raising interest rates.  They will be glued to the television tomorrow when Janet Yellen speaks at the Fed’s summer retreat in Jackson Hole.  Everybody knows that rates have to increase, but why first and then when.

If you are a borrower, you like low interest rates.  If you are a saver, you hate low interest rates.  If you are a bond investor, you loved falling interest rates, because the value of your bonds increased.  Conversely, you will hate rising interest rates, because the value of your bonds will decrease.  That much is easy to see.

But, low interest rates cause a mis-allocation of capital.  Searching for yield, money has poured into stocks, especially large cap value stocks, because those dividends exceed the interest earned on ten-year Treasuries, just as an example.  Then, the excess cash spills over into other stock classes, such as more risky small cap growth stocks.

Consider that investors currently have a historically high level of un-invested cash sitting on the sidelines.  Wait, you might ask — how is it possible that un-invested cash is at historic highs, while enough cash has spilled into stocks to drive those stocks to historic highs at the same time enough cash has spilled into bonds to also drive those bonds to historic highs?  It is due to the massive but necessary increases in the money supply, following the global financial crisis.

There are even insidious minor mis-allocations.  Low interest rates mean the portfolios set aside to pay the generous government pensions are no longer producing enough income.  This means municipal, state, and Federal budgets have to allocate a larger and larger portion of their revenue to prop up the retirees.  That means they need you to pay more in taxes.  Lower interest rates puts upward pressure on taxes.  Not counting municipalities and Federal shortfalls, another TRILLION dollars in revenue (read:  more taxes) is already needed for the states to pay those pensions.

Un-winding all this will take time and will be more difficult the longer we wait.  The Fed raised rates by a quarter-point last December, and I would like to see them raise rates a like amount this December.  A quarter-point each year is certainly not too much for the economy to withstand.

I worry that the Fed will delay raising rates, because it will strengthen the dollar, hurting exporters and posing an economic drag on the rest of the world.  Wall Street is afraid the Fed will start next month.  Big Deal!!

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