The world of money market funds changed forever back in 2008, when an investment vehicle called the Reserve Primary Fund loaded up on loan obligations backed by Lehman Brothers. Lehman famously went under, and the fund “broke the buck,” meaning that when Lehman was unable to pay back its loans, the value of a share of the Reserve Primary Fund dipped under $1.
PIMCO has a good article on rising interest rates that you should read and consider.
A reasoned analysis that takes into account historical interest rates, the likely path of rates going forward and the impact of past interest rate rises on returns suggests that rising rates may not be such a threat to bond investors.
Click the above quote to goto the article.
Scott Dauenhauer, CFP, MPAS, AIF
Long time readers of this blog know that Cullen Roche of the PragCap blog is my favorite economics blogger. If you’re not reading him, you should. In a recent “Three Things I Think I Think” Cullen puts the US National Debt into proper prospective:
The rhetoric on the national debt is again starting to heat up and it’s only going to get worse the closer we get to the Presidential election. So I thought I’d post an article from Cullen Roche over at The Pragmatic Capitalist blog (www.pragcap.com) as a review why we always have the means to pay the interest on the national debt.
If you haven’t read Cullen’s book, you should.
Let’s Talk About the US Government’s Interest Burden
By Cullen Roche (www.pragcap.com)
Greg Ip had a piece in the Wall Street Journal yesterday discussing the debt burden in the USA and how low interest rates have “moved back” the “hands on the doomsday debt clock”. The article touches on the important topic of entitlement spending and whether it’s sustainable, but does so in a manner that misleads readers about why this might be a problem.
For instance, Ip says that “higher federal borrowing puts upward pressure on interest rates”. This is classic “crowding out”, an argument that has been thoroughly debunked in the last 20 years as interest rates have fallen despite soaring government debts around the globe.
But the interest rate burden is a more common misconception. In “The Biggest Myths in Economics” I elaborate on this:
“The interest burden in the USA is actually declining as a % of GDP and is entirely controllable if the government desires. We pay about $250B in debt service every year. The Federal govt could actually reduce this substantially by reducing the maturity on their debt by issuing short-term debt instead of higher interest bearing long-term debt. They have complete control over their interest costs if they so desire.
There is no ironclad law that forces the US govt to raise interest rates if it doesn’t want to. Just look at Japan where interest rates have been zero for two decades. A government that is sovereign in its currency, has no foreign denominated debt and a central bank that can issue its own currency does not have to worry about someone else telling them that they need to raise their interest costs. This interest cost is not controlled by “the market”. It is controlled by the monopoly supplier of reserves to the banking system (the central bank) and the Treasury which dictates the average outstanding maturity of the liabilities it issues. So this too is not a realistic concern.”
Of course, the burden of inflation is a whole different problem for a government (and a very real worry). It’s highly unlikely that interest rates would remain low in the face of rising inflation, but rising inflation is certainly not an issue that appears worrisome now or any time in the immediate future. Unfortunately, we still discuss government finances as if they are precisely similar to a household. As James Montier discussed in his latest GMO piece, this just isn’t true. And putting this discussion in the proper context is crucial to understanding the cause, effect and potential risks we encounter when implementing certain policies.
See the following pieces for more detail:
- The US Government is not Going Bankrupt
- Can a Sovereign Currency Issuer Default?
- Inflation is not Necessarily Another Form of Default
- Yes, the US government can afford the national debt and rising interest rates
I’m not sure even what to say except that I want one of these mortgages! Also, I don’t imagine this ends well.
In May of 2013 (and ever since) it has been a fait accompli that interest rates MUST rise. I wrote in “Do Interest Rates Have To Rise Soon” on May 6th, 2013 the following:
I’ve listened to the prognosticators predict higher rates now for almost four years…and rates instead went lower. Are interest rates going to turn around and go up anytime soon? I doubt it.
Turns out that rates did in fact rise soon after I penned this.
My statement wasn’t meant to be a prediction of where rates were going to go, simply an acknowledgment that there was nothing requiring higher rates and in fact there was precedent for lower rates for longer. The ten year sat at about 1.80% when I wrote that post and by then end of 2013 it had risen to just a tad over 3%, quite a big rise in a short period (though not unheard of). Since that time rates have steadily come back down and the ten year now sits about where was back in May 2013. While rates might rise again and the Fed may even raise short-term rates in the near future, there is nothing keeping rates from staying essentially flat or within a small trading range for the foreseeable future. I’m not saying they will or making bets that rates will stay the same or fall, simply repeating my statement from nearly two years ago that there is precedent for these low rates for a longer period then we might expect and saying that “rates must rise” is not supported by history.
Rates might rise, they also might fall – I certainly don’t know where they are going (nor evidently do economists who get paid to make such predictions), but I do know that basing my client’s investment strategy on the “fact” that rates must rise is ignoring the facts.