Friday, July 13, 2012

Interest Rate Epiphany (Must See Charts)

For what it is worth, I am having an extreme interest rate epiphany today. The following chart shows MZM divided by wage and salary disbursements.


Click to enlarge.

With all that MZM growth compared to wages you might think that interest rates are destined to rise. That seems to be the common knowledge belief. There's just one small problem with the theory. That chart's shape looks just like the inverse of the 10-year Treasury yield. Inverse!


Click to enlarge.

Note: I clipped off some of the most recent data points to both show more detail of the blue and red trend lines and more closely align them with their counterparts in the first chart.

Now let's combine the two charts and test the correlation.


Click to enlarge.

0.85! That's a very high correlation. Of course, we already knew that with a simple inspection of the first two charts. They look like identical twins separated at birth.

So what could this mean?

1. If one expects wages to continue to struggle over the long-term and MZM to continue to grow over the long-term, then one might expect interest rates to continue to fall over the long-term.
2. If this chart has any merit, then the 10-year Treasury is about 1% lower than it should be right now. That's hardly a bubble. See #1. Also factor in the European cluster####. Well, you know. Fill it in with a four-letter word of your choosing. I suggest "euro" but other words work as well.
3. Hyperinflationists may continue to lose money shorting Treasuries and conspiracy theories will continue to grow in order to rationalize the losses.
4. Jeremy Siegel really should throw in the towel at some point.
5. They can pry the long-term TIPS from my cold dead fingers.
6. EE Savings Bonds still look good to me.
7. What's going to stop us from turning Japanese?
8. The exponential trend failure era is here to stay.
9. It will become harder and harder to make money off of money. This economy cannot support high real yields.

These are just the anonymous opinions of a permabear. This is most certainly not investment advice.

The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. - Alan Greenspan (1966)

Update:

I offer another version of that last chart. This time I'm plotting the blue and red zones independently.


Click to enlarge.

For all intents and purposes, the red and blue trend lines are one and the same. Epiphany!

Source Data:
St. Louis Fed: MZM / Wage and Salary Disbursements
St. Louis Fed: 10-Year Treasury

14 comments:

  1. I said I clipped off some of the data points in the 2nd chart. I think I need to clarify that.

    The data is still used. You just can't see it because I fixed the scale's maximum at 40 (equivalent to 2.5% or 1/40).

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  2. There are a couple of things that come to mind looking at those charts.

    1. Japan has blazed the trail into the future for 20 years, with a failed policy of protecting banks, borrowing money, and fiscal boondoggles. The US and europe are following, but with unique characteristics. Europe is also dealing with their currency union boondoggle. Given that, it would not surprise me to see the 10 year yield below 1.0%.

    2. The US, Japan, and Europe have unpayable debts and unpayable social security promises. The only "managed" way to get through that is to severely devalue currencies to make good on the nominal while defaulting on the real promises. The other path forward is an uncontrolled series of defaults, unrest, and chaos. I can't handicap those alternatives with data, but gut feel is maybe 60/40 for a managed default. Timing is anyone's guess.

    Finally, the two shocks the US experienced in 2000 and 2008 have left it weak and unable to respond to the third, that I believe is coming no later than 2015. The third shock will start with unemployment over 8%, a highly skewed distribution of wealth and income, and not much ability for the government to respond. I am not betting on 30 more years of steady declining bond yields, but either managed high inflation or catastrophe.

    Opinions from one anonymous internet permabear to another ;)

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  3. Great post; it looks to me like the money supply BB is printing up goes straight into treasuries. So I pretty much agree with you and Mr. Slippery.

    Re the yen:

    "by the year 1897 the yen was worth only about US$0.50. In that year, Japan adopted a gold exchange standard and hence froze the value of the yen at $0.50...The yen lost most of its value during and after World War II. After a period of instability, in 1949, the value of the yen was fixed at ¥360 per US$1 through a United States plan, which was part of the Bretton Woods System, to stabilize prices in the Japanese economy. "

    Catastrophic devaluation was the only solution for Japan's unpayable debts after the war.

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  4. Mr Slippery,

    It is my belief we're sort of seeing the default right before our eyes.

    If interest rates continue to fall but inflation doesn't, then savers will simply be nickled and dimed to death.

    What's the easiest way to get real negative yields? Too much money chasing too few good investment ideas!

    TIPS investors know up front that today's -0.59% real yield on 10-year TIPS will lose them roughly 5.9% of their purchasing power over the next 10 years. There's something to be said for at least some peace of mind though.

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  5. Scott,

    ...it looks to me like the money supply BB is printing up goes straight into treasuries.

    Even if inflation does pick up a bit, the Mundell-Tobin Effect Epiphany will probably kick in. That's two epiphanies for the price of one, lol. Sigh.

    There's also a trend in money market funds that's worth following.

    July 13, 2012
    Money-Market Funds Face an Uncertain Future

    Total assets in the funds have fallen from $3.8 trillion in 2008 to $2.5 trillion now, according to the Investment Company Institute.

    Where did that money go? Perhaps there is some capitulation as interest rates did not rise as expected?

    I wonder how many people saw what they thought were near record low interest rates and thought that they'd park the money in cash while awaiting even better interest rates. Not working out so well in hindsight. It didn't help that Jeremy Siegel was telling the world about the great TIPS bubble when real yields were over 2%! I'm pretty sure, in hindsight, that many investors would lock in 2% right now if given another chance.

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  6. I've added a bonus chart to this post. You might want to check it out.

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  7. As seen in the third chart, today's 1.5% 10-year treasury yield may be fully justified when MZM / Wages = 2.3.

    As seen in the first chart, here's the trend.

    We made it to 1.25 in the aftermath of the dotcom bubble.

    We made it to 1.54 in the aftermath of the housing bubble.

    We're at 1.6 right now and we aren't even officially in a recession. Or are we? Why is it rising during the recovery?

    In any event, the next recession could be "unexpectedly" brutal. As Mr Slippery points out, we're already weakened. Heading into the next recession with high unemployment and ZIRP doesn't seem like a winning combination to me.

    On the other hand, they say good things come in threes. Who are these "they" people and how do we shut them up, lol.

    Sorry. Gallows humor. Sigh.

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  8. The US, Japan, and Europe have unpayable debts and unpayable social security promises

    I kinda disagree with this. Social security spending goes right back into the economy.

    The question we need to ask is does a nation's economy create (or own) enough hard wealth to cover its hard wealth consumption.

    Japan still is positive on his quite handsomely thanks to its $3T in global holdings.

    The US is screwy but we've got a distribution problem not a wealth-creation problem per se -- our $600B/yr trade deficit is most troubling, but it has nothing to do with social security burdens.

    Now, if Japan and us don't raise taxes (currently ~25% of GDP) up to what the AAA-rated states inflict on their populaces (~45%), then yes, our debts are "unpayable".

    But that's a failure of national will and not financials.

    As for the epiphany, tight money raises rates I guess, but now there's so much money out there it's got nowhere else to go.

    I'll just say that tax raises from 25% to 45% are hella deflationary!

    As our spending cuts, should we want to go that way for some reason.

    The one thing the market is not pricing in is any sort of inflation.

    And it's not just real yields we can't handle, we can't handle anything, since we can't inflate our way out of our 3 main deadweight burdens -- DOD, Medicare, and SSA.

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  9. Troy,

    The one thing the market is not pricing in is any sort of inflation.

    It is pretty much pricing in Bernanke's 2% inflation target. I think he'll try to stick to it for fear things could seriously become unglued. That said, I prefer TIPS and I-Bonds for the added inflation insurance. Things happen and if inflation spikes higher he's not going to lower the target to 0% temporarily just to put things back into balance. What's done is done.

    And it's not just real yields we can't handle, we can't handle anything, since we can't inflate our way out of our 3 main deadweight burdens -- DOD, Medicare, and SSA.

    A few good men? We can't even handle the truth apparently. Sigh.

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  10. MZM/wages is increasing. That means that the amount of money in money markets and other such instruments is increasing while wages are staying flat/barely growing? The question is: Why are so many people sitting in these no rate of return positions? My answer: Lack of confidence.

    We have a way out of the problem.
    1. Quit demonizing business and profits. Open the country up for business - especially the energy business. When confidence increases those MZM deposits will seek some risk and things can slowly return to normal.
    2.Follow Ryan's proposals on SS and Medicare. They are controlled bankruptcies of the programs. My old employer went bankrupt. The pension was given to the PBGC. The PBGC analysed the amount of money and divvied it up amongst us peons. Hard medicine? Yep, but far better than papering over the problem until you wake up one day and find out there's no way to pay anything to anyone. That's what SS and Medicare need to do - divvie up the pot so that it is sustainable.
    3. The U.S. government has many billion$ in surplus real estate and buildings that should be sold to private enterprise. Money to pay debts.
    4. I do not object to an increase in taxes if..........the money is ONLY used to pay down debt. In the past, every time taxes have gone up Congress has just increased spending.
    5. The government automatically increases spending by 8% per year. That is cooked into their plans. Anything less than an 8% increase is called a cut in spending. How crazy is that? Get the economy moving again and hold spending level for ten years. It would solve the problem. The problem is not the amount of debt or money printed - it is that our Congress and President are addicted to spending other people's money. That's what the TEA Party is all about. To break the addiction.

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  11. Jimmy Z,
    You claim: Why are so many people sitting in these no rate of return positions? My answer: Lack of confidence. Lack of confidence in what, I may ask? I think it is quite clear that people are much more willing to trade away some appreciation for a sense of preservation. The market based system, is "fixed," and the small investor sees very clearly that there is no safe haven in a system that is ruled by manipulative, unsavory characters that have no interest in seeing that bad actors get punished. Regulatory capture is quite obvious to anyone paying attention. The notion that we need to relax regulations further is a certain recipe for further disaster.
    The economy is suffering from an aggregate demand shortfall, pure and simple. The problem is that know nothings in one party in particular, think the solution is more spending cuts and sacrifice by those that can least afford it, and had nothing to do with creating the current economic framework. Have you noticed how well austerity is working out in the EU? Keynes had it right in the GT, that when rates are near the ZLB, no amount of additional monetary stimulus can make up for the lack of demand in the short run.

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  12. nanute,
    The chance for the government to provide that stimulus of demand was missed in the $785 billion stimulus bill. The money went primarily to shore up states, unemployment insurance, and green energy. Except for the unemployment insurance little of that money created any demand. Those with all that money in the MZM accounts are a potential source of demand. If only the government would act to stop beating up on business, some of that money would be spent and some of it would be invested.

    Austerity hasn't even been tried in Europe. The people there are so addicted to the cradle to grave socialized state that any mention of cutting spending even a tiny bit sends mobs into the street in protest. Then they elect a big spender like Hollande in France. I don't think that is going to work out so well for France. We'll see.

    The issue here is that Obama and his advisors believe the problem is that the pie is not divided equally enough. It never occurs to them that the pie is shrinking, and instead, needs to be grown. Only the private sector can increase the size of the pie.

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  13. Jimmy J.,

    Anything less than an 8% increase is called a cut in spending. How crazy is that?

    On a craziness scale of 1 to 10, I'd give it a 10.

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  14. nanute,

    The market based system, is "fixed," and the small investor sees very clearly that there is no safe haven in a system that is ruled by manipulative, unsavory characters that have no interest in seeing that bad actors get punished. Regulatory capture is quite obvious to anyone paying attention. The notion that we need to relax regulations further is a certain recipe for further disaster.

    I agree. I guess that puts me somewhere between the two of you.

    I'm of the belief that we're in a lose-lose situation. If I thought there was an easy way out of our problems then I wouldn't be a permabear. All solutions I have seen so far have unintended consequences that may fully offset the intended ones.

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