Interest rate reality check

There is a lot of talk about when “the Fed” is going to “raise rates.” Rates are actually determined mostly by supply and demand in the money market. Without getting into an academic fracas, I am going to present some graphs representing very strong empirical regularities that suggest interest rates, long or short, are not going up any time soon.

I’ve presented one of these before, the long term chart; here I’ve added the 3-month T-bill. These graphs show the relationship between interest rates and the ratio of the St. Louis monetary base to GDP. Data is to April or first quarter 2014. The ratio of base to GDP is ~0.23 currently.

Here is the trajectory of the base/GDP ratio. Can you spot the taper?

Here is the trajectory of base:

From these empirical regularities I draw the following conclusions:

• Interest rates aren’t going up any time soon. The “taper” is really a reduction in the rate of addition to base, not a reduction of base.
• Nor is inflation taking off any time soon, except for stagflationary cost-push. Negative real interest rates will continue. The labor market has no power; the reserve army of the unemployed (whether they are categorized as such or “not in the labor force”) is growing. There is no wherewithal for a wage-price spiral to get started.

This mirrors the experience of the Thirties. ZIRP in that period lasted until near the end of WWII. It took a war to get the inflation started. Federal debt exploded. But America had relatively less sovereign debt going into that war; we are already at comparable levels.

So people who suggest that the Fed “raise interest rates” are really asking the Fed to reduce the size of the monetary base a huge amount. There is no question the Fed would crash the stock market if they did this, purely because of the “optics,” so it won’t happen. Moreover, if the Fed sent all those bad debts back into the banking system they’d be subject to “stress testing” (heaven forbid they were actually marked to market) that I somehow doubt the Fed does on the stuff they hold. (Comment if you know better than I, please.)

Plutocracy World, the Global Casino, rocks on for years to come. The banking system hangs like an albatross around the neck of the world economy. China seems to be making the same mistakes; it will be interesting to see what they do with all their bad debt.

The great economic task of the first half of the twenty-first century will be to reform the world’s monetary system.