TEN-YEAR US TREASURY RATES UP UNTIL DECEMBER 15 2015
By John Richardson
AN important article in the New York Times almost gets there, but like so much coverage out there, misses the crucial conclusion: Demographics drive demand and there is nothing that the Fed has done, or can do in the future, to alter this reality through adjusting interest rates.
The NYT points out that:
- The interest rate on a 10-year US Treasury note was below 4% every year from 1876 to 1919. This happened again from 1924 to 1958.
- The real aberration was 7.3% average seen in the US from 1970 to 2007.
- Interest rates, of course, reflect inflation. As the NYT writes: The Fed and its counterparts overseas at the European Central Bank and Bank of Japan have spent the last few years applying every policy they can think of to get inflation to rise up to their 2%, with limited success. In a world awash in supply of workers, oil and more, financial markets show little sign that investors think that will change anytime soon.
The conclusion of the article is that there are forces deep inside the US and other economies that are poorly understand, which means that, quoting the NYT directly again:
Whether rates will be high or low a few years from now has very little to do with what the Fed does this week.
First of all, before I go any further, I need to apologise for singling out the NYT. It is one of the best newspapers in the world, and, as I said, this is an important and also highly valuable article.
I don’t mean to blame the messenger – i.e. – the newspaper, but rather those who have composed the message: The central bank officials, politicians, economists, other analysts (including a good number who work in and for the chemicals industry) and business leaders who have misled everyone. They should have known better. Here is why:
- In 1946-1970 the average number of G7 babies being born each year rose by 15% per annum compared with the 1921-1945 period. This was equivalent to 33m extra babies, or more than twice the population of Canada in 1950.
- Births in 2013 in the G7 economies (almost half of the global economy) were at the lowest level since the Great Depression year of 1933. Global fertility rates have also halved since 1950 to average just 2.5 babies/woman – and in many countries are already below the replacement level of 2.1. As the Babyboomer generation (those people born between 1946 and 1970) start to retire in record numbers, there are fewer young people replacing these retirees. All the data show that older people spend less money.
My first point explains why US borrowing costs averaged 7.3% between 1970 and 2007. Too little supply was chasing too much demand because those extra 33m babies had joined the global workforce. They were crucially also middle class and so very rich.
And my second point explains why the Fed and the other central banks have failed to get inflation anywhere close to their target since the Global Financial Crisis: Many of those rich, middle class babies are now retiring and are not being replaced by enough of the same kind of young people. Too much supply is now chasing too little demand – hence, we face global deflation.
This excess of supply over demand would not be as bad as it is today if so many people hadn’t been deluded into thinking that China had suddenly become middle class by Western standards virtually overnight, during the 2008-2013 economic stimulus package. This led to vast quantities of oil, iron ore, chemicals and polymers, other commodities and manufacturing capacity being added to serve demand in China that will simply not exist now that China is rebalancing its economy.
How long might this problem of too much supply chasing too little demand last? Again, expectations of future interest rates – which of course point to expectations of future inflation, or rather I think deflation – are a major help here. As the NYT also writes in its very valuable article:
At the onset of the crisis in 2007, the Fed’s official target [interest] rate was 5.25%. Now the officials’ median forecast for that rate’s longer-term level is a mere 3.5%.
In other words, even after they are done with a series of rate increases, Fed officials envision interest rates substantially lower than they were. If anything, financial markets think even this is too optimistic. Thirty-year Treasury bonds are currently yielding 2.9%, implying that markets expect the Fed’s target rate to be even lower than Fed officials expect over the coming decades.
Current Treasury bond prices predict annual inflation in the US of only 1.7% a year over the next three decades.