100% of Mainstream Interest Rate Theory is Wrong

An interesting article on MarketWatch today caught my attention. The subhead is the money quote, “Back in April every economist in a survey thought yields would rise. Guess what they did next.”

Every? The article refers to 67 economists polled by Bloomberg, all of whom would seem to believe in the quantity theory of money. This means they believe a rising money supply causes rising prices. That means they think the bond market expects inflation. Which means they expect the interest rate to rise, because investors will somehow demand more.

It didn’t happen because every assumption in that chain is false.

Many people also expect interest rates to rise after the Fed’s bond buying program—quantitative easing—ends. Let’s take a look at the yield on the 10-year US Treasury bond from 1981 through today. This graph is courtesy of Yahoo Finance, though I have labeled it as carefully as I could for the three rounds of QE so far.

TNX

By zooming out to capture the entire time period of the bull market in bonds—i.e. the period of the falling interest rate—we can put QE in perspective.

The 10-year US Treasury bond now yields 2.21%. For reference, the 10-year German bund is 0.87% and the 10-year Japanese government bond is 0.48%.

It’s obvious from the chart, that QE is not the cause of today’s interest rate near 2%.

MarketWatch implicitly acknowledges that the conventional theory is 100% wrong. I have published an alternative, The Theory of Interest and Prices in a Paper Currency. It’s a long read in seven parts, but I have tried to keep it accessible to the layman.

Spoiler alert: I think interest rates will keep falling to zero, though of course there can be corrections.

The interest rate is pathological. It’s like an object that gets too close to a black hole. Once it falls below the event horizon, then a crash into the singularity of zero is inevitable.

 

You are cordially invited to The Gold Standard: Both Good and Necessary, in New York on Nov 1. There hasn’t been a real recovery from the crisis of 2008, and there won’t be until we return to the use of gold as money. Please come to this event to hear Andy Bernstein present the moral case for capitalism, and Keith Weiner present the case for the gold standard as the monetary system of capitalism.

5 replies
  1. miamonaco says:

    Keith,

    Great post, to which I agree. Following on from your argument, if interest rates are approaching a limit of 0% given ever growing sovereign debt loads, which are difficult to service, and corporations are taking advantage of low interest rates to buy-back stock, pursue marginal investments and effectively automate employees, doesn’t this point to a deep deflationary depression, which will bring down the stock market and commodity prices (at least in the short term before stagflation likely results)?

    Thanks,

    Mark

  2. Keith Weiner says:

    miamonaco: I haven’t talked about the stock market much, but otherwise I address your questions in my theory of interest and prices. We are seeing major drops in commodity prices, though far more muted drops (so far) at retail.

    Greg: If the interest rate on the long bond is zero (arguably that’s the 30-year rather than the 10-year) then the burden of debt is infinite. I think the system will blow up at or before that point.

    • Greg Jaxon says:

      Keith, I think you’re extrapolating Fekete’s argument about the burden of extant debt in a trend of falling rates (yields). Actual debt contracted at below zero interest rates has its “burden” reduced by the maturing at a face amount lower than its sale price. At -5%, a 15 year bond can mature by simply returning the negative interest payments the lender has been sending you for the privilege of holding onto his cash.

      Most folks find this math intractable, but to me negative interest rates are the inevitable triumph of soaring levels of government debt. We pay them to keep our money safe for us…

      I hope you’re right that their system must implode before this extreme is reached, but I fear that classical economics may have perished in the realm of “everything comes from the nanny state”. If their legal tender laws and central banking make negative interest necessary, then Menger’s evolution of organic money will simply remain forgotten, and Friedmanesque Monetary Policy will produce a extortionist medium of exchange so we can be communist while believing we’re all capitalists.

  3. jmf says:

    Some of the elitists must also know the ‘system will blow up’ reasonably soon. Will they therefore try to engineer a scapegoat to avoid culpability ? Is it ebola ?

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