Thursday, July 24, 2014

Bankers unclear on the concept...

Out in Kansas, home of the famous "Fighting 'Flation Hawks", bankers recently gathered to complain how the Federal Reserve was ruining their lives.
"Interest rates have been low longer than needed," said Jim Farrell, president of Farmers National Company and chair of the Omaha branch board of directors of the Kansas City Fed. "The low rate doesn't seem to be stimulating anything now.""Beware of unintended consequences," Farrell added. Discounted interest rates get factored into farmland values, which influence cash rents and that drives up the cost of production, Farrell noted.Another consequence: "Some have called it a 'retirement tax,' because retirees are paying the price, [by not being compensated for their savings]," said Farrell.In fact, George pointed out, "We've seen signs of 'reaching-for-yield' behavior in the leveraged loan market, subprime auto lending and corporate bonds."The lack of alternative investments has been a factor in keeping farmland values high, noted Doug Stark, president of Farm Credit Services of America, based in Omaha."Lower interest rates have also pushed some savers, who traditionally relied on safer assets, into riskier securities," said George. And there is growing concern these savers, especially those retired or nearing retirement, may not understand those risks, George noted. [More]

It's unsettling to me to hear remarks like these from people in charge of our financial system. My understanding of the system seems to be strongly at odds with their POV.

For example, there are easy ways to tell when interest rates need to rise: inflation comes to mind. When people want to buy stuff and services more than they do save money, prices will begin to rise. This demand-pull doesn't seem to be what we've seen for years.  In fact, inflation remains historically low.
The Labor Department’s latest consumer price index report suggests concerns about inflation pressures may again be premature. U.S. consumer inflation firmed last month but largely decelerated outside a jump in gasoline prices, and food costs in particular slowed after surging in recent months.Indeed, the Fed’s preferred measure of inflation—the Commerce Department’s personal consumption expenditures index–has been undershooting the central bank’s 2% target for two years. Any reading that finally approaches 2% – and even one that surpasses it slightly – is likely to be welcomed rather than feared by Fed Chairwoman Janet Yellen and many of her colleagues. [More]
Let's see what this looks like:

Another sign rates are too low would be bond yields. If US debt wasn't paying enough interest the price of bonds would drop to raise the effective yield. But signs of investor reluctance just aren't there.

And while the bankers complained that savers were being "forced" into riskier investments to get some yield, this is another indication we have plenty of money looking for work. Just like we now seem to have more than enough corn, the price has plummeted. For many, it is hard to think of money as a commodity, but the same supply/demand principles apply. 

Here's a curious indicator about the abundance of savings.
A report released Thursday by bank consulting firm Moebs Services Inc. calculated the average balance for U.S. checking accounts at $4,436 at the end of last year — more than double the average of $2,100 over the 25 years of the annual survey.During good economic times, when unemployment and inflation are low, the average balance in consumer checking accounts is about $1,400, the survey noted."When times get difficult, the consumer sits things out and checking balances get larger, normally upward to $3,000 or a bit beyond," the study said. "Generally there is higher unemployment, lower inflation and falling prices." [More]
The idea of more money than can be used by borrowers simply eludes many people. The belief that money has intrinsic value is deeply ingrained in our minds. Perhaps this is necessary, because if we ever did try to come to grips with the fact that it's jut a piece of paper or a number on a screen we'd panic. And buy gold.

But this, I believe, is the big reason why interest rates are low - there are oodles of money being saved, much less being spent. And as for needing money for investing in new business ideas, that's not happening either.

The surplus of savings has gone on long enough to trigger a sense of entitlement in savers - they deserve a decent return! It turns out if nobody wants to use your money, you don't. Money earns a return, it isn't a built-in guarantee.

Finally, these bankers seem to have forgotten they control their interest rates. The Fed can't prevent them from raining what they pay savers. Of course, they would have to charge more to borrowers in return, who would likely go to a) borrow less or b) find another cheaper lender. The Fed doesn't tell banks what to charge. 

Exacerbating the problem is how banks have voluntarily linked loan rates to the prime rate (which links to the Fed funds rate) so as to "automate" and shift blame for rate changes. This is a real help when going up, but less fun for them when rates are falling. Again, this was their choice, not the Fed.

This is simply low demand. While $3 corn may help that situation for some ag banks, right now more saving is going on than spending.  The worst (for them) news is this is unlikely to change very fast. Economic growth is largely being garnered by the saving class, not the spending (borrowing) class.

Banks have the same problem I have: too much product for current demand. Carping about the Fed won't help, and raising interest rates could actually make the problem worse.  Until loan demand and inflation show some life, they need to figure out some other way to make a buck.


Anonymous said...

Nice analysis.

MK said...

I chuckled at your comment about buying gold when you realize other currencies have no intrinsic value. Now that there are fewer industrial uses for gold, even gold's value depends on the skill of good public relations men.

I heard an economist say that although gold may not have a use, it will always have value because it must be mined. His understanding of intrinsic and extrinsic value is different than mine. Using his reasoning, the more excruciating the bowel movement, the higher the intrinsic value.

I agree with your assessment.