World interest rates

Ben Bernanke has joined the blogosphere, offering an invaluable resource for anyone wanting to understand recent economic developments. Last week he had a series of articles examining factors behind the very low real interest rates on long-term bonds.

One interpretation of current low interest rates is that we have moved into an era in which the long-term real return to capital is near zero as a result of factors such as fewer investment opportunities, slower population and productivity growth, and falling labor force participation. Larry Summers argued that the U.S. was only able to achieve satisfactory GDP growth over 2002-2007 as a result of an unsustainable housing bubble and that the strong economic growth of the 1990’s was also partly powered by the tech stock bubble. Larry has elsewhere suggested:

Suppose that the short-term real interest rate that was consistent with full employment had fallen to negative two or negative three percent in the middle of the last decade. Then … we may well need, in the years ahead, to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economy activity, holding our economies back below their potential.

But last week Bernanke outlined some of the reasons he is not convinced by Summers:

I generally agree with the recent critique of secular stagnation by Jim Hamilton, Ethan Harris, Jan Hatzius, and Kenneth West. In particular, they take issue with Larry’s claim that we have never seen full employment during the past several decades without the presence of a financial bubble. They note that the bubble in tech stocks came very late in the boom of the 1990s, and they provide estimates to show that the positive effects of the housing bubble of the 2000’s on consumer demand were largely offset by other special factors, including the negative effects of the sharp increase in world oil prices and the drain on demand created by a trade deficit equal to 6 percent of US output. They argue that recent slow growth is likely due less to secular stagnation than to temporary “headwinds” that are already in the process of dissipating. During my time as Fed chairman I frequently cited the economic headwinds arising from the aftermath of the financial crisis on credit conditions; the slow recovery of housing; and restrictive fiscal policies at both the federal and the state and local levels (for example, see my August and November 2012 speeches.)

My greatest concern about Larry’s formulation, however, is the lack of attention to the international dimension. He focuses on factors affecting domestic capital investment and household spending. All else equal, however, the availability of profitable capital investments anywhere in the world should help defeat secular stagnation at home. The foreign exchange value of the dollar is one channel through which this could work: If US households and firms invest abroad, the resulting outflows of financial capital would be expected to weaken the dollar, which in turn would promote US exports…. Increased exports would raise production and employment at home, helping the economy reach full employment. In short, in an open economy, secular stagnation requires that the returns to capital investment be permanently low everywhere, not just in the home economy.

In a subsequent post, Bernanke takes a look at those global factors. In 2005 he had noted that global saving and investment flows were reversed from what one might normally expect, with the emerging economies and oil-exporting economies (where one might have thought investment opportunities should be most abundant) having surplus savings with the funds being lent to the developed economies. Bernanke described this situation as a “global saving glut” that contributed to low world interest rates at the time. His blog post last week revisits this issue and notes some important changes since 2005.

Thanks in part to increased domestic oil production, Bernanke notes that the U.S. current account deficit today is significantly smaller than it was in 2005. The periphery European economies have swung from big trade deficits into surplus, while Germany’s surplus has increased. The bottom line is that the developed economies as a group appear to have swung from a position of big deficits into surplus.

At the same time, the surplus of emerging economies has fallen significantly. Latin America has moved from trade surplus to a big trade deficit, China’s saving rate has slowed, and oil producers like Russia have seen a big swing. If oil prices remain at the low levels they reached by the end of 2014, we would surely expect to see further big reductions in the saving from the oil-exporting countries.

By the way, one might wonder how it could be that developed and emerging economies today are supposedly both running a trade surplus. Unless, as Jeff Frankel once facetiously suggested, the earth is currently exporting $587 B in goods and services to other planets, there is a problem with the numbers some of the countries are reporting– the exports that country A claims it sold to country B do not equal the imports that country B claims it bought from A. This is labeled as a “statistical discrepancy” at the bottom of Bernanke’s table. Although these discrepancies are enormous, I think we can correctly infer the broad trends and recognize the direction things are headed at the moment, even if we don’t have full faith in the detailed numbers.

I share Bernanke’s conclusion:

If global imbalances in trade and financial flows do moderate over time, there should be some tendency for global real interest rates to rise, and for US growth to look more sustainable as the outlook for exports improves. To make sure that this happens, the US and the international community should continue to oppose national policies that promote large, persistent current account surpluses and to work toward an international system that delivers better balance in trade and capital flows.

And in his most recent post, Bernanke spells out some of the specific changes he is recommending. He notes that the long-term imbalances within Europe arise from a common currency ill-suited to the different needs of its member states, problems with parallels to those documented by Barry Eichengreen for the 1920s. Bernanke lays out several measures that Germany could take today that could help Germans and everyone else, including increased investment in public infrastructure, raising the wage of German workers, and targeted structural reforms.

The bottom line for investors, whether or not the Germans follow Bernanke’s excellent advice, is this: don’t expect the real interest rate to remain at current negative levels.

30 thoughts on “World interest rates

  1. PeakTrader

    I think, rather than a housing bubble, since 2004 when it began to inflate too much, the U.S. needed tax cuts to promote growth.

    1. PeakTrader

      A housing and stock market bubble began in 1995.

      The stock market bubble ended in 2000. We had a mild recession in 2001, because of the Bush tax cuts, while the housing boom continued.

      There was a quick and massive creative-destruction process mostly from 2000-02, in the mild recession, which made firms more efficient.

      While another stock market bubble formed, after the mild recession, more tax cuts were needed than a housing bubble.

        1. PeakTrader

          The point of the tax cuts was to raise income equals consumption and savings, not raise tax revenue.

          Income equals GDP equals output.

          If taxes, or tax rates, were zero, there would be no tax revenue.

        2. PeakTrader

          It should be noted, when output gap closes, taxes can be raised to slow the expansion, to a sustainable rate.

        3. PeakTrader

          And, if taxes become too progressive, particularly huge negative taxes for low income workers and high “middle income” taxes, it’ll cause disincentives to work and invest.

          1. PeakTrader

            If taxes are too progressive, someone may choose a part-time job with tax credits than a full-time job without tax credits.

            A full-time worker may work less hours, because of a higher marginal tax rate.

            High taxes may slow the expansion of a small business.

      1. baffling

        peak, i think you actually are a greater supporter of deficit spending, under the guise of tax cuts.

        1. PeakTrader

          Baffling, I’m for promoting work and investment, including through government spending.

          However, a $5,000 per worker tax cut is regressive and broad-based.

          The housing bubble was unfair. For example, some homebuyers (not only low income buyers) won big and others lost big.

          And, risk in the housing bubble increased dramatically over its last few years.

          1. baffling

            the housing bubble was a result of poor private sector choices. that is why private sector banks such as bear stearns, lehman,… suffered their fate. as well as AIG. all private sector. more should have failed, but they paid a price, including homeowners in foreclosure. poor private sector choices.

          2. PeakTrader

            The private sector made rational choices based on the poor policies of government.

            The housing bubble was the result of a giant social program politicians believed they didn’t have to pay for.

            Government failed and effectively shifted blame to others, because that’s part of what it does.

            The country doesn’t need more failure.

          3. baffling

            peak, the ignorance of your response is astounding! really. private sector made rational choices? private sector made very irrational choices, conducted fraud and presented basically a ponzi scheme passing low quality mortgages off like a hot potato. they exhibited everything bad about an unregulated market.

            the housing program was not a giant social program which failed. if was a financial bubble based on irrational expectations of ever increasing housing prices. it is truly baffling to continue to hear folks try to blame the housing bubble on the government. foolish goobleygock. please do not make excuses for borrowers and bankers who acted financially irresponsible. it is a boring argument you are making, “the government made me do it”.

          4. PeakTrader

            Baffling, without the encouragement and support of the federal government, throughout the bubble, there wouldn’t have been a bubble.

            It would’ve been irrational not to take advantage of the moral hazard and “too-big-to-fail” that government created.

            Don’t fight the government, and the Fed.

          5. baffling

            “It would’ve been irrational not to take advantage of the moral hazard and “too-big-to-fail” that government created.”

            peak, again your argument simply boils down to “the government made me do it” defense. you may find that acceptable, but i simply feel that is an absurd position to take.

            if you want to find fault with government policy, it would have been the lack of prosecution for anybody involved in all of the “fraud” that was conducted in that time period-but this was after the fact. you need to remember, these failures occurred basically because the private sector committed fraud in their business transactions. it was not government policy, it was criminal behavior on the part of many in the finance and mortgage community. a stronger regulatory environment would have helped-would you support that? government policy did not force them to commit fraud-they did it of their own free will. but white collar crimes are not prosecuted for a variety of reasons…

          6. Nick G

            It would’ve been irrational not to take advantage of the moral hazard and “too-big-to-fail” that government created

            I’ve heard it said that’s Gypsy culture: “If you make it easy for me to steal, it’s your fault, and I’d be a fool not to steal from you”

  2. BC

    The BAU scenario of the World3 model presented by “Limits to Growth” (LTG) continues to hold. Growth of real final sales/GDP per capita and “trade” is over.

    ZIRP and NIRP are reflecting price and eventual debt deflation because profits, incomes, and gov’t receipts are insufficient to support growth given the debt burden to wages and GDP.

    Debt deflation implies the increasing risk of decline (or another deflationary collapse as in 2008-10) of primary extractive and industrial output per capita, which in turn means that the complex, high-tech, high-cost, high-entropy value-added (???) service sector is unsustainable per capita, including “illth care”, “education”, gov’t, and discretionary consumer services for the 90-99%. Facebook, Twitter, SnapChat, Instagram, and mobile games and adapps are novel and creative but not sustainable as engines of growth under the circumstances. In fact, the success of Google, Amazon, Craigslist, etc., have resulted in cannibalization of existing sectors, resulting in net loss, and thus incremental slowing of growth, of value-added economic output.

    That is to say, the industrial requirement costs per capita in net energy (and energy costs of materials) terms have become prohibitive and can no longer support growth of value-added services per capita, which constitute 80% of GDP and employment.

    Moreover, with total gov’t, private “illth care” and “education”, and debt service totaling an equivalent of more than 50% of GDP, and net flows to the financial sector equaling all annual GDP growth, the net of prohibitive industry requirement costs is going to supporting the value-added sectors of the economy that are now a net drag on overall real GDP per capita.

    Therefore, net capital consumption per capita has been underway since 2001-08, resulting in no net capital accumulation to GDP required to permit future growth of real value-added output per capita.

    This is another way of perceiving the effects of Peak Oil and LTG.


    We use to think that trade data was the best of all the various economic data being reported.

    But more and more f trade is intra-company transfers reported at “shadow” prices that maximizes the firms profits by shifting the profits to a low tax country.

    It got so bad that in the US – Canadian trade data both countries data reported that they were running a trade deficit with the other. They resolved the problem by each country using the other countries import data for their exports. Supposedly the import data was more reliable.

    The growing size of the world trade surplus is an indicator of the severity of the “data” problem.

  4. Ricardo

    Why would anyone want to read the words of the worst FED Chair in the past 35 years? If he was wrong while in office he certainly is not right now.

    1. baffling

      and he was wrong because he dropped rates and backstopped the banking sector, keeping the financial world from imploding?

  5. genauer

    If you want to understand global interest rates, you have to start looking at Germany, at the supply and demand curves for long term AAAAA government debt.

    The last compact debt sheet of the German Bundesbank was published 2/21/2015
    before the Start of the European Central Bank (ECB) QE program, requiring the purchases of 27% of 1 trillion Euro, over the next 1.5 year.

    But we are selling even 30-year break even “Bunds” (German bonds) (2.5% nominal, after 26.375 % tax and 1.8% inflation (defined as “close but unter 2.0%”) ZERO real interest

    now only with a “little” markup of just 53% : – )

  6. BC

    The claim on labor and productive capital by the top 1-10% who own 85% of financial assets is ~30% larger than the average of previous peaks in 2000 and 2007.

    Therefore, a ~65-70% nominal decline in equity prices (claim) is required to bring equity claims back into line with the current capacity of domestic labor and productive capital. The Fed and TBTE banks’ QEternity and the encouragement and maintenance of the largest global debt/asset bubble in history is preventing/postponing the process of “normalization” of returns to equity claims vs. labor and productive capital.

    IOW, the productive share of the US economy for the bottom 90% is less “wealthy” than it has been in at least 20-25 to 40-45 years, whereas the “wealth” of the top 0.1-1% to 10% is a net non-productive rentier claim that is keeping the economy that way indefinitely.

  7. don

    I cannot forgive Ben his Congressional testimony, in which he cited rather wildly overblown estimates for the “gains from trade.” Anyone with any sense of proportion should have known better. (The estimates, based on calculations by Gary Hufbauer, were rightly criticized by Dani Rodrik, among others). Ben also cited a low probability that the housing collapse would lead to recession (Lehman’s or not, we were bound for a massive balance sheet recession). His explanation of the savings glut was also distorted. He pointed to the Asian crisis as reason why Asian economies decided they needed to build foreign reserves. But the biggest increases were in Japan and China, following obvious export-led growth strategies. His current argument that the U.S. may get a boost from exports seems to hark back to the old competitive devaluation (now depreciation) that occurred in the Great Depression.

    Ben once remarked that the euro was undervalued, because the area was running a surplus. But the currency area is made up of very disparate parts. If the euro was set at a level that brought balance to the members as a whole, I think we would be risking another very big global financial crisis, this time perpetrated by sovereign debt.

  8. don

    The U.S. oil supply increases may ameliorate the headwinds from reserve accumulations by oil exporters, but I am not sanguine that developments will encourage U.S. investment outflows, unless forced artificially by further QE. In my view, the QE-induced dollar carry trade was an important channel that allowed the policy to have effect, at least temporarily (that, along with more asset price bubbles). But that the pressure it put pressure on foreign economies may yet come back to harm us.

  9. BC

    Not unlike the multilateral gold bloc and currency alignments that existed (1930s-40s) at the end of the sterling reserve currency exchange regime between WW I and Bretton Woods.

    About every 32-36 years in the US, a new currency regime emerges, including the state bank note system, bimetallism, classical gold standard, gold-exchange standard, and the fiat system since 1968-73. We are due another “regime change”.

    Moreover, roughly aligned with the aforementioned “rhythm” is Schlesinger’s “turning-point cycle” during which a new peak demographic cohort comes of age and collectively asserts its values and aspirations. As a consequence, historically a major political party is replaced by an emerging coalition to challenge the dominant party, e.g., Federalists, Democratic-Republicans, Whigs, Progressive-Populists, pro-business Harding-Coolidge Republicans, New Deal Democrats, and now . . .?

    During the debt-deflationary regimes of the 1830s-40s, 1890s, 1930s-40s, and Japan since 1998, bank loans contracted 30-50%, clearing the decks of bad debts and resetting the system with a new currency regime. However, this time around the Fed and other central banks have prevented the clearing of the bad loans, whereas the TBTE still have something like $2 trillion “off the books” in bad loans, which is 25% of loans and as much as 30% in the immediate aftermath of the 2008-09 crash. Had the loans been written off, the TBTE banks would have been broken up and liquidated, their depositors made whole, their creditors receiving nickels on the dollar, and equity holders (including the likes of Warren Buffett) receiving nothing. Now the TBTE and the financial sector as a whole absorbs virtually all annual GDP output, leaving no net flows to grow the sectors of the economy outside the financialized sectors, e.g., financial services, “health care”, education, and gov’t, which combined result in spending of more than 50% equivalent of GDP.

    The next currency regime and techno-economic S-curve will by definition disproportionately disrupt, and cause to shrink as a share of GDP, the hyper-financialized sectors of the economy that are now a net cost to the rest of the economy.

  10. westslope

    “…. the US and the international community should continue to oppose national policies that promote large, persistent current account surpluses and to work toward an international system that delivers better balance in trade and capital flows.” -Bernanke

    Not sure how to interpret this. Does Bernanke means that the world should move away from competitive currency devaluations? Or that the USA should end the ZIRP sooner than later?

    The big story behind the global capital glut is the increased productivity of emerging markets coupled with their inability to develop sufficiently safe and secure savings institutions and vehicles to fully accommodate the increase in production and income generation.

  11. TF

    Wouldnt a buyer of $4trillion of UST and guaranteed mortgages, as well as a buyers of EURO 2$ of governments in Europe (and you can throw in Japan too) be a pretty good explanation for low long rates. When you factor in all the investors that piggybacked QE globally, I think the conundrum in pretty transparent. Why wouldnt the former chair mention that possible explanation in his blog?


  12. Kirby Thibeault

    I agree with much of Bernanke’s analysis and macro outlooks and the international component. Where I would take issue is with respect to his historic performance with helping steer monetary policy in the US. In large part, it is my view that his 18 or 19 consecutive 25 basis point increases in the Federal Funds rate pricked the US Housing bubble and no one is talking about that. Everyone pointed their fingers at Wall Street and the financial community meanwhile Bernanke overdid the rate hikes by 1.5 to 2 percent. Once that lag kicked in, the US housing bubble burst an spilled over onto the global economy and financial markets and sentiment exacerbated the negative downward spiral.

    Accordingly, and with respect to setting interest rates, I would discount his views by 30-40 percent to essentially get to what the private sector and markets need.
    Moreover, I agree with much of Larry Summers views on the view that deflation and downside risk is much harder to get out of than is the risk of overdoing things on the upside.

    I began writing about deflation risks in July 2013 when no one was talking about them now that risk is front and center everywhere despite the unprecedented stimulus that remains in the system.

    It is my view that it will take until 2020 – 2030 before the US and global economy resembles anything like a typical post ww2 recover and “normal” business cycle.
    Like it or not, and supported by price level trends around the globe, deflation is the number one risk facing the global economy and US at present. Real wages continue to fall and the jobs creation is a compilation of low quality jobs so the monthly numbers can be misleading.

    Finally, if central banks get overzealous with simply wanting to achieve “liftoff” or push up rates because it seems like the trendy thing to do after so much quantitative easing then the risk of deflation will get exacerbated that much more, the housing price recovery will collapse, market volatility will surge, nonresidential investment spending will fall or weaken from its current weak state, and policy makers will be right back at square one – or will have to add or come up with a new round of stimulus.

    Thus, expect moderate growth 1.5 – 2.5 percent real gdp growth for the next several years UNLESS we get a fundamental shift in fiscal policy and politicians that understand that the economy needs “incentives and risk taking mechanisms” to get the private sector moving and hiring on a ‘sustained’ trend as opposed to new regulations every week that continue to choke off economic growth and investment spending. Recently, and it has been perhaps 15 years since I heard someone say, Jeb Bush in this case, that ‘let’s shoot for 4 percent growth’ and restore the American dream. I agree with his statement and attitude towards a growth target and I am a Canadian. More than just short-term interest rates, the US and global economy really need strong and focused leaders that can help shape policy that does in fact lead to higher standards of living and economic cooperation and integration within the US and global economy as opposed to segmentation ad isolation where lessons from game theory say “self interest” is not the optimal behaviour but instead cooperation leads to the highest payouts for all stakeholders….

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