Are Central Banks Losing Control Over Interest Rates?

In the following article, Mountain Vision points to the potential effects of the “debt trap.” Debts have mounted to record highs. The associated financing costs tend to be high as well, but these costs are becoming unsustainable when interest rates start increasing. Record low interest rates have one characteristic in common: they have much more upside than downside potential.

What happens to an insolvent state when, due to rising interest rates, financing costs suddenly multiply? That question is certainly being asked in Japan. The Japanese Central Bank, under the lead of Mr. Shinzo Abe, has been ‘printing’ money at an increasing rate in its attempt to stave off deflation. To Mr. Abe’s great dismay, interest rates too have been on the rise.

Interes rates – 10 year Government Bonds in Japan


Since March, the yield on the 10-year government bond has doubled. As Japan’s government now has to pay much higher rates of interest on its bonds – rates that have risen substantially across all maturities – to finance its debt and deficits, Abe may find himself having to run that printing press even faster. At what point will he hit the wall? Hard to say, but I would not recommend standing between Abe and the wall at this point!

Meanwhile, in America, yields have moved upwards again as well. It is in this context that we need to consider the most recent minutes released by the Federal Reserve after its last Advisory Council and Board of Governors meeting.

A number of surprisingly cautious and candid comments regarding America’s economic state and the potential drawbacks of quantitative easing were made. In particular, the Fed acknowledged that a “breakout of inflation” is a risk, and that once interest rates start climbing, Americans’ bank deposits could be jeopardized. Moreover, the Fed admitted that there may be no easy exit from QE: “It will likely be difficult to unwind policy accommodation, and the end of monetary easing may be painful for consumers and businesses.”

Interes rates – 10 year Government Bonds in the US


A similar pattern can be observed for German government bonds. Interest rates have been rising there too. And, what about the other European countries like Spain, Italy, or France? Those countries certainly have debt and financing issues to deal with. All of their interest rates have started to rise – albeit not at Japan’s rate, or that of the U.S. – but enough to warrant our attention. Might the European debt crisis be about to erupt again?

Interes rates – 10 year Government Bonds in France


Bernanke, Draghi & Co. are certainly intent on keeping markets in a good mood; after all, most people fall prey to the assumption that if stock markets are up, the recovery can’t be far behind. That is unfortunately a misperception. The fundamental issues, namely the flaws of a fiat currency system, the decades of loose monetary policies, and the resulting effects of large-scale debt and capital misallocation, are still the dominant themes and key drivers today.

While financial markets have been relatively positive, the real economic data globally points toward low growth and difficult times. Higher interest rates will certainly not bode well for recovery.

All graphs are courtesy of VWD Data, BFI Wealth Management.

This article is an excerpt from the Mountain Vision newsletter, an excellent service which we strongly recommend.

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