With all of the talk about rising interest rates, many wonder what difference it really makes and if it’s really all that important.
Perhaps the easiest way to put it into perspective is to think back to what happened in 2008. Or better yet, to go back even a few years earlier. Because the collapse of the housing bubble didn’t just appear completely out of left field.
Following the collapse of the dotcom bubble in 2001 Former Federal Reserve chairman Alan Greenspan lowered interest rates to 1% in order to “stimulate” the economy.
Consider that on May 16th, 2000, Greenspan raised rates 50 basis points from 6.00% to 6.50%. Which is almost unfathomable to imagine in today’s world. And makes it truly incredible to think how much life has changed in the last 18 years.
However it would ultimately be the last hike of that cycle. As in January of 2001 Greenspan began lowering interest rates. By June of 2003, interest rates reached 1%, where they would remain for a year. When Greenspan began raising interest rates again in 2004, the easy money was removed, and many of the excesses that had been built began to be exposed.
The higher interest rates meant more expensive mortgage payments. Especially in a market that was based on adjustable rate products. Which ironically even Greenspan himself continued to advocate even in early 2004, just months before he began to raise rates.
We saw what happened to the banks as rates went up and many of the assets on their balance sheet went down. Keep in mind that when interest rates are rising, the value of a bond is declining. Which means that whoever holds all of that paper is facing a massive loss.
So if what happened in 2008 was enough to require the banks be bailed out then, it’s difficult to see how the banks would be able to survive normalized interest rates now. Particularly because all of the imbalances and bubbles are significantly larger this time around.
Now you’re starting to see the effects of that in the stock, real estate, and labor markets. And if interest rates do continue to rise, this is exactly what you can expect to continue. For the simple reason that the whole purpose of printing money in the first place is to create a positive short-term effect, and when you take the money away, you get the opposite.
So put in the simplest terms possible, the more rates go up, the closer we get to seeing the stock, bond, and real estate bubbles collapse.
Yes, the Fed can always change course and start printing more money. Which I still believe is what they will ultimately do.
Although even this morning as a weaker than expected labor report was released, Fed chairman Jerome Powell indicated that growth has picked up enough to justify rate hikes.
If they do continue to hike, they’ll get a very clear result.
So when you think about what happened to most of us back in 2008, when many were blindsided by the collapse of the bubble then, just imagine how incredible it can be to spot it in advance this time around.
It certainly could have saved a lot of people a lot of money. And if you’ve seen the fantastic movie The Big Short, you might also be aware of how certain investors who understood what was coming also traded their way to a fortune.
It’s an excellent metaphor for what’s going on now. And while it’s not ideal what has happened, both financially and politically, it is still possible to turn this challenge into a great source of opportunity.
For years, many (myself included) have talked about precious metals, and more recently cryptocurrencies as a monetary replacement the next time the system crashes. With interest rates going up, we are moving a step closer towards that ultimate outcome.
-Chris Marcus
April 5, 2018