The Single Most Important Chart For Markets Right Now

by James Gruber on January 12, 2014

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{ 3 comments… read them below or add one }

vijay January 13, 2014 at 8:09 pm

These two comments make a interesting read and if I can come in this.
Raising interest rate will eventually lead inflation out of hand or that is the perception till now. And this wll be very catastrophic.
What I feel is that government willfirst put its fiscal policies in order before moving to any monetary decisions. It will come to monetary decisions after generating enough revenue and recovery. We have to wait for some more time to get any alteration in interest rate.
These can be very naive comments from a layman, but given the opportunity I would like to share and test my thoughts.

James Gruber January 13, 2014 at 6:21 pm

Angela,

Thank you for your thoughts. I was just chatting with another subscriber offline about this exact issue.

During December, it was expected by some that the Fed would announce the reduction in interest on excess reserves, perhaps alongside the tapering discussion. Obviously it didn’t happen.

This particular policy has helped to repair US bank balance sheets, which are now in ok shape, particularly vs their European counterparts. The Fed will be very wary about reducing the interest on excess reserves, given their potential to ignite inflation. My last read of these excess reserves had them numbering around US$2tn.

Perhaps, you will see a reduction at some point in combination with other policies seeking to partially restrict the lending, such as tighter reserve requirements. All in order to try to control the level of lending.

The broader issue is that inflation is a much bigger threat to the US economy than many believe. I read today that if interest rates were to rise to 5.7% in the US (about the long-term avg), then the interest on debt would total 85% of taxes collected by the government by 2020. Failure to get policy right and let inflation get out of hand, putting upward pressure on interest rates, would have very deleterious consequences for the US. While America may be in somewhat better shape than some other developed countries, it remains in a serious predicament with regards to its debt.

That is a bit of a rambling answer to your query but I hope it addresses some of the issues.

Best,
James

Angela Ashton January 13, 2014 at 1:07 pm

Hi James

Firstly I wanted to congratulate you on your newsletter. It is always interesting and well worth reading. There is so little intelligent and unbiased commentary available in the world of funds management – you have delivered on both counts.

One question/comment though. You talk of the fact that the Fed has bought bonds from banks in order to give them money to lend. Conventional wisdom says that the banks just haven’t bothered to do this, with their balance sheets growing lazier as a result.

However, there is another factor that has led to this situation and no-one seems to mention it. At the same time that the Fed started buying bonds, they also started paying interest on reserves for the first time ever – at the same rate for both statutory and excess reserves. Banks are being rewarded for not lending. When the Fed changes this situation by say paying less interest on excess reserves(which they can, with ease), then lending will pick up and we may see inflation increase at that point.

Love to hear your thoughts.

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