Coming to the End of a Deceptive Lull
"Some debts are fun when you're acquiring them, but none are fun when you set about retiring them." ~ Frederic Ogden Nash
We may be coming to the end of a phase that was widely perceived as "a return to normalcy." Recovery hopes have been held high, sponsored mostly by central bankers and Wall Street analysts. Soothing statistics have been dutifully reported. A deceptive lull was the result. However, interest rates are on the rise everywhere, which alerts us to the possibility that the "lull" may soon be over.
The world has maneuvered itself into what can easily be called a "debt trap." With debt at record highs, financing costs tend to be high, as well. Of course, these costs are much more bearable when interest rates are low. But what happens to an insolvent state when, due to rising interest rates, financing costs suddenly multiply?
Into Debt Trap Territory
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.
Yield on 10Y Japanese Government Bonds
Source: VWD Data, BFI Wealth Management
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."
Yield on 10Y U.S. Government Bonds
Source: VWD Data, BFI Wealth Management
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 US – but enough to warrant our attention. Might the European debt crisis be about to erupt again?
Yield on 10Y French Government Bonds
Source: VWD Data, BFI Wealth Management
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.
I recommend you keep a close watch on interest rates and the reactions of the central banks in the coming weeks. 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.
Frank Suess is CEO and Chairman of BFI Capital Group. To subscribe to BFI's weekly Mountain Vision Update, in which this column appeared, click here .
