jbranx wrote: ↑
Sat Apr 13, 2019 9:39 pm
Thanks, Simplegift. Another intriguing topic from you. It would appear that humans have learned how to price risk fairly appropriately over the centuries. I remember reading that the Medicis's charged interest rates of 13% because the Italian city states were risky credits before the consolidation of the nation. Lloyd's priced insurance rates based on the hazards of shipping. Of course, there are innumerable examples of outfits that guessed wrong, like Equitable Insurance, that wrote under-priced annuities in the eighties.
There was a US scandal called Equitable Insurance, I believe (I think it was a computer based fraud; overstating numbers of policy holders). The UK one was the Equitable Life Insurance debacle - it's always said "Equitable Life".
I would have to concur with your logic that if interest rates are low because an interconnected world can better understand risk, then we may be in for one of those inflection points where our understanding of security valuation has to change. (Shudder) but maybe that explains how suddenly Greek bonds now yield less than US treasuries only a decade after the debacle.
Partly it's the ECB and their programme of Quantitative Easing. But also partly it's the German government bond yield - which is negative. It's the risk spread of Greek bonds over German that counts, rather than the absolute interest rate. The analogous phenomenon in the US Dollar bloc is the low rates some Emerging Markets are able to borrow at, despite a history of crises and defaults (Mexico as an example, or Indonesia).
What the Greek government bond yield is telling us is that the market thinks the Eurozone is going to be depressed for a long time to come, and so it is not pricing in any kind of Eurozone interest rate rise.
Whereas with the USA the market is pricing in some sort of interest rate rise - the US economy is pretty near full employment, as conventionally defined. You see it in the unemployment rate (albeit the 25-64 year old employment rate is still below 2000 highs), in the reported shortages of labour (construction, truck driving, airline pilots etc), in rising wages, in greater union militancy (they feel they can afford to take a risk - their services are potentially in short supply). Falling immigration no doubt helps by reducing that supply of labour as well.
We'll see someday if all this was just a credit bubble and a central bank induced asset bubble. If it's a new phenomenon of permanently lower real rates, then stocks may be the best bets around. What we don't know is how often we get turns in the business cycle and how long the recoveries take. It appears the cycles are longer and so are the recoveries. The uncertainties may now be greater than previous even though the risks are better understood.
Central Banks have control over nominal interest rates.
It's doubtful whether they have as much (or any?) control over real rates?
Because the real rate is set by the fundamental demand and supply for loanable funds -- capital, in effect. What's actually going on in the economy.
I am not a Rational Expectations Hypothesis purist, that monetary measures have *no* effect on the real economy, but I think we can overestimate the amount of control Central Banks do have over the financial markets and the economy. They can move nominal quantities around but find it much harder to move real quantities.
Exception - in a liquidity crisis like 2008-09 or 1929-1931, the actions of the Central Banks really are critical. It's possible to turn a bad situation, worse, very easily.