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Janet Yellen Fights the Tide of Falling Interest
by Keith Weiner
On Wednesday Dec 16, Federal Reserve Chair Janet Yellen announced that the Fed was raising the federal funds rate by 25 basis points.
Let’s get one thing out of the way. This is not a move towards free markets. Whether the Fed sets interest lower, or whether it sets interest higher, we still have central planning. We still have price fixing of interest rates.
Interest rates may be set too low. However, forcing interest up is no cure. We need to eliminate central planning, and move to a free market in interest. This is impossible in our present monetary regime.
Anyway, given the system as it is, the Fed is going to have to take back this interest rate hike. Here is Exhibit A of our case: a graph of the 10-year US Treasury bond yield.

Source: Yahoo Finance
At least the US dollar still has interest. Switzerland, and several countries in the European Union, don’t. Their currencies are drowning under the zero line. For example, the Swiss government 10-year bond takes 0.16% per year from lenders. That’s right, if you fork over your francs to buy that bond, you get back less at the end. Germany is little better, with their five-year bond charging investors 0.1%.
The global trend for over three decades has been falling interest. The yield on the 10 year Treasury even fell after the Fed’s announcement. Yellen thinks to fight this megatrend, but that’s absurd. Let’s look at why.
The process that sets the interest rate is complex. I have written many words on its terminal decline. However, there are two simple reasons why the trend remains downward.
One, banks today have a business model called maturity transformation. They borrow short term to lend long term.
To understand this, consider the simple example of buying a house. Only, you don’t get a normal mortgage. You get a balloon loan due tomorrow morning. Every day, you have to borrow anew. This would be crazy for an individual homeowner to attempt.
However, it’s what banks do. They risk an increase in their cost of funding. That would be a problem, because the interest they receive on their bonds is fixed.
The problem isn’t just reduced cash flows. When the cost of funding goes up, some bondholders are obliged to sell bonds. That causes a drop in the price of bonds, and all bondholders take capital losses. With reduced capital, banks have to cut back on lending. Funding to business is reduced, and there can be a recession.
Two, falling interest has driven down the yields of stocks and real estate. This has been a process of borrowing ever more, of going deeper into debt. What else should we expect people to do, with ever cheaper cost to borrow? They borrow, to increase their leverage, to own more assets. At least, there are more assets in dollar terms. But remember, prices are rising in this process, so there aren’t necessarily more assets in reality.
Picture both assets and liabilities rising together. It is a ratchet, that cannot go backwards. Any significant interest hike causes the prices of all assets to drop. That turns many balance sheets upside down. For some, liabilities exceed assets. Their bankruptcies lead to liquidations, which causes further asset declines. Assets must be sold, but no one can get funding to buy them, and everyone’s balance sheet is under stress.
Janet Yellen will want to avoid this catastrophe. She won’t want to be remembered as the Fed Chair who caused a repeat of 2008. She will find that it’s easier to take another hit of financial heroin. Interest rates will go down.
This article is from Keith Weiner’s weekly column, called The Gold Standard, at the Swiss National Bank and Swiss Franc Blog SNBCHF.com.
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Just raising the IOER isn't "raising rates" as we knew it. Liquidity has to be drained as well.
The FED is cleverly changing the rules of the game and the masses are none the wiser.
It is easy to underestimate the FED. It might all actually be according to plan and that most recessions and nose dives the past several decades actually has been planned and intentional.
Hegelian dialectics - once you have the solution, you need a chrisis to get it implemented.
Considering the global movement towards one world currency with SDR, perhaps FED is now installing the chrisis necessary to get the SDR in place by substituting current government debts. Who knows..
If they want rates to rise, all they have to do is stop buying the bonds. Rates will rise as prices drop.
Maybe this is their plan anyway. They are holding far too many pieces of paper right now. Pretending to control rates will give them the cover of unloading the bonds they hold.
The FED will do what they have done for the last 7 years and ignore reality.
They will raise rates again as planned, never mind the reality.
They don't ignore reality, they avoid it completely. It's kind of like driving several miles out of your way to avoid the bad part of town.....
The Fed driven debt explosion led to overcapacity everywhere. When that ended in the 2008 crash the debt and excess capacity remained. Interest rates had to go lower as the cash created by the new Fed created debt could not fund even more capacity so it went into stocks & commodities, etc. otherwise there was no demand, only supply. Withdrawing the excess funds in the system, the illusion Yellen wishes to create with the 0.25% rate rise, can only reverse the excesses in the asset classes that benefitted from the QE-ing of America. Commodities were the first to collapse and we can count on the others, in their turn, to follow - and that's if her ploy works. If it fails, the few pockets of economic growth will recede and the pump will need to be turned on once again. This ends where all Centrally planned economies end with a hollowed out middle class, more poverty and - dare I say it - a civil war. Not if but when.