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Guest Post: Falling Interest Rates Destroy Capital

Tyler Durden's picture


Submitted by Keith Weiner of 'Gold and Silver and Money and Credit' blog,

I have written other pieces on the topic of fractional reserve banking ( and duration mismatch, which is when someone borrows short-term money to lend long-term and how falling interest rates actually encourages duration mismatch (

Falling interest rates are a feature of our current monetary regime, so central that any look at a graph of 10-year Treasury yields shows that it is a ratchet (and a racket, but that is a topic for another day!).  There are corrections, but over 31 years the rate of interest has been falling too steadily and for too long to be the product of random chance.  It is a salient, if not the central fact, of life in the irredeemable US dollar system, as I have written (


Here is a graph of the interest rate on the 10-year US Treasury bond.  The graph begins in the second half of July 1981.  This was the peak of the parabolic rise interest rates, with the rate at around 16%.  Today, the rate is 1.6%.

Pathological Falling Interest Rates


Professor Antal Fekete introduced the proposition that a falling interest rate (as opposed to a low and stable rate) causes capital destruction.  But all other economists, commentators, and observers miss the point.  It is no less a phenomenon for being unseen.  In early 2008, a question was left begging: how could a company like Bear Stearns which had strong and growing net income collapse so suddenly?


Here is Bear’s five-year net income and total shareholder’s equity





















Isn’t that odd?  Even in 2007, Bear shows a profit.  And they show robust growth in shareholder equity, with only a minor setback in 2007.


And yet, by early 2008 Bear experienced what I will call Sudden Capital Death Syndrome.  JP Morgan bought them on Mar 16, for just over $1B.  But the deal hinged on the Fed taking on $29B of Bear’s liabilities, so the real enterprise value was closer to $-19B.


Obviously, Bear’s reported “profit” was not real.  And neither was their “shareholder’s equity”.  I think it something much more serious than just a simple case of fraud.  Simple fraud could not explain why almost the entire banking industry ran out of capital at the same time, after years of reporting good earnings and paying dividends and bonuses to management.


Also, other prominent companies were going bankrupt in 2008 and 2009 as well.  These included Nortel Networks, General Growth Partners, AIG, two big automakers.


I place the blame for Sudden Capital Death Syndrome on falling interest rates.  The key to understanding this is to look at a bond as a security.  This security has a market price that can go up and down.  It is not controversial to say that when the rate of interest falls, the price of a bond rises.  This is a simple and rigid mathematical relationship, like a teeter-totter.


A bond issuer is short a bond.  Unlike a homeowner who takes out a mortgage on his house, a bond issuer cannot simply “refinance”.  If it wants to pay off the debt, it must buy the bonds back in the market, at the current market price.


Let’s repeat that.  Anyone who issues a bond is short a security and that security can go up in price as well as go down in price.


Everyone understands that if a bond goes up, the bondholder gets a capital gain.  This is not controversial at all.  Nor is it controversial to say that there are two sides to every trade.  And yet it is highly controversial—to the point of being rejected with scorn—that the other side of the trade from the bondholder incurs the capital loss.  It is the bond issuer’s capital that flows to the bondholder.  To reject this is to say that money grows on trees.


We won’t explore that any further; money does not grow on trees!  Instead, we will look at this phenomenon of the capital loss of the bond issuer from several angles: (1) Hold Until Maturity; (2) Mark to Market; (3) Two Borrowers, Same Amount; (4) Two Borrowers, Different Amounts; (5) Net Present Value; (6) Capitalizing an Income; (7) Amortization of Plant; and (8) Real Meaning of an Interest Rate.


Hold Until Maturity

There is an argument that the bond issuer can just keep paying until maturity.  While that may be true in some circumstances, it misses the point.  When one enters into a position in a financial market, one must mark one’s losses as they occur, no matter than one may intend to hold the position until maturity.  How would a broker respond in the case of a client who shorted a stock and the stock rose in price subsequently?  Would the broker demand that the client post more margin?  Or would the broker be sympathetic if the client explained how the company had poor prospects and that the client intended to hold the short position until the company’s share price reflected the truth?

Mark to Market

The guiding principle of accounting is that it must paint an accurate and conservative picture of the current state of one’s finances.  It is not the consideration of the accountant that things may improve.  If things improve, then in the future the financial statement will look better!  In the meantime, the standard in accounting (notwithstanding the outrageous FASB decision in 2009 to suspend “mark to market”) is to mark assets at the lower of: (A) the original acquisition price, or (B) the current market price.


There ought to be a corresponding rule for liabilities: mark liabilities at the higher of (A) original sale price, or (B) current market price.  Unfortunately, the field of accounting developed its principles in an era where a fall in the rate of interest from 16% to 1.6% would have been inconceivable.  And so today, liabilities are not marked up as the rate of interest falls down.


Refusing to put ink on paper does not change the reality, however.  Closing one’s eyes does not prevent one from falling into a pit on the path in front of one’s feet.  The capital loss is very real, as we will explore further below.

Two Borrowers, Same Amount

Let’s look at two hypothetical companies in the same industry, pencil manufacturing.  Smithwick Pen sells a 20-year $10M bond at 8% interest.  It uses the proceeds to buy pencil-manufacturing equipment.  To fully amortize the $10M over 20 years, Smithwick must pay $83,644 per month.


The rate of interest now falls to half its previous rate.  Barnaby Crayon sells a 20-year $10M bond at 4%.  Barnaby buys the same equipment as Smithwick and becomes Smithwick’s competitor.  Barnaby pays $60,598 per month to amortize the same $10M debt.  Is it correct to say that both companies have identical balance sheets?  Obviously Barnaby will have a better income statement.  This is because it has a superior capital position, and this should be reflected on the balance sheets.  It certainly is not because of its superior product, management, or marketing.


Let’s look at this from the perspective of the capital position: the present value of a stream of payments.  Obviously, at 4% interest the monthly payment of $60,598 has a present value of $10M (otherwise we made a mistake in the math somewhere).  But what is the value of an $83,644 monthly payment at the new, lower rate of 4%?  It is $13.8M.  Smithwick’s has just experienced the erosion of $3.8M of capital!  This is reflected in reality, by the uncontroversial statement that it has a permanent competitive disadvantage compared to Barnaby.  Barnaby can undercut Smithwick and set prices wherever it wishes.  Smithwick is helpless.  Most likely, Barnaby will eke out a subsistence living, until the rate of interest falls further.  When Cromwell Writing Instruments borrows money at 2%, then Smithwick will be put out of its misery.  And Barnaby will be forced into the untenable position it had previously placed Smithwick.


It should be noted that the longer the bond maturity, the bigger this problem becomes.  For example, if this were a 30-year bond, then Smithwick would take a $5.4M hit to its capital if interest rates were 8% when it issued the bond and then fell to 4%.

Two Borrowers, Different Amounts

This is not the only way that a competitor can exploit the capital loss of a company who made the mistake of borrowing at a too-high interest rate.  Let’s look at the case of Poddy Hoddy Hotel and Casino.  Poddy sells a 20-year $100M bond at 8%, and has a monthly payment of $836K.  It builds a nice hotel and casino with bars, a restaurant, a pool, and a few jewelry stores.


A short while later, Xtreme Hotels sells a $138M bond at 4%, and has the same monthly payments.  The extra $38M goes into a second pool with a swim-up bar, another restaurant that is themed based on the Galapagos Islands, bigger and more opulent retail stores, and a spiral glass elevator to take guests up to their rooms while enjoying the breathtaking 270-degree views of the city.


Which hotel will consumers prefer?


The Poddy Hoddy Hotel may have been planned based on accurate market research that showed real demand for such a hotel in that location.  Unfortunately, the falling interest rate has undermined it.  Its investors will likely lose money.


The Xtreme Hotel, on the other hand, is probably a mal-investment.  It is likely a project for which there is no real demand.  But the falling interest rate gives a false signal to the entrepreneur to build it.  Of course, the Xtreme won’t be the one to experience Sudden Capital Death Syndrome first.  That fate will befall Poddy.  Xtreme’s turn will come later, at a lower interest rate.


With Smithwick, one might argue that it can pay off its bond in the 20 years it originally expected, so it has not experienced a loss.  But in fact, there is a loss even from this angle.  Smithwick is paying off its 8% bond at $83,644 per month.  But the rate of interest is now 4%, which should be a payment of $60,598.  The accurate way to look at this is that Smithwick is paying off a market-rate bond plus a penalty of $23,046 for every month remaining before the bond is fully amortized.


With Poddy Hoddy, one might similarly argue that it can pay off its bond as planned, so it has not taken a loss.  But the loss here is even clearer.  By borrowing $100M at a rate that was too high, it has effectively dissipated the extra $38M that its competitor, Xtreme, put to good use.  It will pay for this waste every month for 20 years (or until it goes bankrupt).


By not marking the losses at Smithwick and Poddy, the accountants are not doing these companies or their investors any favors.  In the short run, these companies may declare “profits” and based on that pay dividends to investors and bonuses to management.  But sooner or later, they will meet Barnaby and Xtreme who will deal the coup de grace of Sudden Capital Death Syndrome.

Net Present Value

As alluded above, one can calculate the Net Present Value (NPV) of a stream of payments.  First, let’s look at the formula to calculate the present value of a single payment is:

It should be obvious that the present value of a payment is lower the farther into the future it is to be made.  One does not value a payment due in 2042 the same as a payment to be made next year.  What is not so glaring is that the value is lower for higher rates of interest.  A $1000 payment due next year is worth $909 if the rate of interest is 10%, but $990 at 1%.  This difference is amplified due to compounding.  At 10 years, the payment is worth $385 at 10% versus $905 at 1%.


The NPV of a stream of payments is the sum of the value of each payment.  The value of a $1000 payment made annually for 20 years is $9818 at 8% interest.  That same payment at 4% has an NPV of $13,590, a 38% increase.


It is important to emphasize that while the bond issuer’s monthly payment is fixed based on the amount of capital raised and the interest rate at the time, the NPV of its liability must be calculated at the current rate of interest.  The market (and the universe) does not know nor care what bond issuer’s entry point was.  Objectively, all streams of payments of $1000 per month have the same value at a given maturity and current interest rate, regardless of the original rate.

Capitalizing an Income

Let’s look at this from yet another angle.  An income can be capitalized, and the purpose of capital is to produce an income.  Professor Antal Fekete wrote[3]:


“Suppose you are a worker taking home $50,000 a year in wages. When your income-flow is capitalized at the current rate of interest of, say, 5 percent, you arrive at the figure of $1,000,000. The sum of one million dollars or its equivalent in physical capital must exist somewhere, in some form, the yield of which will continue paying your wages. Capital has been accumulated and turned into plant and equipment to support you at work. Part of your employer’s capital is the wage fund that backs your employment. Assuming, of course, that no one is allowed to tamper with the rate of interest.” [Emphasis in the original]


“Suppose for the sake of argument that the rate of interest is cut in half to 2½ percent. Nothing could be clearer than the fact that the $1,000,000 wage fund is no longer adequate to support your payroll, as its annual yield has been reduced to $25,000. This can be described by saying that every time the rate of interest is cut by half, capital is being destroyed, wiping out half of the wage fund. Unless compensation is made by adding more capital, your employment is no longer supported by a full slate of capital as before. Since productivity is nothing but the result of combining labor and capital, the productivity of your job has been impaired. You are in danger of being laid off ? or forced to take a wage cut of $25,000.”


Without capital, human productivity is barely enough to produce a subsistence living.  Without tools, one is obliged to work long hours at back-breaking tasks in order to have a meager meal, some sort of clothing, and something to keep the rain off one’s head.  Capital destruction is the process of moving backwards towards a time where one worked harder to obtain less.


As described earlier, when the rate of interest falls, it erodes the capital of every bond issuer.  If one looks at this capital as being the wage fund (or part of it is the wage fund), then the bond issuer can no longer afford to pay its employees the same wage.  If it does continue the same wage anyway, it will eventually suffer the consequences of running out of capital.

Amortization of Plant

Now let’s consider the concept of amortizing equipment and plant at Smithwick Pen.  Smithwick borrows $10M to buy equipment.  Out of its revenues, it must set aside something to amortize this over the useful life of the equipment, which is 20 years in our example.  This set-aside reduces net income; it is not profit but capital maintenance assuming the company intends to remain in business after the current generation of equipment and plant wears out.


How much should it set aside every month?  This is the inverse of the NPV calculation.  We are now interested in the current monthly payment to arrive at a fixed sum at a future point in time (as opposed to the present value of a stream of fixed payments).  The lower the rate of interest, the more Smithwick must set aside every month in order to reach the goal by the deadline.  To understand this, just look at what Smithwick must do.  Each month, it puts some money into an interest-bearing account or bond.  Even if it chooses the longest possible maturity for each payment (i.e. the first payment is put into a 20-year bond, the next into a 19-year 11-month bond, etc.) it is clear that if interest rates are falling then each payment must increase to compensate.  Smithwick’s profits are falling with the rate of interest!


If Smithwick persists in setting aside every month what it initially calculated when it purchased the pencil-making equipment, it will have a shortfall at the end, when it needs to replace the equipment.

Real Meaning of an Interest Rate

Let’s consider what it really means to have a high or a low rate of interest.  I propose to do reductio ad absurdum.  We will look at two cases (which would be pathological if they occurred) to make the point clearer.


The first case is if the rate of interest is 100%.  This means that a $1000 payment one year from today is worth ½ of the nominal value, or $500 today.  A payment due in two years is worth $250 today, etc.  At this rate of interest, for whatever reason, “future money” is worth very little present money.  In other words, the burden experienced by the debtor is a small fraction of the nominal value of the debt.


The second case is if the rate of interest is zero.  This means that a $1000 payment due one year from today or 100 years from today is worth $1000 today.  At this rate of interest, for whatever reason, future money is worth every penny of its nominal value today.  There is no discount at all, not for the loss of use of the money in the meantime, not for the risk, not for currency debasement.  In other words, the burden experienced by the debtor is the full nominal value of the debt.


Again, to emphasize, one must use the current market rate of interest not the rate of interest contracted by the borrower at the time of the bond issuance.


The lower the rate of interest, the more highly one values a future payment.  The higher the rate of interest, the more highly one discounts a future payment.  These statements are true whether one is the payer or the payee.  The payer and payee are just parties on opposite sides of the same trade.


Irving Fisher, writing about falling prices (I shall address the connection between falling prices and falling interest rates in a forthcoming paper) proposed a paradox[4]:


“The more the debtors pay, the more they owe.”


Debtors slowly pay down their debts and reduce the principle owed.  This would reduce the NPV of their debts in a normal environment.  But in a falling-interest-rate environment, the NPV of outstanding debt is rising due to the falling interest rate at a pace much faster than it is falling due to debtors’ payments.  The debtors are on a treadmill and they are going backwards at an accelerating rate.


How apropos is Fisher’s eloquent sentence summarizing the problem!


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Fri, 07/20/2012 - 20:11 | 2638075 knukles
knukles's picture

Irving Fisher, The Rate of Interest, 1907, McMillan Co.

Fri, 07/20/2012 - 23:12 | 2638295 AldousHuxley
AldousHuxley's picture

10 Year Treasury Constant Maturity Rate Graph


1950: 2.5%

1960: 5%

1970: 7.5%

1983: 15%

1990: 7.5%

2000: 5%

2010: 2.5%


Game Over!

Fri, 07/20/2012 - 23:32 | 2638314 The Monkey
The Monkey's picture

You forgot 2012 (1.5%), and I should mention the 10 year JGB is @ something like 0.75%.

Sat, 07/21/2012 - 01:56 | 2638423 derek_vineyard
derek_vineyard's picture

TIPS have negative yield up to 20 year maturities.

Sat, 07/21/2012 - 09:27 | 2638613 disabledvet
disabledvet's picture

absolutely...which is why this is "full retard math" presented in this article..."WITHOUT EVIDENCE." the people who write this crap should have their balls ripped a financial sense of the term of course. the fact of the matter is capital investment in NON FINANCIAL REAL GOODS has been surging for over a decade. So some stinking cocktard is bitching because the REAL RETURN IS ON THE LOWER PRICE OF A GOOD (natural gas, solar panels, cloud computing) just says to me BUY YOU'RE PHUCKING DEBT OF PHUCKTARD TOWN...i don't care...AND NEITHER DO THE NUMBERS. "It's your money to lose." it is simply not the responsibility of the American people to pay the price for folks who know nothing but how to pay too much for EVERYTHING..."because we use debt and MASSIVE AMOUNTS OF LEVERAGE to do everything in our puny and now defunct existence." IS the responsibility of the American people to AVOID AND POINT OUT SUCH BEHAVIOR AS WRONG at every turn possible. Let the government claim "we are not responsible for the bankruptcy of the State of California." All the American people need do is make sure they don't live there...that's all. How odd that a sight devoted to the intrinsic value of gold would spew such trash.

Sat, 07/21/2012 - 09:59 | 2638636 NotApplicable
NotApplicable's picture

Wouldn't it have been easier to simply state "I don't understand why loans have a pre-payment penalty!"?

Sat, 07/21/2012 - 09:43 | 2638619 Hmm...
Hmm...'s picture

It seems to me that the author has been fooled by a confounding variable.

it is true that over time interest rates have fallen, and also that during that time one can argue that capital has been destroyed.  (one could also argue that fictious capital that never really existed is being destroyed, but I digress. 

However, one (falling interest rates) does not cause the other (capital destruction).

The real problem is that exponential debt creation cannot continue forever.  A bond is obviously a debt instrument. Any debt created with a positive interest rate requires MORE money in the future for that debt to be satisisfied.  For instance, $100 in debt with a 10% interest rate requires $10 dollars to be created within one year.

Over time as more and more debt instruments are created (including the Federal Reserve Note which is a DEBT instrument), you have more and more liabilities.  Thus, you "need" more money creation in order to pay off these ever increasing liabilities.  If new money is not created then you will have default (i.e. capital destruction).

The Central bank will of course oblige, creating hordes of money.  It's what they do.
But then this newly created money gets recycled back into the debt market.  Increased money available to purchase debt leads to higher bond prices, which leads to a lower bond yield.  The falling Fed Funds rate then FOLLOWS (not leads) the private market.  Look at what happened in 2007-2008... the Fed Funds Rate was far behind what "the market" was showing for some time.  Similarly, 2003-2005 the Fed Funds Rate was behind where the market was.

Perhaps more simply put, creation of debt is what leads to capital destruction... the falling interest rates are a side show. 

On a side note, the biggest problem BY FAR is not the Fed "printing", at least not directly.  The biggest problem is Fractional Reserve Banking which allows the banks to create $10 in debt for every $1 of "printed" money.

The Fed "printing" is a major issue.  but the banks converting every $1 into $10 (or $30, or $100) of debt is a much larger problem.  The Fed is still to blame, because Fractional Reserve banking would not be AS EFFECTIVE without the Fed.

My last point is something that I believe many Fed haters miss.  Yes, we should end the Fed.  But it will not stop boom/busts and depressions (we had MANY US depressions prior to Fed Creation).  What is more important is to ban Fractional reserve lending.  THEN end the fed.


Sat, 07/21/2012 - 10:06 | 2638639 NotApplicable
NotApplicable's picture

I think you're getting hung up on the word "destruction". Capital is destroyed in the sense of being removed from a profitable environment to a sub-marginal one, where income can no longer be generated at a pace to justify the investment. Now, some capital may be able to be sold but certainly not all of it. So it sits in an underutilized state while it decays further.

Sat, 07/21/2012 - 10:53 | 2638706 Oracle of Kypseli
Oracle of Kypseli's picture

It looks very similar to a home buyer, when falling home prices require that additional equity is needed to refinance from 8% to 4%, thus drowning the owner.

Sat, 07/21/2012 - 11:01 | 2638736 rwe2late
rwe2late's picture


there is one solution the banks really hate

... some local governments are considering using "eminent domain" to seize underwater properties at "market value" (and then resell them to the occupants).

Sat, 07/21/2012 - 19:57 | 2639018 Doña K
Doña K's picture

So then, you say when a 300K house which is now $150k as a rough example;

mortgage is say: 250K@8%/360M=$1,834 will go to

$150k@3.53%/360M=$676  (a bit more than 1/3)

That amount is less than rent or equivalent and doable. Thus, the community does not get devasted and the homeowner has now incentive to stay. But...the mortgage bond value is now zero. (For practical purposes the loosers for each particular property are unidentifiable.)

This is a case where a loophole design to favor big business, is turned arround. Brilliand. We need more brave municipalities. 

Sat, 07/21/2012 - 11:38 | 2638812 Hmm...
Hmm...'s picture

I think you're getting hung up on the word "destruction".


I agree with you.  I just think that it should be noted that a lot of the capital being destroyed never really existed.  It was phantom wealth created by fractional reserve lending and limitless creation of debt.

Sat, 07/21/2012 - 10:48 | 2638689 Popo
Popo's picture

"  The falling Fed Funds rate then FOLLOWS (not leads) the private market.  Look at what happened in 2007-2008... the Fed Funds Rate was far behind what "the market" was showing for some time.  Similarly, 2003-2005 the Fed Funds Rate was behind where the market was.

Perhaps more simply put, creation of debt is what leads to capital destruction... the falling interest rates are a side show. "


Gold star for you!  (And a +1) 

Fri, 07/20/2012 - 20:21 | 2638089 reader2010
reader2010's picture

Everyone needs income, and nobody's getting that from deposits nor from gold.  The message is that you need to "invest", which means to be robbed by the Wall Street. 

Fri, 07/20/2012 - 20:30 | 2638097 fonzannoon
fonzannoon's picture

Everybody does not need income from their investments. If you are getting total return that is just as well, Ask anyone who owns bonds. It ain't for income at present. People flipping condo's in Miami in 2004 were not looking for income.

What is plain as day to see is that Zirp followed by Nirp is going to crush the insurance companies and a lot of banks too. It creates a breaking point.

Fri, 07/20/2012 - 20:39 | 2638111 reader2010
reader2010's picture

If nobody's looking for investment income,  you end up with the fools that buying Nasdaq in 1999 and buying RE in 2006 because they firmly believed the Total Retard shit, such as the Total Return.

Fri, 07/20/2012 - 20:40 | 2638115 fonzannoon
fonzannoon's picture


Fri, 07/20/2012 - 23:28 | 2638309 AldousHuxley
AldousHuxley's picture

Nasdaq crash was only bad for long greedy.

smart hedgies made tons of money going short.


ride up the gains then turnaround and short till 0.


don't be greedy, then you will be ok.

Sat, 07/21/2012 - 09:46 | 2638621 disabledvet
disabledvet's picture

REALLY???? "Now you're a market timer"? From whence comes this "extraordinary wisdom"? Let me answer that: "because wisdom it ain't." Bulls and bears make money moron..."not Mr. Smarty Pants." Indeed "look at the devastation wrought on the ENTIRETY of Wall Street because of the WONDROUS Big Short." Ah, if "only we were so smart." Rouseau had it right...all the start of the Arts and Sciences has done for man is create more effective ways at destroying everything.

Sat, 07/21/2012 - 10:39 | 2638671 aerojet
aerojet's picture

I wasn't paying attention during the Nas crash in the early 2000s, but it seems to me that the HFT algos of today will eat you alive if you try to short.  They have the ability to blow out your stops and force you to sell at a loss.  Bottom line, anyone small trying to short gets skullfucked.

Sat, 07/21/2012 - 13:50 | 2639023 Doña K
Doña K's picture

True, But you can buy long dated puts and wait.

Fri, 07/20/2012 - 20:42 | 2638119 FieldingMellish
FieldingMellish's picture

Or buying zero or even negative rate bonds in 2012.

Fri, 07/20/2012 - 21:40 | 2638202 I should be working
I should be working's picture

I wonder what the price of gold will be if bonds have a negative nominal return?

Fri, 07/20/2012 - 21:54 | 2638219 FieldingMellish
FieldingMellish's picture

We may be about to find out with Swiss and German 2yr already exchanging signs. I suspect this might spill over to the US and maybe even creep up the curve. The results could be quite dramatic.

Sat, 07/21/2012 - 00:09 | 2638347 The Monkey
The Monkey's picture

The changes in the yield curves are quite menacing. 30 year rates have gone beyond what I can comfortably hold, but I have this feeling they will sink a lot more.

Fri, 07/20/2012 - 23:18 | 2638298 andrewp111
andrewp111's picture

To the Moon and beyond!

Fri, 07/20/2012 - 23:38 | 2638322 The Monkey
The Monkey's picture

From what I've read (gold miners), all else being equal, gold performs well in environments with falling real interrest rates, and poorly when real interest rates are rising. I don't know that the nominal rate matters.

Fri, 07/20/2012 - 23:57 | 2638336 FieldingMellish
FieldingMellish's picture

Correct. Nominal rates are more or less meaningless when it comes to gold.

Sat, 07/21/2012 - 06:16 | 2638526 mrdenis
mrdenis's picture

How crushed will pensions get? 

Sat, 07/21/2012 - 06:57 | 2638553 Nachdenken
Nachdenken's picture

Pensions is a generalisation. Returns on pension portfolios are drying up, a great many are netting out time based returns .  All long term investment calculations need to be very modest, risk on,on.

Sat, 07/21/2012 - 09:48 | 2638625 disabledvet
disabledvet's picture

wonderful dialogue. Socrates is smiling.

Sat, 07/21/2012 - 11:11 | 2638755 FieldingMellish
FieldingMellish's picture

You are 65 years old. Your financial advisor says its time to turn your retirement fund into an annuity (or a bond ladder if you'd rather). Your fund, now severely depleted, buys very much less than you had planned it to. Oh well, you say, I will just have to tighten my belt. Problem. The yield of your annuity (or your bond ladder) follows long term interest rates which are now record lows. Not only has your capital been crushed but now the yields are too. Tighten that belt further. Now... inflation returns but you are stuck in a (much smaller) fixed yield annuity at crushingly low (or negative) real rates. As inflation increases you find you have to tighten that belt harder and harder until eventually you need to rely on income assistance from a gov't that is already DEEPLY in debt. Result for the boomers: print, print, print and pain, pain, pain. BTW, the peak of the boom was 1961 so still 14 years to go until they start retiring. I would hope they plan accordingly.

Sat, 07/21/2012 - 14:08 | 2639036 Doña K
Doña K's picture

If you retire and have limited savings/investments. Pick up and go to Indonesia, Thailand, South America and other countries where you only need $2k/month to have decent life and fun at the same time. Added bonus, you can never be cold.

The fear though of many, is that the gov. may start requiring that you live in the US in order to collect SS payments. In that case you set up a direct deposit and have a US address of record, but live overseas. If you were in the Phillipines for example you may setup an address in Guam or Northern Marianas which are US territories and visit there every so often. (2hr flight from Manila)

Same with Central American countries if you need to visit the 48 states instead.

Yes! Plan ahead

Sat, 07/21/2012 - 10:42 | 2638676 aerojet
aerojet's picture

Unless gold, too, is in a bubble, which it is.  I suspect that when all the malinvestment comes home to roost, the liquidity holding up gold will have to sell to cover other losses, taking metals (and all commodities) down with it.  There are no safe havens.

Sat, 07/21/2012 - 11:18 | 2638763 FieldingMellish
FieldingMellish's picture

Given the small fraction of portfolios that hold gold, I would not classify it as a bubble just yet. Maybe when you start seeing gold-for-cash commercials on TV.

Sat, 07/21/2012 - 11:16 | 2638764 Citxmech
Citxmech's picture

If this is true I'm going to end up with a lot of gold. . .

Fri, 07/20/2012 - 21:35 | 2638194 Manthong
Manthong's picture

It might be a lot simpler than folks are making it out to be.

Something like $5 Trillion sits in deposit accounts that lose money every month to inflation.

A lot of people are going to figure out that a mattress is safer than a deposit account that is backed by nothing, pays nothing, is insured by nothing and is threatened with investment risk and state capital controls.. and they will all figure it out at the same time.

You will see more than a little destruction then.

Sat, 07/21/2012 - 07:01 | 2638554 Nachdenken
Nachdenken's picture

There is the other side to the book entry.  Deposits are lent out or invested, and those returns balance out losses and then some.  Which is the value added, on the other side of the equation.

Sat, 07/21/2012 - 09:50 | 2638628 disabledvet
disabledvet's picture

meaning "the equity market." If i get the oil out of the ground and create a useful product with it...have I done "God's work" then? (not saying I'm Godly by saying this btw...

Sat, 07/21/2012 - 10:43 | 2638680 aerojet
aerojet's picture

There is not enough return, though, because growth has stopped and we are in reversal.

Fri, 07/20/2012 - 21:36 | 2638196 cynicalskeptic
cynicalskeptic's picture

When 'income' is less than the losses due to inflation, you're still losing out.  And even 'growth' can be meaningless under some circumstances.  The Zimbabwe Stock Market was the best performing in the world as far as growth in value went - but values still lagged the rate of inflation.

Sometimes the mere preservation of value - maintaining the purchasing power of your savings i s the best you can hope for.

Fri, 07/20/2012 - 23:57 | 2638337 The Monkey
The Monkey's picture

Monetary policy has a limit. Whereas in Zimbabwe, money was literally printed and handed out, the Fed has no way to directly put money in the hands of consumers. If they inflate the money supply and weaken the dollar, commodities spike (circa 2008), causing a crunch in real income and earnings. Limited benefit when you're already close to a top.

I think they get a lot more bang for their buck if they allow the market to correct a bit and can more appropriately size policy and get more benefit. Reserve the printing for the situation it's really needed. But, who knows. It's an election year and we are talking about Helicopter Ben and his insane posse.

Lower rates via communicating a longer low rate period might support the market without resorting to printing. Wouldn't do anything for gold, but might squeeze another few basis points out of the 30 year.

Sat, 07/21/2012 - 09:52 | 2638631 disabledvet
disabledvet's picture

the Fed CAN do that..."but it is illegal." Which goes to prove "some forms illegality have more merit than other forms." Having said that "there is nothing to prevent the Fed from lending DIRECTLY to the People if need be" thus bypassing the State and Wall Street altogether.

Sat, 07/21/2012 - 10:38 | 2638669 LMAOLORI
LMAOLORI's picture


Ding, ding, ding we have a winner! Keep in mind if interest rates rise they also rise on govt. debt. and that might hinder obama's & the politicians insane spending. Global bankers are Fabian Socialists and it's all part of the plan to eventually destroy the dollar and capitalism. 

Sat, 07/21/2012 - 10:45 | 2638684 aerojet
aerojet's picture

None of them have any plan. 

Sat, 07/21/2012 - 12:31 | 2638913 Errol
Errol's picture

None of them have any plan other than to juice their bonus.  Talking about next year is sooo 19th century!

Fri, 07/20/2012 - 20:24 | 2638092 blunderdog
blunderdog's picture

Sounds like the final conclusion we must draw is that Central Bank manipulation of interest rates is the problem.  In a properly functioning financial system, every interest rate must be determined after measuring risk.

The Fed can't do that.

I think this point has been raised before.

Fri, 07/20/2012 - 20:33 | 2638103 AUD
AUD's picture

When the obligations of the central bank are irredeemable there is no other option than manipulation.

Fri, 07/20/2012 - 20:55 | 2638137 blunderdog
blunderdog's picture

Right, it's simple enough to understand.  But not so many folks really delve into distinguishing between capital and currency.

Sat, 07/21/2012 - 02:49 | 2638454 Harbanger
Harbanger's picture

Very simple really. I had one Grandma that never even went to school at all, but she knew about saving money for fixed capital and the currency it produced.

Sat, 07/21/2012 - 10:49 | 2638693 aerojet
aerojet's picture

She didn't know jack--it's just that in the past, either you worked and saved or you hit the wall and then died because there were no safety nets and people would just step over your corpse in the street and eventually someone might bury you or haul you off to be used as a medical cadaver.

Fri, 07/20/2012 - 22:58 | 2638275 centerline
centerline's picture

Cant boil it down much further than that explaination.  In the end, it is all faith based.  The greatest threat is the loss of said faith, which is inescapable.

Sat, 07/21/2012 - 02:36 | 2638447 AUD
AUD's picture

I prefer to call it a mania, a credit bubble, rather than faith based.

Fri, 07/20/2012 - 21:20 | 2638178 duo
duo's picture

As Jim Willie put it, we are in an anti-capitalist state.  Real goods and real factories are being liquidated and the funds put into 10yr treasuries yielding a negative interest rate.  Capital is being destroyed.  Do not confuse capital with money.

Sat, 07/21/2012 - 04:14 | 2638469 Harbanger
Harbanger's picture

Real goods, real factories and real capital are being liquidated and redistributed by the State. Capital is not being destroyed, it’s being robbed from weak hands.  This won't last, there will be a natural reset, success is not an accident.

Note: if you have the money now to buy an investment outright, how can you say no to a fixed interest rate loan in today's market.

Sat, 07/21/2012 - 05:13 | 2638502 Dr. Sandi
Dr. Sandi's picture

Capital IS being destroyed. Every time a production facility closes permanently, that capital is gone forever.

Production that is taken offline by a corporate cost cutting is the destruction of capital in favor of quick money.

In this scenario, capital dies and money appears in its place. Eventually, the money becomes worthless and there is no production brought online to replace that which was turned into scrap for cash.

Jim Willie is correct. Money is not capital. And a whole lot of us are going to find out what that means when the capital has been traded for paper markers that pretend to represent capital.

Look around at the many derelict factories and service centers in any city. THAT'S DESTROYED CAPITAL.

Sat, 07/21/2012 - 09:07 | 2638600 rwe2late
rwe2late's picture

regarding theoretical capital destruction,

one might also ponder:

human capital destruction inasmuch as economic theory regards humans as a form of "capital".

and environmental destruction inasmuch as say, a fishery represents a natural "production facility",

or the liquidation of other natural resources equates to a loss of natural inventory, if not capital.

Sat, 07/21/2012 - 10:33 | 2638663 mess nonster
mess nonster's picture

Have to agree. Shuttered factories, unused, rusting equipment, hordes of unemployed in the unemployment SSI waiting rooms and Food stamp lines, decaying infrastructure, the inability of most people to build or repair anything... it is all capital destruction.

It is capital destruction because how much capital would it take to rebuild all of this?

I appreciate the convoluted elegance of thsi article, but I can't buy it. It assumes there is no way to refinance. Humans arte clever, and wonlt stand by while their money is robbed, unless they are conned, whhich is doubtless happening.

I appreciate the article because it looks for underlying causes. There is a local radio station here. All it plays, in order of the amount of airtime, is public service announcements and classic rock. This is the future of state-run media. the snippets of entertainment can be tailored to taste- rock, hip-hop, country, etc, but the proaganda is all the same.

This station, if it had to rely on private advertisers, would have been bankrupt long ago in this depressed region. But the goomint steps in and it stays on the air.

The end-game of capital destruction looks like North Korea. Welcome to the future.

Sat, 07/21/2012 - 10:57 | 2638702 aerojet
aerojet's picture

That doesn't quite make sense.  A production facility is forced to close when there is no market for the goods it produces.  You can't just produce stuff nobody wants for very long (see: China).  So there's more to it than what you just said.

You're dead on with the radio station example.  The problem is far, far worse, though--every going concern right now has some kind of connection to the free money spigot. NASCAR has military sponsorship for many of the teams, attendance at races has collapsed.  I'm sure other pro sports are exactly the same.  The govt. is pulling out of that NASCAR deal pretty soon, though.  It won't be much of a race with a field of say 10 cars, and they will eventually just disappear. 

Construction is another place--all the road work done every summer.  Pure union handouts.

The government has been clever in concealing how it picks winners and losers, but it is all malinvestment of counterfeit capital and it is all going to end badly at some point.  We're the Soviet Union, we (they) just hid it better.

Sat, 07/21/2012 - 21:16 | 2639576 blunderdog
blunderdog's picture

I don't think obsolescence is quite the same as destruction, but clearly there's ongoing erosion.  This is true of almost everything.

The shuttered factory is just a building.  Buildings *can* be repurposed when asset valuations are somehow associated with "real" physical capacity or potential.  They cannot be repurposed when other unrelated legal entanglements prevent change in ownership.

Gotta love the dying industrial spaces in NYC.  There are gutted rotting structures in decent locations which have a negative financial value, often just because of taxes.  It would not be at all hard to change policy and put those buildings back in use.

Sat, 07/21/2012 - 09:56 | 2638632 disabledvet
disabledvet's picture

this is empirically false. what you should say is "some are, some aren't" and where "the some are." my advice: "look where the rodents are living well." Like this one:

Sat, 07/21/2012 - 14:19 | 2639039 Solon the Destroyer
Solon the Destroyer's picture

Sounds likethefinal conclusion we must draw is that Central Bank manipulation of interestratesis the problem. In a properly functioning financial system,every interest rate must be determined after measuring risk. The Fed can't do that. I think this point has been raised before.

The final conclusion is that under a gold standard interest rates are very stable. The interest rate risk described by the author does not exist. There is a more level playing field for all market participants over the course of time.

An irredeemable currency is inherently destabilizing because it requires bribing speculators to buying Treasury paper by steadily cutting rates and OMOs, or else the Ponzi cannot grow and it dies. But the central banking clowns don't see the capital destruction and deflation this survival tactic brings, thus guaranteeing the death of the Ponzi anyways.

Rates can be halved for a long time, but at some point the bribe will be too small for the accelerating devaluation and bond speculators will pile into precious metals (there are other ways the future could go, for example the lack of physical in the precious metal market might get exposed first, which would also bring down the Ponzi).

This was a very pro-Gold article.

Fri, 07/20/2012 - 20:34 | 2638104 mark mchugh
mark mchugh's picture

The point you were trying to make gets completely lost in the 60 paragraphs you felt compelled to write.

Fri, 07/20/2012 - 20:39 | 2638113 FieldingMellish
FieldingMellish's picture

Do people not read anymore? Only took me 10 minutes to glance through. (linked from JSMineSet). All things worth persuing take time, especially with today's ten second attention spans.

Fri, 07/20/2012 - 20:49 | 2638128 mark mchugh
mark mchugh's picture

Then please share your insights as to what point the author was making without regurgitating the title.  I suspect you haven't even the slightest clue what the key points of the discussion are.

Fri, 07/20/2012 - 20:49 | 2638133 FieldingMellish
FieldingMellish's picture

As rates fall, the NPV of the debt grows, making the debt burden greater and greater. Its simply the opposite side of the trade from a bond holder. As the value of the bond goes up (yields fall), the "shorter" or bond issuer, has to mark the bond as an ever growing loss.

Fri, 07/20/2012 - 21:11 | 2638140 mark mchugh
mark mchugh's picture

I apologize.  You summed up 60 paragraphs nicely in ONE.

What I'd like to read about is how rising rates have the reverse effect.  How big banks use their own poor creditworthiness to reduce the amount of debt they have outstanding.

How countries like Greece and Spain (and even the US) could get out of the hole they're in by inverting their own yield curves (operation "untwist").

Instead I got a bunch of self-indulgent key-slapping.

Fri, 07/20/2012 - 21:31 | 2638186 FieldingMellish
FieldingMellish's picture

No worries. It was kind of long winded but I don't think ZH is the intended audience. Like I said, I caught it linked off somewhere else. Yeah, when the ship turns around, bond holders will be holding a big bag of hurt, holding an "investment" that is returning more and more negative real returns (on their original capital) and whose value is falling if you want to sell.

Fri, 07/20/2012 - 23:25 | 2638305 andrewp111
andrewp111's picture

The graph shown in the article was woefully incomplete. Showing a timeframe of centuries would show nearly 40 years of rising interest rates, a double peak in 1981, and then a steady decline averaging 0.23%/yr. If the curve is (almost) symmetric, one should expect the reversal point to occur in the later part of this decade or the early part of the next. It is just the great credit cycle in action.


It would not surprise me if nominal long term rates are negative at the reversal point!!!

Fri, 07/20/2012 - 23:55 | 2638334 FieldingMellish
FieldingMellish's picture

That's highly possible (nominal negative long bond rates) but I don't feel that there is anything requiring it to be symmetrical and I also think that given the huge expansion of the money supply, when she turns it will be very quick. As people try to disassociate themselves with anything dollar related, be it currency or Treasuries, yields could rise sharply. It could be a case of a deep and sudden V where yields fall from 0.5% - 1% to negative 1% in a sudden market panic and then the real printing starts. This could be a bond blowoff top situation and things come crashing down hard and fast. Just a thought.

Sat, 07/21/2012 - 08:37 | 2638588 spinone
spinone's picture

As long as OPEC only takes dollars for oil, no worries.

Sat, 07/21/2012 - 10:45 | 2638685 FieldingMellish
FieldingMellish's picture

You mean like OPEC founding member The Republic of Iran?

One more point to consider. The world's only swing producer in size is The Kingdom (for how long?) of Saudi Arabia. Their economy runs a 5% inflation rate but their currency (and therefore interest rate) is pegged to the USD (3.75 to 1) and has been for 25 years. They need to maintain a 5% increase in the price of oil annually just to cover inflation. Imagine now if the USD suddenly collapses. I think even Saudi Arabia would no longer be able to control price.

Sat, 07/21/2012 - 08:01 | 2638573 Go Tribe
Go Tribe's picture

OK, help me out here. I get the interest rate relationship to NPV. But how does that explain how all the banks suddenly had no money at the Crash?

Sat, 07/21/2012 - 11:00 | 2638729 FieldingMellish
FieldingMellish's picture

They had the money but they would or could not lend it out. The other assets they held as collateral, particularly sub-prime mortgages, were (and still are) worthless although they were rated investment grade (and in some cases AA or AAA). As the value of their colateral fell, they needed to conserve the only thing not falling in value, cash. That is why FASB (Financial Accounting Standards Board) introduced more "leniency" in their accounting rules for mark-to-market (updated FAS 157) to basically redefine what it meant by market (only when things are "stable"). This was done, surprise, surprise, on March 16, 2009 just 7 days after the market bottomed (I wonder if a few of day boyz got wind of it early?). Accounting fraud added to the mix, particularly in Lehman's case.

Sat, 07/21/2012 - 07:18 | 2638559 SWRichmond
SWRichmond's picture

What I'd like to read about is how rising rates have the reverse effect.  How big banks use their own poor creditworthiness to reduce the amount of debt they have outstanding.

How countries like Greece and Spain (and even the US) could get out of the hole they're in by inverting their own yield curves (operation "untwist").

Nevertheless, capital destruction is a bad thing, no?  Since you seem to not be arguing the point, but merely attempting to make fun of the author for his effort to explain the problem to the less-financially-educated.

Also not discussed in the article is the impact of falling rates on consumer behaviour.  After all, is not the point of capitalism the production of consumer goods? And don't falling interest rates cause a change in consumer behaviour?  Isn't that in fact why the Fed tries to maintain the regime of falling rates forever?

RIsing rates can certainly be seen as causing a change in consumer behaviour.  They will cause consumers to borrow and spend less, and save more.  We might even make an attempt to say that savings aids the process of capital formation, replacing depleted capital.

I don't think anyone can argue the fact OF the deliberate policy of falling interest rates, and the fact that this deliberate policy causes capital destruction.  Capitalism, left to its own devices (one we call "price discovery"), can keep these forces in some kind of balance, or at least bring them rapidly back into balance when their balance is lost.  We can say "Price discovery crushes malinvestment." Market rates of interest are nothing more than prices.  When any agent tries to thwart price discovery, they are in fact destroying capitalism.  The Federal Reserve Bank of th United States is in fact the most anti-capitalist organization on the planet.

I don't think the author intended the article to be a master's thesis. 

Sat, 07/21/2012 - 07:50 | 2638570 Return2Sanity
Return2Sanity's picture

I thought about those questions too for a while. Since refinancing transfers losses from the borrower to the lender (if I loan you money for 30 years, but you pay it off early, I lose my expected income stream), doesn't it stands to reason that in a country where lenders and borrowers are equal in number, there should be a balance of power between the two to keep interest rates steady. However, in a country where borrowers outnumber lenders (perhaps many lenders are outside the country), a general preference for lowering rates will probably develop since it benefits borrowers who have the continuing ability to refinance and pass off their losses. The balance of trade issue comes to mind.

Sat, 07/21/2012 - 10:37 | 2638668 mess nonster
mess nonster's picture

I'll sum it up for you. Interest rates fall... you lose. Interest rates rise... you lose.

The borrower is the servant of the lender. It's that F**king simple.

Sat, 07/21/2012 - 00:20 | 2638356 The Monkey
The Monkey's picture

I have never thought of it that way. Only that rates are (theoretically) lower when debt is rolled over, if spreads are the same width. Interesting.

Fri, 07/20/2012 - 20:58 | 2638142 Return2Sanity
Return2Sanity's picture

When interest rates go down, the businesses that borrow last get a competitive advantage because their debt service costs are less than for previous borrowers. The previous borrowers have great trouble repaying their loans, so the debt overhang continually increases until all capital is used up.


Fri, 07/20/2012 - 21:16 | 2638174 mark mchugh
mark mchugh's picture

Fine.  But I thought the mechanics of debt slavery were pretty well understood around here.


Fri, 07/20/2012 - 21:55 | 2638216 ihedgemyhedges
ihedgemyhedges's picture

This article isn't about debt slavery per se, it's about how a centrally planned interest rate (economy) destroys that same planned economy over time..........

Fri, 07/20/2012 - 22:19 | 2638241 mark mchugh
mark mchugh's picture

Fair enough, but the end result is saddling people with debts they never agreed to, and worse, putting preserving that spiral ahead of everything else.

And for the record, I never said there wasn't any truth in the article.  I found the presentation unfiltered and agonizing. 

Sat, 07/21/2012 - 10:42 | 2638677 mess nonster
mess nonster's picture might have a future in literary criticism...

Sat, 07/21/2012 - 04:23 | 2638467 Poor Grogman
Poor Grogman's picture

The point could have been made that the market price of the earlier business is reduced compared to the later business, because the earlier business has older equipment that has not been replaced, whereas the more recent competitor has newer equipment and is thus a more desirable asset per-se.

If you take this point even further a new market entry would be better off to set up from scratch using all new facilities rather than buying the older business on the open market, thus creating still more overcapacity.

You could look at the US housing market and say that a late market entrant paying low interest within the last few years, has a huge advantage over an owner of only 5 or 6 years earlier. This situation is not exactly the same but it does have the same basic characteristics as what the article is trying to say, I think.

What the article did not mention however was that the earlier business has enjoyed a usefull income stream for much of the time up untill the competition arrived which is a useful end in itself and should not be discounted.

Edit   The article also doesnt mention the effect that decreasing interest rates have on nominal prices of said business, and just what this effect couold have on owners capital, if any?

Curiouser and Curiouser???

Sat, 07/21/2012 - 10:54 | 2638708 mess nonster
mess nonster's picture

More real world...

Manufacturer A has domestic plants and workers with older debt at higher interest.

Manufacturer B gets new debt at lower interest, sets up plant in dismal 3rd world shithole and pays its workers nothing plus a bonus of longer shackles to the machinery.

Manufacturer A is alarmed because WalMart is holding its feet to the fire and making it sell product at B's prices or lower.

So A goes quitely to Bain Capital, and asks for help from the Dark Lord.

Bain creates a fraudulent shell company based in the Cayman Islands, that buys A, and then sells derivatives on the sale. Bain colludes with LIBOR manipulating banks to get shadow refinancing to liquidate outstanding bonds and cornhole the bond-holders, who are your widowed grandma. then Bain sells off the factory and machinery of A to another Bain subsidiary at inflated prices, all of which is intended to make Bain look goooood and to generate froth for calculating bonuses for Bain and its henchmen at GS and crony hedge funds.

Someone tells a little birdie and the old A factory mysteriously burns down and Bain collects the insurance. A's original owners buy a condo in the Virgin Islands and quietly stay drunk to ward off any twinges of guilt they may feel for the whole affair.

I think this is... unsustainable.

Sat, 07/21/2012 - 11:09 | 2638750 aerojet
aerojet's picture

While somewhat tongue-in-cheek, I think you have hit on the complexity of the situation and why the original article is much too simplistic.  I'd be careful saying "fradulent" because most of what Bain did/does is technically legal.  It's just that it isn't really contributing to anything useful except adding confusion and sleight of hand to fix up a bad situation for someone--it's all about manipulating the system to create favorable outcomes for preferred entitities.  That's what the US Government is nowadays, and perhaps always was--a means for the few to lord over the many. 

All those Chinese stocks are like what you just described--a shell company in front of Chinese Communism.

Sun, 07/22/2012 - 12:18 | 2640333 dsg2003gt
dsg2003gt's picture

i was also thinking about something along these lines.

continuously lowering the interest rate provides the appearance of growth, as each company coming into the market subsequent to the previous market participant has increased cash flow (and better net income/eps) due to lower interest payments-regardless of if they are truly a "better" company.

Sat, 07/21/2012 - 11:36 | 2638808 GMadScientist
GMadScientist's picture

This article completely ignores the competitive advantages of being first to market, which may be worth the "$3.8M" and hassle of restructuring their remaining debtload (otherwise why did they borrow $10M while rates were high?!).

This smacks of the same stupid reaction that underwater "home-owners" have when someone moves in next door for 20% less than they paid. They act as if the new neighbor is "destroying their capital" instead of just admitting that they made a poor investment decision.

Sat, 07/21/2012 - 22:18 | 2639650 Poor Grogman
Poor Grogman's picture

The article is too simplistic, I wonder if the Author has ever run  a business?

The sole insight that the article seems to  make cannot exist in an isolated frame of reference,

Market conditions market share, customer loyalty, experience gained through longer period of operation and Q/C of the manufaturer/s and other competitive advantages must also be factored in in order to determine if interest rate exposure is even a variable worth considering at all.

Sat, 07/21/2012 - 01:42 | 2638408 CuriousPasserby
CuriousPasserby's picture

But don't smart bond issuers make their bonds callable? Making the whole article pointless.

I know the bonds I bought at 12% (1986) were all called in as soon as rates went down. Should have bought 30 year treasuries...

Sat, 07/21/2012 - 07:09 | 2638557 negative rates
negative rates's picture

No, only your bonds got called, the issuer still had to pay the orignal interest every 6 months for 10 years. You got scammed by believing your money manager and therefore then believed 30 treasuries would be better, for you.

Sat, 07/21/2012 - 10:31 | 2638660 CuriousPasserby
CuriousPasserby's picture

Huh? There were several companies, like Philadelphia Electric and they sent out a form letter saying which bonds were called and mine were on the list. They issued new bonds at the lower rate to pay mine off. There was no money manager. I bought then through a local broker and held them at home and dealt directly with the issuer. (Back when you received the physical paper bond.)

Fri, 07/20/2012 - 23:10 | 2638291 algol_dog
algol_dog's picture

Totally agree. This was an excellent article.

Sat, 07/21/2012 - 07:02 | 2638556 negative rates
negative rates's picture

The 60 paragraphs was a bit over the top especially considering the premise was flawed for no reason of its own.

The crisis occured for a number of reasons, one being a little known clause which forgave debts every 50 years and the US was on the list of nations to be forgiven. It was to have occured in Aug of 08 but shortly before that it was clear this cycle would be different and now cash has to be raised, or created or just plain helocoptered by then treasury Hank Paulson to reverse the non-forgiven situation. That in it's self sent the snow ball down the hill where it became larger and more sinnister. Just imagine what the future holds.

Sat, 07/21/2012 - 14:23 | 2639051 Solon the Destroyer
Solon the Destroyer's picture

The point he is trying to make requires demonstration, examples, reasoning. These things take words, sentences and paragraphs, believe it or not.

The liquidation value of debt (the PV of liabilities) is not an accepted concept. It needs to be well-reasoned.  The author has done a fine job.

Fri, 07/20/2012 - 20:42 | 2638120 Jim in MN
Jim in MN's picture



Korruption Kills Kapital.



Fri, 07/20/2012 - 20:58 | 2638139 tom
tom's picture

But the capital losses of borrowers will be limited to the extent they can refinance.

Fri, 07/20/2012 - 23:29 | 2638311 andrewp111
andrewp111's picture

True. If the bond issuer can call the bonds, then he can refinance them. Lesson: in a falling rate environment, always make sure the bonds you issue are callable.

Sat, 07/21/2012 - 01:16 | 2638399 unununium
unununium's picture

The esteemed article seems ignorant that bonds can be, and often are, callable.  I guess it detracted from the "insight" that issuing a bond is the same as being short that bond.

Fri, 07/20/2012 - 21:01 | 2638147 I am a Man I am...
I am a Man I am Forty's picture

Bear Stearns was leveraged 35 to 1 when the housing and stock market turned.  Kapoof.  This is the main reason Bear Stearns collapsed.

Sat, 07/21/2012 - 06:36 | 2638515 buzzsaw99
buzzsaw99's picture

+1 There is a point to be made there but the author flails around aimlessly and pointlessly without nailing it down. A bunch of greedbags tried to compensate for lower returns in the case of corporations, stagnant wages in the case of many individuals, with increased leverage. It finally bit them on the butt. Lower interest rates should be somewhat beneficial to asset prices but not so much the general economy in the long run when one has a huge trade deficit.

Sat, 07/21/2012 - 10:55 | 2638712 disabledvet
disabledvet's picture

Thank God Wall Street has learned from their mistakes. Lord know's they'll never over leverage ever again after the experience of 2008.

Fri, 07/20/2012 - 21:03 | 2638151 LawsofPhysics
LawsofPhysics's picture

Let me summarize all the bullshit above. There is a very real cost for creating capital, especially when nothing of real fucking value is created. Fuck the paper pushers already.

Fri, 07/20/2012 - 22:07 | 2638230 Never One Roach
Never One Roach's picture

ZIRP will kill off  more seniors then Alzheimers.

Fri, 07/20/2012 - 23:05 | 2638285 centerline
centerline's picture

Just wait for ZIRP's angry step-brother NIRP.  He really hates baby-boomers something awful.

Sat, 07/21/2012 - 07:24 | 2638563 GCT
GCT's picture

I may be looking at this wrong but I see ZIRP as a program not to help housing but to get savers that want a return to invest in the markets to try and get a return.  But instead they will lose their money.  This is criminal in my mind.  Never you make a valid point as most of the wealth is held by seniors.  I am one of those seniors and with the run up in stocks it is so tempting to invest there, but honestly I will not. 

We are being forced to either live the low interest rates and exhausting our savings or pull our savings and risk losing it all if the markets dive.  I am actually torn as I look at election years and see  the markets usually rocket on up.  This year it is not happening. 

Sat, 07/21/2012 - 09:27 | 2638612 rwe2late
rwe2late's picture

ZIRP also

1) avoids further unbalancing the federal budget by reducing nominal interest costs

2) increases the subsidy (tribute) foreign nations must pay to support the petrodollar

Sat, 07/21/2012 - 10:57 | 2638721 disabledvet
disabledvet's picture

actually "this year it is." But your point is well taken. ZIRP has nothing to do with "helping savers." This is about helping BANKS. And it appears to have FAILED.

Sat, 07/21/2012 - 11:42 | 2638824 GMadScientist
GMadScientist's picture

You sound like a hooker with a lifetime of regrets.


Fri, 07/20/2012 - 23:03 | 2638282 centerline
centerline's picture

The principle creation of capital is savings... which is the denial of prosperity (e.g. is risk).  Not money conjured out of thin air at manipulated (limited) risk.  +1 for the fuck the paper pushers statement.  I agree in full.  The era of these assholes is overdue to come to an end.  The pain they have caused and will continue to cause is going to be severe.

Sat, 07/21/2012 - 07:01 | 2638555 i-dog
i-dog's picture

Unfortunately, while that era of paperpushers is [nearly] over, the new era that is about to replace it comprises only paperpushers.

There will be no private capital or banking in the NWO. Just a Politburo with a very large computer (maybe even that new one in Utah!) allocating single world slectronic currency 'credits' to compliant citizens and 'Agenda 21' projects.

Sat, 07/21/2012 - 11:00 | 2638732 disabledvet
disabledvet's picture

heh, heh, heh, heh, heh. "that's a good one!" capital creation comes from LEVERAGE not savings. "Watch me blow up Wall Street" and you'll understand. "After that...I'M RUNNING FOR OFFICE!"

Fri, 07/20/2012 - 21:12 | 2638164 The Swedish Chef
The Swedish Chef's picture

This would have been crucial information or thinking if it had been delivered ten years ago. Now we have arraived at NIRP country and thus the capital destruction through falling interest rates has ended. Now all we have is currency debasement and that Gogol guy that never comes...


An excellent read however and refreshing train of thought. We need more of this kind of writing.

Fri, 07/20/2012 - 21:12 | 2638166 Snakeeyes
Snakeeyes's picture

The zero bound is approaching. Many 2 yr sov rates already negative in terms of yields. Nothing working. House of cards.

Fri, 07/20/2012 - 23:33 | 2638317 andrewp111
andrewp111's picture

If rates are going negative, is zero really a bound at all? There is a high cost to paper currency in large amounts with IRS reporting and such. I am afraid that rates can go seriously negative.  And if paper currency is ever eliminated completely,, there will be no lower bound on interest rates. Interest rates will have a real range of +infinity to -infinity.

Sat, 07/21/2012 - 00:32 | 2638365 Return2Sanity
Return2Sanity's picture

Yes, I think zero is still the boundary for monetary policy to be effective. Lower interest rates will motivate borrowers to engage in economic activity in order to repay their loan if the loan has a positive interest rate. But if the interest rate is negative, why would you use the loan for economic activity? If you're being paid to borrow, no economic activity is required.

Sat, 07/21/2012 - 03:55 | 2638472 Zaydac
Zaydac's picture

You are right. We will never see NIRP for private and corporate debtors. NIRP will always be reserved for sovereign issuers whose principal purpose is often to administer transfer payments inefficiently.

Fri, 07/20/2012 - 21:35 | 2638195 vft2212
vft2212's picture

Last time I looked pencils & crayons were not the same.

Fri, 07/20/2012 - 21:49 | 2638211 gookempucky
gookempucky's picture

Had to green chef and snakeIIs --was a good read and truely reflects -the needs of the few outweigh the needs of the many.

Many are still lost as to how Merry go round the Bonds affects the world we try to live in today.

one mans lost wages is another mans lost wages. It is sero bound.

ZH has the sharpest knives on the planet--

Fri, 07/20/2012 - 22:27 | 2638248 gookempucky
gookempucky's picture

turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP.


reality bites as most folks seem to have just one dollar.

thanks for the link Bob

funny stuff

Fri, 07/20/2012 - 23:08 | 2638287 centerline
centerline's picture


One of my favorites.  Painting a ugly bear flag for years now.  (Yeah, TA is dead and it can't be applied to this sort of chart... blow me.  LOL.)

Fri, 07/20/2012 - 21:57 | 2638224 jimmyjames
jimmyjames's picture

But the deal hinged on the Fed taking on $29B of Bear’s liabilities, so the real enterprise value was closer to $-19B.

 Obviously, Bear’s reported “profit” was not real.  And neither was their “shareholder’s equity”.  I think it something much more serious than just a simple case of fraud.  Simple fraud could not explain why almost the entire banking industry ran out of capital at the same time, after years of reporting good earnings and paying dividends and bonuses to management.


When you're levered up in the CDO/SIV etc. markets at 40-1 like BS was-all hinging on a housing bubble (mortgages) for collateral-making insane profits-but when the collateral is contracting-the leverage is still 40-1 -

That's what killed BS


Sat, 07/21/2012 - 00:46 | 2638372 Return2Sanity
Return2Sanity's picture

His answer and yours are not so different. His point is that when interest rates are falling, businesses are forced into a kind of "arms race" where they have to borrow more and more and take more risks to avoid being crushed by the competition. Your point is that Bear borrowed a lot and took a lot of risks and it blew up on them.

Sat, 07/21/2012 - 01:50 | 2638414 jimmyjames
jimmyjames's picture

Your point is that Bear borrowed a lot and took a lot of risks and it blew up on them.


No my point wasn't about borrowing or falling interest rates-it was about holding a balance sheet full of levered up SIVS/Alt-A paper that was stamped AAA by rating agencies which turned out be nothing but sub-prime liar loans-worth zero when the mortgage markets went bust- interest rates had little to do with it-if anything-

Sat, 07/21/2012 - 10:31 | 2638661 Griffin
Griffin's picture

The tether that holds the finacial system together is made of  The sound of the Cat's foot fall, The beard of a woman, The roots of a Mountain, The sinews of a Bear, The breath of a Fish and the spittle of a Bird.

It took a month to forge this tether because those 6 impossible things were so hard to find.

This will hold as long as we believe it will.

Sat, 07/21/2012 - 11:06 | 2638745 disabledvet
disabledvet's picture

THE BAILOUT SURE DID THO! (You're point about the entirety of Wall Street being a FRAUD is well taken however. It also happens to be true. NOW LEVER UP THAT PEANUT PHUCKER! OR YOU'RE FIRED!)

Sat, 07/21/2012 - 19:28 | 2639429 jimmyjames
jimmyjames's picture



Except for BS- they were thrown to the squid-

Fri, 07/20/2012 - 22:29 | 2638250 A Cruel Accountant
A Cruel Accountant's picture

Pay off your DEBTS NOW!

Fri, 07/20/2012 - 23:11 | 2638294 centerline
centerline's picture

No dumbass.  Build funds to do this - but dont give the money to the banks while interest rates are shit.  The cost to carry is nil versus the risk.  Better to stay nimble and decide for yourself how to deploy funds... hopefully trying to stay just a day or two ahead of the curve (cough... reason for reading ZH... cough).

Sat, 07/21/2012 - 17:28 | 2639277 grid-b-gone
grid-b-gone's picture

No. Pay it off now and hold clear title before any panic or devaluation arrives.

Don't ignore or be a victim of money market and account rule changes that allow institutions to withhold your cash or freeze accounts to preserve their cashflow or reserve requirements, or to avoid cashing in longer-term instruments with a hefty early withdrawal penalty.

These rule changes gave money market managers more freedom to chase yield by buying into 3rd party reverse repo instruments tied to the whole mortgage-backed security mess. 

This is why some accounts gave you a higher-interest sweep option a couple years back. If that is where your "nimble" money is, it will probably be less nimble than you think under certain circumstances.

Anything you intend to own after the next crisis you should work toward owning outright before the next crisis.

Fri, 07/20/2012 - 22:59 | 2638276 proLiberty
proLiberty's picture

An economy is NOT SUSTAINABLE when the time value of money is suppressed to zero, and doubly so when it is suppressed by flooding the money supply with air-backed currency.


Fri, 07/20/2012 - 23:36 | 2638319 andrewp111
andrewp111's picture

What if the Government decrees that the rate of interest shall be zero forever?

Sat, 07/21/2012 - 01:02 | 2638390 Peter Pan
Peter Pan's picture

At under 1% with inflation at 2% plus we are already there and the question that investors might wake up and ask themselves is "why leave it in the bank?" Then let's see how the Ponzi system of fractional reserve banking copes.

Sat, 07/21/2012 - 11:04 | 2638743 mess nonster
mess nonster's picture

The Catholic Church tried this, and was successful for about 1000 years, except there was this small group of people who were exempt from the law. They loaned money at interest and this indebtedness eventually led to the Lombard Collapse of the late 15th century, unleashing the bubonic plague and the depopulation of Europe.

Somehow, capital must be created without regards to a risk premium (interest), or debt-destruction inevitably follows credit creation. But I think my time will be better spent if I devote my energies to the creation of a perpetual motion machine.

Sat, 07/21/2012 - 11:09 | 2638751 disabledvet
disabledvet's picture

well...we no longer have Salt Roads so we solved that problem. Shall i interest you in a direct drive solar powered aircraft and engine then?

Sat, 07/21/2012 - 01:07 | 2638394 Peter Pan
Peter Pan's picture

Agreed and we need to remember that zero per cent interest not only destroys capital but will also destroy even the CONCEPT of capital.

Fri, 07/20/2012 - 23:12 | 2638296 rbg81
rbg81's picture

The fact that interest rates are falling is no accident.  They will continue to fall because....they simply cannot be allowed to rise--period.  If they were to rise, the current rate of Government spending would quickly become unsustainable.  You see this happening to the PIIGS in Europe.  Liberal politicians have done their best to make the populace dependent.  Now that a majority are, rising interest rates would force entitlement cuts and/or hyperinflation, which would certainly lead to social unrest.  This is unaccepable, so rate will continue to go down.  This is a huge tax, but it has the advantage of being stealth and levied on those who won't riot.  The engame is that, eventually, the Government will make $$ on the deficit.

Sat, 07/21/2012 - 00:53 | 2638378 Peter Pan
Peter Pan's picture

I suspect that what they might do is halve all debts but double the interest rate. This will maintain the same cash flow for the lender but will aprroximately halve the repayment period for the borrower. This will destroy some of the debt but at a higher rate of interest we may see the value of capital re-asserting itself and we might see value investing rather than speculation.

Sat, 07/21/2012 - 11:15 | 2638762 disabledvet
disabledvet's picture

but the rates are going up...not down in Europe. "What happens if it doesn't work"?

Fri, 07/20/2012 - 23:27 | 2638308 proLiberty
proLiberty's picture

At a permanent interest rate of zero, nobody has the incentive to lend and a borrower has every incentive to amortize the loan in perpetuity. There would be no incentive to save in the form of money. Instead, the incentive would be to save wealth in forms that have intermediate use, like vehicle or antique furniture. But these would tend to lack liquidity.

Moreover, purchases that today are financed by long term debt could only be financed via some equity arrangement. This would tend to concentrate wealth in fewer and fewer hands.

Lastly, an interest rate on zero destroys the property right of the holder of money to be compensated for its actual time value.

Fri, 07/20/2012 - 23:40 | 2638323 andrewp111
andrewp111's picture

Forget permanent ZIRP. Think Permanent NIRP. A perpetual tax on money for savers and a perpetual depretiation in the value of a debt for the debtor, at least for those debtors that have floating rates.

Sat, 07/21/2012 - 00:57 | 2638384 Peter Pan
Peter Pan's picture

Agreed andrewp111. This is why it will be important to convert money into things that have value, whether it be gold, silver, well situated housing, whiskey etc.

Currencies will only be of use for transactional purposes and nothing more.

Sat, 07/21/2012 - 11:17 | 2638765 disabledvet
disabledvet's picture

Indeed. Now if we could only destroy the taxing power and VICTORY IS OURS!

Sat, 07/21/2012 - 00:48 | 2638373 Peter Pan
Peter Pan's picture

The problem with dirt cheap interest rates is that it made everyone a home owner, everyone a consumer on credit, everyone a business person, everyone an investor. And so for one brief period it was nirvana for both lenders and borrowers until we realised that this excess capacity destroyed margins, turnover and capital when the consumer could no longer borrow more to keep the pretence of the good life up which in turn used to feed all this excess capacity.

Sat, 07/21/2012 - 11:18 | 2638769 disabledvet
disabledvet's picture

don't pay your taxes. DESTROY THE PONZI NOW!

Sat, 07/21/2012 - 01:15 | 2638398 Peter Pan
Peter Pan's picture

"Constant properity through credit is no more possible than constant peace through heroin."

Dr Darryl Schoon

Sat, 07/21/2012 - 01:55 | 2638420 Jumbotron
Jumbotron's picture

"Constant properity through credit is no more possible than constant peace through heroin."

Dr Darryl Schoon

Wise man.

Sat, 07/21/2012 - 02:37 | 2638448 onebir
onebir's picture

This completely ignores the reason interest rates have been falling: to generate (/maintain) inflation. But the time rates have fallen substantially, the real value of the earlier issuers's debt has been eroded; later competitors have to issue a lot more debt to get the same equipment...

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