Economist types: Help me w/ high debt vs low interest rates

[darkstar]

I don't get it, but that's nothing new when it comes to economic matters. But how can the national debt, combined w/ the massive household debt, not have already put upward pressure on interest rates? I understand this isn't pure supply and demand and that the Fed sets rates, but doesn't increased demand generally increase costs, even for borrowing money?

And, if rates should have gone up by now but Greenspan et al are holding them artifically low, this must be to the detriment of something else, huh? If so, what might that be?

[Renew Deal]

1. You might want to also ask in the Economics forum

Those people are brilliant.

[myopic4141]

2. CMD

The nation's debt (better know as Credit Market Debt or CMD) hit 303.48% as a function of GDP (CMD/GDP) in 2002, up from 291.54% in 2001. CMD is the combined government, commercial, and corporate debt of the nation. Interest rates should be climbing, especially long term and they were until this year. Right now, the interest rates are being kept artificially low, supposedly to help stimulate the economy; but, it is not working as planned. Eventually, the pressure to raise rates is going to become unbearable and they will go up. When that will be is anyone's guess.

[darkstar]

4. Thanx for the response.

but I'm a bit more confused, I think. Hope you aren't sorry you responded....

Haven't rates come down across the past few years even as the debt has climbed? You spoke of "long term rates." That's distinct from the Fed determined .75 or whatever it is now?

Plus, do you see a downside to the artificially low rates?

Thanks again. Believe me, I ain't trying to quibble w/ you. Just confused.

:toast:

[myopic4141]

15. Downside of artificially low rates.

Unknown to many, when the Fed needs funds to cover deficit spending, it looks to the private sector as the source for the required funds. The interest rate during the final Clinton years was low because, the Clinton Administration was buying down the debt which did two things, namely: 1) Infused capital into the private sector and 2) Kept the Fed out of the private sector competition for funds. The Fed did not have to keep the interest rates artificially low because with the Fed out and infusing funds, there was sufficient fund availability to meet the needs of the remaining competitors. Right now, because of deficit spending, the Fed is part of the private sector competition to borrow funds. This increased the number of competitors and removed the infusion of funds. The Fed is the lendee of first choice, so it gets the funds it needs before anyone else which reduces the fund availability to the remaining competitors. Normally, this would increase borrowing costs because the number of competitors has increased and the available funds have decreased. The end result would be less borrowing; therefore, less debt increase. The CMD is a good indicator of the borrowing trend. Too get an idea of normal pressure, one only has to look at CMD to GDP change on a dollar to dollar basis. In 2000, CMD increase $1.31 for every $1.00 of GDP growth (this was the last year of the Clinton buy down). In 2001, the CMD increase dropped to $1.13 (last year of government surplus under a Clinton budget). In 2002, the CMD increase rose to $1.16 (first year of Bush deficit). The loss of funds created a precipitous drop in borrowing between 2000 and 2001 by reducing the fund availability and not yet entering the competition. The increase between 2001 and 2002 is a result of the Fed entering into the competition.
Now, on to how this is bad. Artificially keeping the rates low encourages borrowing when there should not be any. The hope is to keep an economy going during a down turn without too much debt being accumulated. For a short term and a low debt, this is not too bad of an idea; however, the debt is not low nor is the down turn period short. The already existing high debt means that there exists a high debt service which is going to get higher with the added borrowing. Debt service takes away from discretionary spending which slows economic growth. For example, a 5% debt service rate on the 2000 CMD would be 13.92% of GDP while the same debt service rate would be 14.58% in 2001 and 15.17% of GDP in 2002. The debt service cost rose by almost the same percentage in 2002 (.59%) as in 2001 (.66%) even though there was a decrease in the CMD increase rate in 2001 from 2000. The debt service for the 2000 to 2002 period (1.15%) is equivalent to the increase from 1997 (12.78% in 1997) to 2000 period (1.13%) which shows the increase of debt service costs is accelerating (2 years vs 3 years respectively).
Actually, a 5.13% long term on a Fed rate of .75 (I think it is actually lower now) is a large disparity in rates which indicates the upward pressure. The rates dropping under the current conditions is why the low is artificial rather than natural.
As a note of concern, the $1.31 increase in 2000 was not that good of a sign for it meant that commercial and private debt rose at a very high rate when government debt was dropping. At some point in time, the piper has to be paid.
I hope this is some help in understanding what is happening.

[unblock]

3. actually it IS just supply and demand

you pointed out that demand is high. well, yes and no. correct, household and federal debt are surging, but business borrowing hasn't been so hot. in sluggish economies, businesses retrench, consolidate and paydown debt. they don't borrow to expand.

now that business activity is (sort of) improving (oh yes, it IS improving, just not for the u.s. job market) business will be borrowing more, so demand should indeed start hitting on all cylinders.

the other side of the coin is supply ... supply has also been great. there is a ton of cash with no good place to invest. stocks suck, businesses haven't been expanding, so what to do with the cash? lend it to consumers! lend to the government! this supply has been keeping rates down.

incidently, when the fed 'sets' rates, it really just marks a number as its 'target'. then it goes into the market just like anyone else and buys or sells treasuries until the market moves the yield to where it wants. the fed acts like just another market player. it's just that the fed signals its intent and has deep enough pockets to really affect prices and yield. so if the fed says it wants rates to be one thing or another, people tend to get out of the way.

i point this out just to clarify that it all does comes back to supply and demand. at some point, not even the fed can fight the market, and eventually, they're smart enough not to try. if the market really wanted the rates to be, say, 5.0% instead of the current 1.0%, the fed would go broke trying to buy up all the treasuries everyone was dumping.

[darkstar]

6. Thanx

That helped my understanding of things, unblock. Appreciate your time and expertise.

:toast:

[unblock]

7. regarding today's rates,

as for today's rates, the market would like rates to be mildly higher, the fed is indeed weighing in to keep rates low.

once some actual inflation numbers come out (where ARE those ppi numbers?) the fed will have no choice but to raise rates a bit.

[kysrsoze]

5. I believe the only reason this is happening is b/c Japan and China

have been buying up all our debt to keep interests low, balance currencies and keep their biggest consumers buying their products. I don't expect it to last, so I finally locked in my mortgage at 5 1/8 yesterday and I'm NOT selling anytime in the foreseeable future. No new cars. Paid off all my debts. I'm cutting my credit cards. There will be a day of reckoning.

[darkstar]

8. Can you expand just a tad?

Whay are you so emphatically NOT selling your house? (I mean, in the economic context; not trying to pry into your personal life.)

And the day of reckoning. That's really what I'm trying to understand. What negative consequences do you forsee?

[kysrsoze]

10. Why am I not selling? Good question

It's because I have a nice place in a very nice neighborhood in Chicago which doesn't look to lose value unless there is a huge housing decline. Even so, the rate I'm getting is so ridiculously low that I'd be a fool to sell the place anytime soon. I previously cashed out to pay off my bills (hence no more credit cards), but still have a decent amount of equity in the place.

If I were to sell in the near future, the odds are that rates will have gone up and the market will have softened. This means less profit if I sell in the near-term, plus over the long run it's going to pay off big time (firm believer in long-term investment). My cost of ownership in the place is low compared to the long-term gain in price, so if anything I'd actually rent out the place if I get married again or whatever else happens. Plus, if I sell in the near future, moving into a bigger place will cost me much more at higher interest rates.

As for the day of reckoning, I do believe interest rates are going to go up in the next year or two. They've stayed so artifically low and there is little incentive for people to invest in something that doesn't give a return, such as mortgages and treasuries. This is going to impact business investment, housing prices and most certainly will have a huge impact on consumer spending.

Now, if I can just keep my job.....

[darkstar]

12. Thanks a bunch for

your lengthy, helpful responses. I've really leaned a lot in this brief thread.

Thanks again,


darkstar

:toast:

[kysrsoze]

13. No problem. Incidentally, unblock had a good point about....

currency crises if foreign central banks buy up too much of our debt. If they do too much, they will lose a huge amount of money when rates go up b/c their investment in our debt will be worth less compared to the going rate, potentially creating a debt crisis in their own country. They have been buying multiple billions of dollars worth of our debt each day to try and keep everything stable. It can't go on this way forever.

[unblock]

9. downside to artificially low rates

when rates are artificially low, that means treasuries prices are artificially high, so investors want to sell.

the fed makes this unattractive by basically saying, if you sell too much, i'll step in and buy until prices go back up. this means there's no profit in selling and there is safety in buying.

but this 'bluff' by the fed only working if people think the fed can and will back up their words with actual trades. so every once in a while, the market tests the fed. investors sell, and the fed buys, burning the sellers. no problem, except that now the fed has more securities and less cash. in the scheme of things, no big deal.

the problem comes in when that starts to happen a LOT, or if every day the fed has to buy a LOT of treasuries. then, after a while, the fed would have removed a ton of securities from the market and flooded the market with cash. you can see where that can cause problems.

other countries' equivalents of the fed regulate their own interest rates the same way, but of course none have the pockets and the clout of the u.s. fed. so those foreign central banks can be broken a lot easier. when this happens, there's usually a bailout and/or a currency crisis.

[darkstar]

11. Thanks very much

once again.

Are you an econ teacher? Even if not, you have a knack for explaining this complex subject.



Take care,

darkstar

:toast:

[unblock]

14. it's in the genes

my father's a professor of nuclear physics.