Fed Chairman Alan Greenspan has run out of excuses to postpone America’s day of reckoning with sharply higher interest rates.
His first excuse — back in the early 2000s — was the danger of deflation, prices falling out of control.
He looked across the Pacific Ocean and saw multi-year deflation in Japan. He looked over the Atlantic and saw incipient deflation in Europe.
So he was afraid the sparks would leap to U.S. shores, ignite deflation here, and drive our economy into a tailspin. In that environment, he figured the last thing we needed was higher interest rates.
Now, however, that fear is gone … and in its place, the monster of inflation is rearing its ugly head — from all seven seas.
Mr. Greenspan’s second, related excuse for not raising interest rates was low commodity prices. Crude oil was selling at less than half its peak prices. Gasoline at the pump cost one-half or even one-third what it cost in Europe or Japan. Steel, copper, and lumber were dirt cheap.
Now, that excuse has also been wiped away. Suddenly and without warning, Mr. Greenspan sees the cost of industrial materials and consumer goods going through the roof. (Details in last week’s “Martin on Monday.” Click here to review.)
Mr. Greenspan’s third and final rationale for not raising interest rates more quickly was lackluster job growth. But that excuse was zapped on Friday when the Labor Department announced that employment grew by 262,000 jobs last month, twice as many as in January and the biggest increase since last October.
This is why …
Greenspan’s Harsh Deficit Warning Last Week Is Really A Strident Interest-Rate Warning In Disguise
As long as Mr. Greenspan felt he had good excuses NOT to raise interest rates dramatically, he was mostly silent about the federal deficits … avoiding the issue like a plague … keeping his views mostly to himself … largely ignoring the proddings from us and others to speak out more openly.
In retrospect, it made sense. If he had admitted that deficits were so bad, how could he have justified keeping interest rates so low?
Now, however, that too is changing …
In his testimony last Wednesday, Mr. Greenspan warned that the federal budget deficits in this country are unsustainable.
He warned that the deficits could be driven sharply higher by Social Security and Medicare.
He urged Congress to tackle the problem NOW, rather than later.
According to the New York Times,
“The assessment was Mr. Greenspan’s gloomiest to date about the government’s budget straits. Unless Congress takes major action to reduce the deficits, preferably, he said, by deep cuts in spending, annual budgetary shortfalls will continue and closing those gaps will become even more difficult.”
Now, step back for a moment. Think about the critical choices Mr. Greenspan’s Federal Reserve will have to make about interest rates in the coming weeks. Then read the above paragraph again — this time, between the lines.
Listen carefully and you will hear — loud and clear — the not-so-subtle message that Mr. Greenspan is sending us:
Since the U.S. Congress has neither the will nor the power to take major action to reduce the deficits, the Federal Reserve has no choice but to act unilaterally.
In order to properly ration scarce financial resources, in order to make all borrowers — including the government — pay a fair price for money, and in order to prevent future chaos in our financial markets, the Fed has decided it must raise interest rates at a much faster pace.
This raises eight urgent questions for all American savers, borrowers, spenders, and investors:
1. When Will Interest Rates Start Rising?
They already are. The reason you probably have not noticed the rise is because, until now, it has been restricted to short-term interest rates. Long-term interest rates have been zigzagging sideways.
As a result, 30-year fixed-rate mortgages are still near their lowest levels in decades. The rates on ARMs and interest-only mortgages, despite some increases, are also still close to rock-bottom levels.
Reason: The Federal Reserve has, until now, been pursuing a policy of raising short-term interest rates very gradually — by just a meager quarter point at a time. So there has been no sense of alarm or urgency by lenders to charge more for long-term money.
Now, however, the Fed seems to be signaling that an acceleration is in the making.
2. When Will This Become More Evident?
The Fed’s Open Market Committee, which decides short-term interest rates, meets again on March 22, just two weeks from tomorrow.
I can’t guarantee that’s precisely when they will start raising rates more quickly. But if it’s not then, the pressure will be even greater at the following meeting, coming on May 3.
3. How High Can Interest Rates Go?
There’s no hard and fast ceiling, and any one who believes in ceilings is in for a rude awakening. Consider the facts …
Fact #1. Today’s interest-rate levels are similar to those we saw in the early 1960s.
Fact #2. In those days, inflation was under control, oil prices were locked at dirt-cheap levels, the dollar was strong and stable, the U.S. federal deficit was virtually non-existent, and the U.S. trade balance was in a surplus.
Fact #3. Today’s economic conditions — rising inflation, surging oil, a weak dollar, bulging federal deficits, and an out-of-control trade deficit — are similar (or worse!) than the conditions which corresponded to interest rates that were double or TRIPLE those of today.
This anomaly — extremely low interest rates in an environment that mandates high interest rates of a similar extreme — cannot last.
It’s a pressure cooker about to burst.
Once the Fed pulls the lid– by sending the signal that they’re raising rates more rapidly — you could see an interest-rate explosion that will shake Wall Street to its core.
My forecast: Later (or sooner!) short-term interest rates will triple. Long-term interest rates will double.
That means you could see 3-month T-bill rates at 6% and 30-year bond yields close to 9%.
Suppose these rises are delayed. Then what? Then, the subsequent rises will take rates to even higher levels.
4. What Happened The Last Time Rates Began A Historic Rise?
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These charts give you the answer …
In January 1961, the 3-month Treasury bill rate averaged 2.3%, a level very similar to where we are today; and for the following two decades, it continued to rise with only temporary interruptions.
Twenty years later, in May 1981, the 3-month Treasury bill rate averaged 16.3%, more than SEVEN times higher (chart 1).
Similarly, in January 1961, the yield on 20-year Treasury bonds was at 3.89%, not much lower than it is today.
About 20 years later, in September 1981, it averaged 14.14%, or over THREE times higher (chart 2).
And naturally, every time interest rates rose, bond prices fell, wreaking havoc with the portfolios of fixed-income investors.
As you can see from charts 3 and 4, the pattern was the same with municipal bonds and corporate bonds. All bonds were devastated — whether private or public, low-rated or high-rated, foreign or domestic.
Every single bond on the face of the planet declined in value — sometimes precipitously. There was no exception.
5. If All This Is So Obvious, Why Aren’t More People Warning Us About It?
During the entire interest-rate rise of the 1960s and ’70s, we also witnessed an interesting psychological phenomenon:
Every time interest rates reached a plateau, hesitated, or declined a bit, Wall Street’s interest-rate “experts” would declare, with near total unanimity, that “the end of the interest-rate rise is at hand.”
“Interest rates have peaked,” they’d say with a single voice.
“The interest-rate cycle is finally over,” they’d add with great conviction.
And every time, they were proven wrong as interest rates surged again to new, higher levels.
In that era, I can recall only three men who consistently warned about rising interest rates: Albert Wojnilower of First National City Bank, Henry Kaufman of Salomon Brothers, and my father, Irving Weiss.
According to the Economist,
“In his time as head of research at Salomon Brothers (later Salomon Incorporated), Henry Kaufman was known throughout the world’s financial markets as Doctor Doom or Doctor Gloom. His fellow-traveler, Albert Wojnilower, then chief economist at First Boston Corporation, was Doctor Death.”
The economist was not referring to their forecasts of the stock market’s direction. Rather, it was all about their warnings of rising interest rates and sinking bond prices.
Similarly, according to the Bond Buyer, Irving Weiss was also among the only ones on Wall Street to warn of the inevitably consequences of scarce cash and excessive debt — sharply higher interest rates.
6. What Distinguished These Three Men From Their Contemporaries?
Were they that much smarter?
Did they know that much more than everyone else?
Not really.
Certainly, it was widely known that rising inflation would almost definitely bring higher interest rates.
And undoubtedly, most people recognized a connection between the government’s growing appetite for debt and the need to pay a higher price for that debt.
So the critical difference between these three men and their peers could not have been either their superior intelligence or deeper knowledge.
It was their courage.
They were among the few who had the guts to announce — publicly and unambiguously — what should have been abundantly obvious to everyone.
Meanwhile, almost all Wall Street analysts, bankers, and even Fed officials recognized that higher interest rates would be a threat to their livelihood or their job. So they decided to do something that came easily to them in such circumstances:
They decided to shut up.
They were silent. They dared not rock the boat. They dared not forecast higher interest rates.
And today unfortunately, we are, in many respects, back to the same kind of environment.
Sure, most people recognize that interest rates are going higher. But they say the rise will be “very gradual” and, thus, “largely inconsequential.” No one of stature has stepped up to the plate to tell us, honestly and unabashedly, how far the interest-rate rise could go.
No one in the spotlight has had both the courage and the credibility to speak out and warn us about the INEVITABLE consequences of the OBVIOUS conditions we are confronting RIGHT NOW.
Alan Greenspan came as close as he could to such a warning last week. But due to who he is and where he sits, he dared not connect the dots for you — at least not at that particular point in time.
Today, my primary purpose in writing you is to do just that — to connect the dots. Let me repeat:
* Surging oil prices = Sharply higher interest rates
* Surging steel, coal, and other commodity prices = Sharply higher interest rates
* Bulging budget deficits = Sharply higher interest rates
* Weaker dollar = Sharply higher interest rates
* Stronger employment = Sharply higher interest rates
I see no other alternative.
7. What Are The Consequences Of Sharply Higher Interest Rates?
In recent months, I’ve told you repeatedly what the consequences are. But in case you missed it, let me summarize them for you again.
Sharply higher interest rates will kill the white-hot mortgage market, which, in turn, will kill the red-hot real estate market.
Sharply higher interest rates will devastate bond portfolios.
They will cause severe damage to bank stocks.
Sooner than later, they will drive most debt-heavy companies into a financial pinch.
Ultimately, the financial markets as we know them today could be turned inside out and upside down.
The only question remaining: After their initial rate hikes, will the Fed step in and try again to hold interest rates down? Will they try again to postpone the inevitable? Probably.
But the harder the Fed tries to fight the inevitable, the longer the inflationary surge will continue, ultimately driving interest rates still higher.
Don’t wait until it’s too late. Get ready now.
8. How Can I Profit From Higher Interest Rates?
Essentially, you buy investments that are specifically designed to go up when long-term interest rates rise.
You should be aware that, in recent months, these have not worked out because long-term rates have moved sideways or even down.
However, that’s the past — and all the more reason why I believe these investments will shine in the months ahead.
For specific recommendations on non-leveraged investments to profit from higher interest rates, see my Safe Money Report.
And if you are interested in a publication on high-leverage interest-rate plays, call us at 800-815-2917. (Sorry, no web page yet for this opportunity.)
Good luck and God bless,
Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.
martinonmonday@weissinc.com
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