The Fed and Real Interest Rates
Recent increases in nominal interest rates, and decreases in inflation rates should have the Fed very worried.
The Fed is buying more than $85 Billion/month because they are reinvesting both the principal and the coupon payments. The duration of the 4 trillion is about 6.5 years, and the average coupon is somewhere around 2%. So the Fed receives $80 Billion a year in interest, and around $400 billion a year in principal. So Fed purchases are $1.50 trillon per year ($125 Bn/Month), of which $1.1 trillion adds to the balance sheet.
The Fed purchases with the current program actually increase slightly as the balance sheet increases. An extra trillion on the balance sheet at 2.5% is an extra $25 billion/yr in interest payments- slightly more than $2 billion/month. Similarly, as interest rates rise, the new bonds the Fed buys have higher coupons. So an extra trillion from here has more interest income than last year’s extra trillion.
2013 US Federal budget deficit is projected to be $680 Billion. Fed purchases are significantly larger than new issuance by the US Treasury (although Fed is spending some of the money on mortgages).
What does this mean? Inflation continues to fall, the Fed is on a slightly increasing path of purchases. However, nominal US Treasury yields continue to rise. This means real rates are rising even more significantly.
==> The Fed should be very worried. In spite of their historic purchases, real rates are going up. One could argue that real rates are going up because of a strong economy. An alternative view is that the Fed does not control real rates.
My doom and gloom call on the Dow Jones Industrial Average
For some years now I have been obsessed with the idea that the world will undergo an economic depression that could be much worse than the 1930’s.
I will create a behavioral plan to survive in the coming depression. The plan has several key elements:
Behavioral — The plan is designed for human beings. Asset markets are very challenging for people. Thus, the plan has to account for the realities of human emotions.
Survive — Success in an economic depression will be one of relative success. In the late 1990’s, a friend of mine worried about the world. In response, he stashed tens of thousands of dollars and gold in a safety deposit box. Then 9/11 happened, and it would seem that he had been foresighted in his fears. However, his safety deposit box was in the World Trade Center. The authorities recovered his box in the rubble; it was filled with melted gold and ashes. Everyone will be hurt in a depression. the goal is to survive and lose less than you would have otherwise.
Economic Depression — this plan is designed for a world where people buy food with US dollars. If the outcome devolves to gangs with guns these ideas will not help.
October 2, 2013