Rising Interest Rates Reveal Economic Mistakes

Bill Bonner - Tue 11 Dec, 2007

To err is human, we had told them. Mistakes are always being made. In a properly functioning economy, these errors are always being madeand corrected. People go broke. Investments go bad. Projects are cancelled discardedand rejected. But in the last quarter century, interest rates were generally falling. This created a very forgiving economy. Mistakes were still made. But the cost of them went down. You could pay more for a house than you should have paidbut no problem; you could refinance at lower interest!

“It’s Tuesday, isn’t it? Isn’t Bernanke supposed to cut rates today? And isn’t the stock market going up in anticipation? Aren’t investors sure that the zoo keepers will always protect the animals and keep them happy?”

Yes to all of the above.

But to each question you could give a much longer answer…with plenty of nuances.

To the simple question: “What day is this?” for example. The answer depends on where you are.

“It’s Tuesday morning, mate,” said an Australian colleague.

“What day is it in America?”

“It’s a day earlier…it’s Monday; we’re about 12 hours ahead.”

“How could it be different days in different places? Isn’t time universal? Doesn’t it actually have to be the same moment everywhere at the same time?”

“No, no…it depends on where you are. Here, our work day will be over…it will be the next day…just as it is just beginning in America.”

We’ve always yearned for the ability to read tomorrow’s newspapers today. Here in the antipodes, we can finally do it. We picked up the paper this morning – and read Tuesday’s news – while it was still Monday (at least in the USA).

What do we find? “Sub-prime fallout sinks $12 billion deals,” says the local paper. You will find this in tomorrow’s news, dear reader: credit is getting crunched all over the world – including Down Under.

Tomorrow’s paper in America will tell us what the Fed is up to. But whatever it does, the answer to the ‘what happens next’ question depends on where you are…if you are at the beginning or the middle of a credit expansion, you get one answer. If you are at the end, you get a much different one…


*** “Well…which is it?”

We put yet another question, rhetorically, to a group of dear readers, in Melbourne last night.

The background for this question is as follows:

To err is human, we had told them. Mistakes are always being made. In a properly functioning economy, these errors are always being made…and corrected. People go broke. Investments go bad. Projects are cancelled… discarded…and rejected.

But in the last quarter century, interest rates were generally falling. This created a very forgiving economy. Mistakes were still made. But the cost of them went down. You could pay more for a house than you should have paid…but no problem; you could refinance at lower interest! And then, the price would go up – problem solved. Or, you could overpay for a stock. Again, falling interest rates were generally pushing up stock prices – you almost couldn’t lose.

Then, in the last six years, mistakes almost disappeared. People might have wanted to go broke – but lenders wouldn’t let them. The lenders kept showing up with more money! You could buy a house…or a Structured Investment Vehicle; no matter how big a mistake you made, you’d be rescued by easy money and rising asset prices. 

Looking at the economy itself, as the flood of money gushed in…mistakes disappeared beneath the surface. Typically, in the US, there was about one quarter of correction – with negative growth – to every four or five quarters of expansion. But more recently, the ratio of correction to growth fell to only one quarter out of every 19. Which was where our question began:

Either humans are less prone to error than they used to be…or there are a lot more mistakes in need of correction.

But we’ll have to explain this tomorrow. Today is already over here in Melbourne…stay tuned. 

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