Wednesday, 9 April 2008

The 'therapeutic range' of interest rates. Saturday 2006-11-25 pm.

Rewind to my second ever post - over a year ago: Saturday 2006-11-25 after lunch:

I have just listened to the Matt Simmons interview on Jim Puplava's FSN broadcast. Matt Simmons is one of the most eloquent advocates of peak oil and is being interviewed on his response to the Cambridge Energy Research Associates (CERA) report which says basically that the peak in oil production won't come until 2037 and will then more likely be a plateau. He explains that this report is based on a lot of assumptions that are very risky and complacent and that we will not do significant work to tackle peak oil until there is a serious life-threatening crisison on the scale of 911 or New Orleans. A fascinating subject. Personally, I am at least three-quarters in the Peak Oil camp. Simmons thinks that the peak may have occurred already, in December 2005.

I went to the local bank branch in my town and picked up the HSBC Economic Report for October 2006. The cover story is called 'A Conflict of Interest' and whether the Federal Reserve and the Bank of England will raise or lower interest rates and what effect that will have on the property markets, inflation, etc. It highlights the current dilemma we face.

My view on this is that the inflation has already occurred, at least in the money supply, which is the major part of the actual definition of inflation. It has also occurred due to the 'Yen Carry Trade' with the Japanese Government selling their own currency and turning it in to US Dollars and buying US dollar-denominated assets (e.g. US Treasury Bonds), in order to prevent the Yen from rising against the USD to keep their export trade competitive with the USA. Famous gold bug Jim Sinclair blames Ben Bernanke for this (when Bernanke was Chief Secretary of the Treasury) and calls this the "massive amount of liquidity that cannot be withdrawn." It has been a main ingredient that has financed low interest rates in the USA and led to our current massive credit, refinancing and property market bubbles.

There seems to be uncertainty as to the future path of interest rates. There have been 17 rises of 1/4 point each in the USA and a smaller number from a higher starting level in the UK. No-one seems to know where they will go from here, up or down - or nowhere from this level of about 5%.

I think that the Central Banks are going to have trouble with the 'therapeutic range' of interest rates, which is very narrow. Below 5% and there is a danger of large currency devaluations and price inflation. Above 5% and the risk of defaults on the gigantic debt levels becomes a major problem and the housing market may crash.

There is a dilemma coming, where the therapeutic range of interest rates may not exist at all and a whatever level is chosen will result either in large scale inflation or debt defaults or both.

Earlier this year, we saw a taste of the likely future, when we saw the US dollar depreciate while interest rates are rising! With the USD depreciation came a close to runaway rise in the price of gold.

Now that the pre-elecion period in the USA has gone, any market manoevrings done by the Fed and/or the US Government to keep commodity (principally oil and gasoline and possibly gold) prices down seem to have given way. The prices of these assets have started to rise since the Congressional Elections and maybe we are in another bull run for gold and silver agter this recent lengthy correction period. It should be interesting to see how long it will last and how far it will go this time around.

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