Interest Rates are Forecast to Go Much Higher – That Puts Us in a Box

Eyes are anxiously turned to the future of interest rates. For years now, pensions and retired investors have suffered under the head wind of very low interest returns that were less than the rate of inflation. On the other hand, super low mortgage rates have supported rebounds in the value of real estate and, most prominently, the stock market. Super low interest rates have also enabled governments to run up huge debts without the public caring. But after 36 years of falling rates, the winners and the losers of suppressed interest rates are watching what happens next.

Thirty-six years of generally falling interest rates may be reversing and some very accomplished people say they are set to rise. Accomplished bond managers Jeffrey Gundlach, Bill Gross and Scott Minerd are predicting, or see scenarios, where rates work higher, even doubling, over the next four years…. and that would mean a new trend has come into place, a trend of rising rates. Sea changes like that matter a great deal.

Breaking a 36-year trend of falling rates will constitute a new economic era with new winners and losers, opportunities and problems. It would be big news. In 1981, interest rates were in the high teens. Imagine that? Falling interest rates meant borrowing to consume. Borrowing to build homes for investment became easier and easier, cheaper and cheaper. Imagine how that would change things if interest rates went the other direction?

Take, for example, the US debt. The cost of servicing the debt would rise in round numbers by $200 billion/year for every 1% increase in long-term interest rates. Add that to the budget deficit.

Take, for example, the stock market. Bonds aren’t much competition when the dividend yield on blue chips is the same as bonds. What if bonds yielded much more? Would money shift away from stocks?

What about property values? What do you think would happen if the monthly cost of the average new mortgage (which is about $300,000) were to increase by $600/month? Rising rates really could put us at that level in a year or two.

There may be winners. Higher interest rates would help pensions and retirees. Public pensions need to earn 6-7% a year. Rising rates would really help them. Public Pensions are only earning about 2.5% on their bonds currently. And that could double, or more.

It is interesting to consider that some very smart people are seeing an historic change coming in interest rates. It is one that affects us all.

There is another interesting aspect of this possible scenario. A better economy force rates higher which in turn triggers some very bad effects on the economy that may reverse the whole process or prevent the increase from happening at all.

The problem is, we are in a box. How does the economy deal with higher interest costs on the $145 trillion dollars of outstanding debt in the US economy? Rates just 2% higher would be adding close to $3 trillion in interest costs. The problem is for some borrowers, there is too much debt for their available revenue. The Federal government, for instance, has $20 trillion in debt. Where does it find the tax revenue to service a 2% increase, or $400 billion in interest costs? The answer is, they do what they do now i.e. borrow to pay interest until they can’t anymore.

When normalized economic growth moves us towards normalized interest rates, we find that our huge debts have put us in a box. It comes down to this. The size of the debt relative to the economy has never been so large, ever. So, when interest costs rise, the cost of servicing debt rises faster than many entities can handle. It is a debt trap, or box.

Our very large outstanding debts create an apparent dead end. The economy’s return to a normalized growth will bring higher interest rates, and higher rates combined with record debt levels will, in turn, be a restraint on the economy. The future seems hampered by the amount of debt we took on since 2008, and before that 2001. Pensions and retirees may be winners, but debtors like governments and overly indebted households and businesses will have trouble paying future interest costs.

Summer Vacation 2016 Investment Asset-Class Rethink: A 3-Part Series

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US stocks are at new Highs and Record Valuations

Are You Bullish, Bearish or Confused?

The media is reporting that the stock market is trading at just 17 times next year’s estimated earnings. Many in the stock-buying business will tell you stocks are a “good” buy. Here are their reasons:

  • Interest rates are near 0% which means there is no alternative to stocks.
  • The dividend yield of the S&P 500 is about 2%.
  • The stock market always goes up over time.

Yes, but…….

  • There is Always a Business Cycle, and We Are Near the End of One Now


  • History Shows Buying Stocks at these Valuations Project Low Returns and High Riskcondensed shiller
  • Interest Rates Are At Record Lows – But Why?tenyear

Interest rates are at their lowest point ever. Stock dividends appear to be a strong competitive value. Consider, however, the reason interest rates are at record lows. It isn’t good. Central banks everywhere are forcing rates down to prevent a global depression.

The average stock is at its highest valuation EVER which doesn’t match up with the fact that S&P 500 earnings haven’t increased since 2012!

Stagnant earnings and expensive valuations with the backdrop of the risk of a global depression, seem like good reasons to be cautious about putting money to work i.e. not rushing to buy.

We think investors should explore the disconnect. After 4 years of stagnant earnings, why do stock prices continue to climb higher and higher?

  • Are Dividend Stocks Basically Safe?

One big investment theme this year is dividend stocks. Many stocks are yielding around twice the interest rate of the 10-Year Treasury Bond, which is a good argument to own them. But the valuations of these stocks are now really expensive. Are ultra-low rates an opportunity for these stocks, or an indication of the risk of a financial depression? That is the question. Don’t be deceived that dividend paying stocks are “safe”. In 2008, dividend paying stocks were down nearly the same as the S&P 500, that is to say, negative 50% at one point.

Buying expensive stocks, dividend payers or not, becomes hazardous to your wealth at some point. From our perspective, the current environment of unresolved global risks, very high equity valuations and growing pressure on profit margins, means cash has a very strong chance of being a better asset. Not only will cash hold its value in a correction but having liquidity available to buy at lower prices is an underrated way to actually make money!

In our next installment of “The Summer Vacation Investment Asset-Class Rethink”, we take a look at the most widely owned financial asset of all, the bond market.

Peter Quigley

Renvyle Partners LLC


Bitcoin: What is it? Why do people want to own it?

by Peter W. Quigley, Renvyle Partners LLC



Novel, ground-breaking, the first digital currency, are all apt descriptions of Bitcoin. But is it really money as so many millions who already own it and transact in it believe? If so, why exactly, and why is it valuable?

In the fall of 2008, an unknown entity calling himself, or themselves, Satoshi Nakamoto released the concept and technological framework for Bitcoin. By January 2009, it was up and running. Besides introducing the radical financial innovation of a stateless digital currency, Bitcoin was also the launching pad for a new security technology called the blockchain.

The blockchain is the software innovation of coding that makes Bitcoin possible. The blockchain is not just an encryption that keeps Bitcoin safe, it is also an accounting system that keeps an up to date ledger of each owner’s Bitcoin and transactions globally. In fact, this ledger is updated across the network every 10 minutes! It is pretty amazing.

The blockchain’s secure coding protects Bitcoin owners; but where are Bitcoin stored and can they be stolen? Bitcoin exchanges are the “banks” where users buy, sell and store Bitcoin. The protection of Bitcoin owners became an issue in 2013 when a major robbery took place. Mt. Gox, a prominent Bitcoin exchange was hacked and the Bitcoin taken. What prevents that from happening again?

A host of Bitcoin exchanges say they have added more network and account security. Some offer account insurance. In addition, the gangs of hackers itching to steal Bitcoin face the entire universe of Bitcoin users, many of whom are very tech-savvy themselves. Since the Mt. Gox scandal, Bitcoin investors have, to a great extent, repaired their confidence in the security of the currency, but a healthy sense of vigilance remains.

Blockchain’s encryption and ledgering has impressed the global finance and payments industry and it is investing heavily in the technology for its own use. But has the global financial system adopted Bitcoin itself? On the margins, the answer is definitely yes. Since 2009, having survived growing pains like Mt. Gox, Bitcoin’s credibility is strengthening. Both the user base and vendors accepting it as cash are growing. The value of outstanding Bitcoin is now $7 billion, and the idea that it is in fact real and here to stay is gaining traction.

What is Money?

Bitcoin has provoked important conversations. Because it isn’t backed by an asset or a government, how can it have any value and be considered a credible currency? Transacted over the internet, how can it be taxed? Hasn’t the internet’s global presence made Bitcoin inevitable? Is it really money?

Bitcoin’s advocates make good points. All money requires the belief that it is a store of value that can be exchanged readily with others. Even the most enduring money of all, gold, though it is indestructible, rare and expensive to produce, is only worth what people believe it is worth.

National currencies are confidently used for transactions in every land, but all currencies in the world are depreciating and printed on useless paper issued by governments who print more and more of it all the time. Despite these shortcomings, paper currency is used all the time and even used as a store of value. Despite constant depreciation, paper money’s credibility is seldom questioned.

Bitcoin advocates argue that the nature of money can be better understood in the purpose it serves. Money, they say, is essentially a way of keeping a ledger of payments and debts and as such has been essential to trade since before recorded history. For untold centuries, wampum, feathers and shaped stones served as money in North America. In the 1800’s there were dozens of currencies used in the US that had been issued by local authorities and private companies. Backed by very little that was tangible, these forms of money still served as currency.

Bitcoin advocates say Native American wampum and 19th century local currencies were useful in their time and in today’s digital networked global economy, Bitcoin is extremely useful and will become even more so. Bitcoin is perhaps even more credible than other currencies of the past and present if for no other reason than it is immutable, durable and since the quantity is limited a better store of value.

Bitcoin’s Unique Usefulness as Currency

Bitcoin’s is unique because it only exists on an information network. It has the unprecedented advantages of being accessible anywhere at anytime and existing outside of the banking system. How many currencies can say they are so useful in these ways?

Transacting instantly outside of the banking system, Bitcoin has proven uniquely useful to the Chinese who have been moving money out of China and out of the Yuan, for example. It has long been recognized that Bitcoin is useful for illicit money movements. It is becoming increasingly useful in daily trade and commerce by travelers and in cross border trade where it is possible no currency translation is needed.

Among the thousands of firms accepting Bitcoin payments are Microsoft, Dell and Expedia. This is a long way from Visa’s market share, but the use of Bitcoin can conceivably grow exponentially when companies and people decide they are comfortable holding quantities of money in Bitcoin rather than converting it to paper currency.

Whether Bitcoin even has a right to be money may in the end just come down to the point that in a networked world, isn’t a currency like Bitcoin not only very useful but also simply inevitable?

Bitcoin Looks Increasingly Attractive as a Store of Value

Holding cash outside of the banking system is increasingly sensible. In many countries, today negative interest rates on deposits and bonds exist in Japan and much of Europe. This means you pay to keep money in the bank or to own a government bond. Negative interest rates are a good reason to move some Yen, Euros or Krona into a Bitcoin exchange.

Some investors have learned the hard way that holding money outside of the banking system is a good idea when banks go broke. In 2013, Cyprus went broke and its banks were closed. When the banks were reopened, funds on deposit in excess of the insured 100,000 Euro maximum were largely confiscated by the European financial authorities. Holding money outside of banks is sometimes a good idea. Banking rules are being changed even in the US to permit the takeover of deposits like in Cyprus. If Bitcoin has arrived as money, investors will use it to avoid growing banking system risks.

Bitcoin’s quantity, like gold is limited, as both are increasingly difficult to produce. The rate of new Bitcoin “mining” has already slowed and in 2040, the number in existence will go from today’s 15 million to the end point of 21 million. The contrast between Bitcoin and its finite quantity in an era of unprecedented levels of paper money printing is stark.

Paper money makes a poor store of value. If in 1966, a child put a US dollar they had received for a birthday gift in a secure place in an effort to save the money, what would it buy today? In 1966, it would have bought 20 first class stamps; today a tad over two. It would have bought over 3 gallons of gasoline; today about 1 ½ quarts. That’s how money printing works and paper money fails as a means of storing value.

The number of Bitcoin will stop increasing in 2040 at 21 million. How can there be enough of them for it to be money? Rather than being divisible into 100 cents, Bitcoin is divisible by one million parts. So there will be 21 million, million Bitcoin cents. If Bitcoin becomes accepted by a billion people, its finite quantity will make it quite valuable while the value of paper currencies will be largely governed by the huge increase in their quantity in circulation. Bitcoin sitting in a digital “wallet” has a better chance of maintaining value than paper money over time.

Bitcoin is easy to use. It is really easy to transfer money back and forth from a checking account to a Bitcoin exchange. People do not yet realize how easy it is to transact Bitcoin.

Bitcoin is controversial and ground breaking. It introduces the concept of digital supra-national money. Governments are challenged by it. Yet the number of businesses globally accepting it as payment is growing and skepticism about it seems to be declining. The usefulness of Bitcoin is becoming ever more apparent to its users, including those who want to hold money outside of the banking system or national currencies.

Bitcoin’s Future is Not Assured

The future is not all glorious sunshine for Bitcoin, however. Its future is very much dependent on preventing another Mt Gox theft. People are more confident in the security of their accounts now but the Bitcoin exchange industry and user base have to remain vigilant. Increasing and protecting user confidence is critical if Bitcoin is to expand.

There are also the undefined risks of another digital currency superseding it or a government declaring “war” on it. Bitcoin is not without risks but if you think the US Dollar is risk free consider these facts. Since 2008 the national debt has almost doubled, or recall the loss of buying power we have seen over the last 50 years. Those are risks that have materialized and are operative today. All currencies have risks.

Frankly, many Bitcoin boosters believe it is going to increase a great deal in value. So far, the value of Bitcoin has been very volatile. It rocketed up to over $1,000 in 2013 and then crashed to the low $200’s last year. A two year bear market is over and it is around $450 at this time (May 15, 2016).

Coindesk chart from snippet tool (1)

Bitcoin’s growing adoption globally as well as the need for a digital currency outside of the banking system, points to an increase in its use and demand. Its proponents see a big future for Bitcoin as the world’s digital alternative to paper money and even gold. If the risk of digital theft is contained, maybe this vision will be realized.