Doug Casey on Interest-ing Times
Interviewed by Louis James, Editor, International Speculator
Recently: Doug Casey on the Echoes of War
Q: Good Afternoon Doug, anything on your mind this week?
Doug: Yes, actually. I've been thinking about interest rates.
Q: What's your gut feeling? Are they going up? Down? Staying the same?
Doug: Well, let me start out by telling you a joke. Einstein dies and goes to heaven. When he gets there, St. Peter meets him at the pearly gates and tells him that he's sorry, but because heaven operates on a centrally planned economy, there's a housing shortage, and Einstein will have to share a cloud with three cloud-mates for a while. Einstein is agreeable and is introduced to his new roomies.
This first fellow says, "Professor Einstein, I'm honored to meet you! I have an IQ of 130 and would love to talk with you."
Einstein replies: "That's great. Let me settle in and we'll have a talk about astrophysics."
The second fellow says, "Professor Einstein, I only have an IQ of 100, but I'm honored to meet you, too, and would love to get to know you better."
Einstein answers: "That's fine. Let's chat over a game of chess later on."
The third fellow says, "Professor Einstein, I'm not as smart as those other guys, but I'd like to speak with you as well."
And Einstein says, "So where do you think interest rates are going?"
It's a very complex matter, trying to figure out where interest rates are going. It's not generally something I'm inclined to do, except at times that are clear tops or clear bottoms. Clear in relative terms, of course.
Interest rates reached their last long-term peak in the early 1980s, in the 15% to 20% range, depending on the financial instrument you look at. Since then, they've dropped to 2% to 3%. Part of that has been a secular trend. But in recent years, the government has been looking to suppress interest rates artificially, in the belief that that will stimulate the economy.
And of course that's true. When you have low interest rates, people borrow more and they save less. But in today's economy, low interest rates are the problem, not the solution. What people should be doing at this point is saving more.
In other words, people should produce more than they consume — but these low interest rates are causing people to consume more than they produce. And that's the genesis of the problem we have today.
Q: So, with the rates at historic lows, and some economists including our own Bud Conrad saying that the effective rate is practically zero, are you calling a bottom?
Doug: Yes. Within a percentage point or two, I'm comfortable calling a bottom now. People who short interest rates — in other words, people who bet they are going much higher in the coming years — are going to make a fortune. I think interest rates will go back to the levels we saw in the early 1980s, possibly higher.
Now, there are basically three ways you can capitalize on that.
1. The riskiest way is to short interest rates on a futures exchange. That's not the easiest way to go, for a number of reasons, but it's the most direct.
2. An easier way is to buy a reverse ETF, which is like an ordinary stock that gives leverage to interest rates.
3. The third thing, and this is something that almost everyone can and should do, since most people own homes, is to take out the largest mortgage you can against it on a fixed, low interest rate. As interest rates go up, the value of your mortgage goes down.
On the third point, I don't think the bear market in real estate in the U.S. is over, but I do think we'll see a new bull market in real estate for many years to come. In the meantime, having a significant fixed-interest, long-term mortgage on your house is an excellent way to bet on higher interest rates.
And, of course, you have to do something prudent with the proceeds of that mortgage — you can't go out and spend it all. With all the risks inherent in different investment classes today, I think the best answer at this point is gold. I can't think of anything else that, for purposes of security and prudence, is even in the same class with gold.
Q: That's music to the ears of BIG GOLD and International Speculator subscribers, but what do you say to the people who argue that, for the very reasons you give, the government won't let interest rates rise?
Doug: I admit it seems like a paradox at times. Like any market, interest rates are set by the numbers of buyers and sellers. So, if the Federal Reserve buys government bonds, they drive the price of those bonds up, which drives interest rates down.
That's the immediate and direct effect of the Fed buying government debt. And they are going to have to do a lot of that, because the government is issuing so much debt because of its huge deficits. But more important than the immediate and direct effects of the government buying debt to drive down interest rates are the indirect and delayed effects. The primary one is the creation of more money to buy that debt.
If you double the amount of money in circulation, prices double. It's cause and effect. And when the price level doubles, people who have money will demand to be compensated for the depreciation of that money — so they won't lend it, except at much higher interest rates.
So it seems paradoxical, but that's what governments do to economies when they intervene; they create conflicting signals, which leads to economic and financial chaos.
It's very hard to predict the timing of these things, but in the long run, interest rates are going to go much higher. It's inevitable.
And as I said before, not only is it inevitable, it's also the solution to the economy's problems. It will cause people to borrow less and save more.
As an aside, one other thing we can be certain of is that as new money is created, it will be directed politically, which means it will go to the state and its friends.
Q: Is there anything else people should do, or keep in mind, as interest rates bottom and head back up again?
Doug: The important thing to remember is that the prices of everything revolve around them. So, as weak as real estate is right now, with record-low interest rates, when interest rates go up, it could drive real estate down even further. And as much as the stock market is off from its previous peaks, when interest rates go up, it's going to drive the stock market down even further. Everything else being equal.
So, even though higher interest rates are the solution, they are going to create even more financial pain in the future. It's a painful cure.
But even before the economy corrects and people learn to save again, you can do it yourself by making the decision to consume less than you produce — and sticking with it.
Q: That makes sense — thanks Doug!
Doug: My pleasure.
September 26, 2009
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