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Just read the transcript and see what is says about unelected central bankers etc.
Just like we talk about the weather almost every day, those who follow financial markets constantly talk about interest rates. An interest rate signals the price of money. For borrowers, it is the cost of having money and influences what money can buy. For lenders, it is the reward for investing and influences how money can be saved. But as we will learn in this segment, interest rates can also do a lot more. 0:41 Central bankers who oversee a nation's commercial banking system, and other senior policy makers take the lead, because they have the power to change interest rates. This in turn, sets up the economic conditions, that can enable politicians, businesses, and civic leaders to do their part. 1:00 In this sense, interest rates can profoundly effect our economic well being. 1:06 Central bankers not only supervise the banking system and money supply, but are independent of elected politicians. They have almost stayed in the background until former chairmen of the US Federal Reserve system Alan Greenspan. He came along, and he was considered a savior following the dot come crash of 2000, which he famously labeled as a period of irrational exuberance. But Mr. Greenspan's policy decisions were also blamed for much more serious sub-prime mortgage crash of 2007. And we'll talk more about these crashes later. But the subprime crash and the resulting global financial crisis did reveal just how interconnected stock, real estate, bonds, and commodity markets are and how globalized they have become. 1:53 According to Mohamaed El-Erian, the ex-CEO of PIMCO, one the world's largest bond investment firms, central bankers are quote the only game in town unquote. Which is the title of his book, an excellent resource that you can find the link to in this course's curation corner. In this book, El-Elrian explains that the current problem for the developed world is slow or no economic growth. What central bankers are now expected to fix by setting interest rates. So when the major central banks of the world including the US Federal Reserve Bank, the European Central Bank, the Bank of Japan, and the People's Bank of China, change what's called the bank rate, the rate which affects the banking system. All other interest rates and several financial markets get affected. It's a domino effect. The recent actions of central bankers are just unprecedented. 2:53 The feds referring to the American central bank have made over 600 cuts to the interest rate since 2008. Central bankers are in the public eye even though most would rather not be, so they that they can ensure their independence from the government. And for the layperson, they are unelected bankers who are directly affecting the pocket books of their countries citizens, which some might find troubling. The point is often linked to the question of inequality, which asks why economic benefits are concentrated with the few. A recurring theme in finance for everyone, even though the question of wealth distribution should really be taken up by politicians responsible for fiscal policy. 3:36 Regardless, thinking about interest rates gives us a chance to look into all of these very important connections. Here, it's easy to see that over the past two decades, interest rates have been cut to almost zero. 3:51 This might explain why central bankers feel cornered. They're damned if they change interest rates, and they're damned if they don't. Increasing rates means money becomes more expensive. So everyone spends less, which is almost certain to trigger an economic recession in countries with a sluggish or fragile economy. 4:12 Also, governments who have borrowed too much really gets squeezed when rates rise. For example, the U.S government already pays more interest on it's national debt than for the combined total that it pays for it's food assistance program, higher eduction, unemployment benefits, and pollution control. 4:34 The Congressional Budget Office calculates that if interest rates move up by about two and a half percent in the next four years, the annual debt payments will double and explode to more than 840 billion US dollars. This will further squeeze a lot of existing programs or force even more borrowing. 4:54 But decreasing rates any further makes them negative, which central bankers have little experience with. Negative rates turn everything we've learned about time value of money upside-down. For example, negative rates imply that banks would return less than what is deposited, which can clearly hurt them, as they signal disincentives to save. 5:16 Insurance and pension companies would no longer have products to sell, even though these will always be required in a well-functioning marketplace. 5:25 Negative rates also encourage hoarding cash, which takes money out of the system and puts the brakes on economic growth. 5:33 So let's step back for a second to understand how all of this works. 5:38 Policy makers reduce interest rates, assuming that we will spend more and invest most in bonds and stocks. Governments follow suit by reducing rates on their bonds. Which attracts more buyers and subsequently drives bond prices up. 5:55 The result is a cycle of decreasing interest rates to encourage people to invest more in increasingly expensive bonds. 6:04 Today, about one third of government debt worldwide is trading at negative interest rates. Low rates also get investors to buy riskier products like stocks, so that they can make a better return on their investments. 6:18 Like with bonds, demand increases stock prices, but not because companies have become more productive. These conditions set up both the stock and bond markets to crash, because prices are a result of money flows rather than based on intrinsic value, something we discuss at length later to explore Corrections and crashes. For consumers, low interest rates makes money cheaper. So if you need a vehicle, a home, or an education. Your payments become more affordable which boost's the economy. But not all consumers experiences are equal. Interest rates differ for different people, and for many, it's easy to get stuck with too much debt too quickly. 7:03 Generally, debt has always been a temptation. And has been associated with greed, sin, and poor morals. If you have maxed out on your credit card, or are unable to pay your loans, you no longer end up in a debtors prison, which were abolished in the 19th century. But, it becomes very hard to erase a record of bankruptcy or raise money for that matter. 7:26 For millions of Europeans and Americans that thought they had affordable student consumer or home loans, changes in the interest rate caused unimaginable distress in 2007. 7:37 But on the flip side, for those who are setting up a fund to care for a family member, or an education fund to invest in, low interest rates affect you just as well. 7:49 According to Larry Fink, the CEO of Blackrock, the largest money management firm in the world, if you're 35-years old, you have to save more than three times as much to make the same retirement income if long term interest rated decrease from five to two percent. 8:06 The magic of compounding that we discussed in the decisions course comes to a crawl when interest rates are low. And in most developed economies, aging populations don't have enough for retirement. And low returns make the problem just extremely worse. Today's very low interest rates are having just that effect. When cheap money becomes the norm, investors increase savings rather than spend more to make up for the loss in future value. As we have mentioned, with negative interest rates you can also expect people to hoard more money. Including companies who will move money to look for more productive uses. This is reflected in the velocity of money, the rate money changes hands from one transaction to another. 8:53 Velocity is a very good measure of money's impact on the entire economy. For example, suppose you spend twenty dollars for a haircut, yhe barber then purchases $20 of hair products. The gross domestic product is now $40. This GDP would increase to $480 annually, if you went for a haircut every month. So the velocity of $20 had a multiple of 24, but only parties were involved. Now you can imagine what happens when there is a chain reaction of transactions triggered by the frequency of how much, and how many times we spend money. 9:36 From this chart, we can look back and see that during the past two decades of low interest rates, velocity has continued to steadily decrease and is now at its lowest point. 9:47 The lower velocity explains deflation or price decreases, which cause a contraction or slow down of economic activity. 9:58 Note that deflation, which is the opposite of inflation means that money can buy more in the future. In other words, since the risk free rate of interest has two component, the real and the inflation component, then replacing inflation with deflation by partly explained negative interest rates even though there is a positive real interest rate component built within 10:23 to summarize low interest rates are not a panacea. They have been overused by central bankers to cure low growth, which is now having massive unintended side effects. Especially, considering negative interest rates. 10:39 We will explore interest rates further in the next video to help us understand more about how they conne...
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|Is there any part of our economy that you can see as a ticking bomb? I know student loans are a concern for many individuals of my 20 something generation, but is there something else we need to be worried about? Were people aware of the housing market warning signs before the 2008 collapse?||Ticking bomb is strong but officials both inside and outside the Fed are concerned that low interest rates we've had for so long is causing some bubbles to be built. Student debt has grown rapidly, and is impacting the spending decisions of students after college, but so long as the economy improves, it's a good bet both for the lender and the student taking on the debt. Before 2008, were there warnings about housing? Absolutely. But even among those who thought housing was overvalued, there were very few who then saw how leveraged the entire financial system was to housing.|
|Do you think the current Administration deserves credit for the recovery of the stock market in the past several years? If so, what policies in particular do you think helped the recovery?||My colleague Russ Britt recently ran a terrific story examining those very issues -- well worth a click. Link to www.marketwatch.com My quick 2c is that the White House did act quickly to restore the financial system and provide stimulus (flawed as it may have been) during the recession, but has done comparatively little to help ordinary homeowners.|
|What do you think can be done to create incentives for people to learn manufacturing trades and (hopefully) bring a lot of manufacturing back to the United States?||Two great questions. I think there's a big movement more generally to improve what's an education system badly needing repair, and improved literacy and numeracy more generally would help that. I'm a little less enamored with specific tweaks here and there to give breaks to manufacturers. We want a dynamic economy and don't want to load it up with too many complicated and often conflicting incentives.|
|What do you think about rating companies?||So on the one thing they've been doing forever -- rating the prospects that debt-issuing companies will go bankrupt -- they are actually very good. On rating asset-backed securities, obviously, not. And on government debt, also they haven't done a good job. Classic example of difficulties in moving out of the niche you understand.|
|How is the unrest in the world (Ukraine/Israel) going to affect the economy short term or long term?||In the short term, the risks are with commodities, and energy prices in particular. But remember, everyone has an interest in selling, and buying, oil. Read a fascinating article on how even the terror group ISIS is selling oil. The Israeli economy will definitely feel the pinch of lower tourism, but that's not likely to have an impact on the global economy.|
|Don't you think that the market is a parasite for the economy? There are people who earn millions and billions without producing anything. Edit : typo.||Interesting Q. I think there's a benefit to trading and arbitrage -- it can help lower costs for businesses to invest, by making it easier for companies to raise money. But abuses can filter out of this world and, as 2007 showed, wreck the broader economy. What's important is making sure the large banks and other institutions aren't providing too much leverage to financial markets.|
|Do you think that the floating NAV for money market funds benefits the end investor?||So, the issue with money-market funds really is one of risk perception. People treat MMFs like banks, but they're not, and don't have a backstop, yet when there was a run, the federal government stepped in. This is what the SEC tried to address recently after four years of intense debate. Not sure they came up with the perfect answer.|
|The consensus every year since 2009 has been later half 'strength" gdp has been remarkably weak during the recovery. If we have another miss of latter half strength, do you expect fundamentals to meaningfully lead to a correction, or has the sea of liquidity put in a floor under markets that cannot be broken?||I saw a little essay on this yesterday, and honestly, I don't agree that the second half always disappoints. Q3 2013 was 4.1% growth, Q4 was 2.6% -- that's pretty good! But then, Q3 2012 was 2.8% and Q4 was 0.1% -- not so good! The Fed's taking away liquidity -- or will be soon -- so no, I don't think markets cannot be broken. You can argue of course that the Fed rushes in as soon as markets struggle, and I would have a hard time disagreeing!|
|Historically, this period in fed policy mirrors almost exactly what the federal reserve did in the 1930s with the gold stock. This time, they are calling it QE. When the fed backed off of gold stock accommodation leading up to 1937, the market corrected 60 percent. What kind of reaction do you expect to see at the end of QE3?||I think one good thing the Fed has done is to be extremely open about the timing and schedule of bond purchases and when they're going to end. So there will be no surprises. I don't think QE3 has had much of an impact on the economy so the lack of it shouldn't, in theory, have much of an impact either. Markets have a mind of their own, however.|
|What's the most unexpected thing you have ever had to cover at work?||I was in London during the Great Recession and to keep coming into market implosions was just jaw-dropping some days. I remember one day at a meeting with our colleagues, discussing the possibility of what would happen if banks collapsed and how supermarkets would function. We were actually having those discussions.|
|Hypothetically, if the GOP takes the Senate and keeps the house, what (if any) tax legislation could be passed and signed by Obama?||I think it will be difficult for any tax legislation to go through. But right now there's a lot of focus on what are called inversions -- a way for U.S. companies to pay tax overseas instead of here -- so corporate tax reform has the highest chance. The idea would be to lower rates and eliminate deductions but this is easier said than done!|
|Do references to Bitcoin automatically make you roll your eyes or do you have an interest in it?||I don't have a financial interest in bitcoin, but I am intrigued by it, for sure. There's clearly flaws, and the whole 'mining' process seems to be nearly as bad for the environment as physical mining. But I could see a continuing role in the financial system for bitcoin or for different electronic currencies.|
|Is now a good time to buy a home? There seems to be a echo-bubble going on at the moment.||Mortgage rates are historically very low. If you can get credit, and you're comfortable with prices in your area -- and are comfortable with idea of living in that house for quite a while -- then absolutely. But not all areas are the same -- prices in some areas, like San Francisco, are looking expensive.|
|Hi Steve. Thanks for doing an AMA. I'm curious about the longer term effects of QE on the market once QE ends soon and rates are set to rise. Is this something the Fed might keep in its toolbox to use in the future even once rates are above zero?||I do think the Fed will keep in the toolbox, so to speak. In fact, I'm pretty sure Janet Yellen explicitly said so. I think history will judge it was a terrific tool when markets were basically frozen-- so-called QE1. QE2 and QE3 have had far less impact on the economy and possibly have been more trouble than they were worth, though that's going to be debated for some time to come.|
|Thanks for the reply! Great way to interact directly with your readers.||Definitely. It's important not just to write but to listen.|
|What's your favorite visually, personal, or information packed infographic/chart that you'd like to show us? Personally I'm a fan of the largest Phylogenetic Tree I know of found here in .pdf format made by the people over at the UoT. Come join us over at /infographics sometime!||This is one I did recently that has received a lot of attention -- on the happiest and unhappiest cities. Why are people in Louisiana so happy? I have no idea. Link to blogs.marketwatch.com Not just on MarketWatch, you're seeing news sites devoting much more attention to infographics, and some are quite good. I'll be sure to check out the Reddit thread.|
|Why is it a good thing that the Federal Reserve is controlled by private bankers? How can we be sure that they serve the interest of the general public ?||Whatever the set up, the Fed is mostly under most control by the people appointed by the president and confirmed by the senate. The regional Fed presidents (who are not picked by elected officials) have a say but Janet Yellen, the current chairwoman, has a far bigger influence than they do.|
|Do you think the SEC will regulate dark pools and HFT as more evidence of front-running trades comes to light? Have you read "Flash Boys" or followed the work of Nanex?||The SEC is definitely looking into this area. And I've read Flash Boys, and do read Nanex, as well as those with opposing opinions. Not all HFT is front running, but it's apparent some is. The SEC for good reason is treading carefully into this area, but it's clear there will be action.|
|Do you want to abolish the FED?||Nope! I think Congress should provide healthy oversight, and honestly I'm not as freaked out by this 'auditing the Fed' idea that some are. But we had a world before central banks, and the data I've seen suggest we weren't better off for it.|
|What's your opinion on basic/guaranteed income?||It's an interesting concept, the one the Swiss were debating. It's not totally different from the safety net we have here, and writing checks is more efficient than means testing. That said, I don't think anyone seriously thinks it will happen.|
|Would what be your best piece of advice for a recent college grad looking to break into the finance world?||I'm probably not your best source here! What I can tell you is that the traditional investment banks aren't the only place to look -- hedge funds, venture-capital funds and private-equity funds are often at the cutting edge.|
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