A couple of days ago i said the Fed should raise rates by 0.5% and make it the last raise this year.  If you are an economist, you probably think i am crazy.  But if you are not an economist, please listen to me out.   Because it is important to understand in our current situation where the Fed has started to raise rates to combat inflation..

For nearly thirty years (between 1981-2011) the Federal Reserve decisions were responsible for the largest wealth transfer from the poor to the rich in U.S. history.  I will show you this in a minute with an article that i wrote for Talkmarkets in February 2017.  During that period, poor and middle class American's were paying usury mortgage, automobile, and credit card rates inconsistent with inflation during that period.  The usury interest rate payments that the poor and middle-class American's paid went to the wealthy and to countries like China who were purchasing the securities that backed those loans.  In effect, poor and middle-class Americans through these usury rates were responsible for (1) funding much of China's growth during that period and (2) increasing the gap between the wealthy and the middle class through that same period.

Actual historical figures shows that it took thirty-years and the Greatest Recession Since the Great Depression (GRSGD) before the Federal Reserve lowered rates to where they should have been more than 20-years before.  Don't blow me off here because it is important not to make this same mistake again--unless of course you actually do believe that the poor should subsidize the wealthy and countries like China.

Inflation comes and goes, and the current bump in inflation which has come about these past two-years, is soon to go.  And instead of raising rates, the Fed will have to begin lowering rates again--and quickly--otherwise, Here We Go Again (as i pointed out in a blog a few days ago).

It does not take a rocket scientist to understand what i am claiming.  Even a rational economist (if there is such a person) should understand.

Now with that said, here is my February 2017 article addressing this issue, which is relevant to the current situation.

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If you have been reading my recent articles for TalkMarkets, you will know that I have been showing readers the history of inflation in the United States measured by the Consumer Price Index (CPI) over the past 101 years. And if you have read those articles, you would understand why I say that the last 35-year history of inflation in the United States is different than any other period in history and that we are now living in a “new world economy”, driven by “unparalleled technological advances”, “enhanced productivity increases”, and “globalization”—all driven by the United States of America.

Based upon these rather recent developments in our economic history, I thought it would be worthwhile now to begin showing you what this means in terms of bond rates—focusing today on long-term “risk-free” bond rates—measured by the average annual 30-year fixed mortgage rate.

Why? Well, first, mortgage debt in the United States is significant, affecting both the U.S. economy and investment and middle class income. Secondly, financial theory says that “risk-free interest rates” should track well with inflation with a slight adjustment for variant uncertainty. Thirdly, I want to show you how long it took our esteemed economists at the Federal Reserve to finally recognize this “new world economy”. And fourthly, I want to explain what this “lagging recognition” meant in terms of transfer of wealth. I will deal with other “risk free” rates, such as the 10-year Treasury and 1-year Treasury in future articles.

Oh, and if any of my readers question whether U.S. mortgage rate bonds or securities are “risk-free”, then I just have to laugh. Trust me, they are—at least those issued by Fannie, Freddie, Ginnie, and any other organization that survived our latest financial crisis, which includes the “Big Four” banks.

Now with that said, the following graph plots the 30-year running average of inflation measured by the CPI and the average annual 30-year mortgage rate as recorded by Freddie Mac—the agency who submits these numbers to the Federal Reserve for evaluation. 

Note how flat the 30-year running average of the CPI change has been. For the 30-year period between 1982-2011, inflation averaged 3.0% in the United States and dropped slightly thereafter. By the way, to calculate the 30-year running average, I assumed, based upon the recent history of the “new economic world”, a constant 2.4% inflation rate in the out years beyond 2016.

Based upon the above graph, risk-free mortgage rate bonds could have been issued at 4.0% (or a little lower) over the last 35-year period and investors in those bonds would have had a good hedge against inflation.

Now I know that it is totally unfair to think that in 1982, coming right out of an extremely difficult economic period with high inflation, that any person in their right mind would have expected U.S. inflation to average a low 3.0% over the next 30-year period with a low variance. Likewise, no one in their right mind would have purchased a 30-year mortgage rate bond at 4.0% in 1982.  But what about 1990, 1995, 2000? I ask.

By 1990, inflation had steadied to around 4.0% for nine years straight and 30-year mortgage bond rates were still being issued at more than 10.0%. Through 1995 and 2000 inflation continued to remain low, dropping the average inflation rate even further over a longer period and 30-year mortgage bond rates remained nearly constant around 8.0%. I could go on and on, but it was not until 2012 that average 30-year fixed mortgage rates dropped below 4.0%--the point where history shows they could have been all along and still been a good risk free investment and hedge against inflation.

Oh, but Jim, everything you are saying is hindsight topped with more hindsight. What good is that?

My response is, “no, it is not hindsight”. If you understand what I said in my last article, the new world economy with low inflation was due to several things: (1) new computer, chip, robotic technology; (2) development of the internet; (3) the end of the Cold War; and (4) globalization—all of which started in or before the early 1990s. By 2000, any reasonable economist should have recognized the impact of these factors on inflation. The evidence in terms of inflation numbers was already there.

Okay Jim, maybe you are right, but so what?

Well, there are a lot of “so whats”—and most of the “so whats” are extremely important to understand. Here are a few for example:

1. Interest in terms of a 30-year mortgage (or any other long term debt) is significant in terms of “cash out of hand”. For example, the interest paid over 30-years on a $100,000 mortgage with an 8.0% rate is $164,155—an amount that is more than all the principal paid ($100,000) and an amount that is more than double the interest that would have been paid at a 4.0% rate. And most mortgages were for a lot more than $100,000.
2. Most mortgage loans are issued to “middle and lower class” homeowners and the interest paid on those loans goes to the people who invest in mortgage securities, such as large insurance companies, China, the Treasury, the wealthy. Some might be purchased by the “middle class” themselves, which would result in a wash in a transfer of wealth, but regardless, one could say, because of the lag in understanding of inflation in the new economy, that “American homeowners with mortgages” transferred a good portion of their wealth to China to support their growth and to further line the pockets of the insurance companies and the wealthy since 1982.
3. U.S. Mortgage debt, more than $10 Trillion, and thus the interest paid on that debt is significant—meaning that the transfer of wealth was large, too.
4. Going forward, American homeowners should get very angry and disgusted if average mortgage rates move much above 4.0%. And if they do, the people to take that anger out upon should be the “ever vigilant, inflation-monitoring, economists” at the Federal Reserve (sic).
5. The United States deserves its leadership role in the “new world economy”. A 4.0% fixed rate on long-term debt should be part of its reward. And the next step the U.S. should take is to refinance all student loans at this 4.0% rate, making it available to its young people, too. Investment in education should be treated at least as well as an investment in housing. 

And for those who still doubt what I say above, all I ask is for you to please explain to me the continuous downward shape of the "mortgage rate curve" in the above graph and why mortgage rates have hovered near that 4.0% mark for the last five years.

Now if you understand what i am saying then you should purchase my latest book called Globanomics.

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