RABBIT HOLE ECONOMICS

5/24/11

The Wall Street Journal’s Katy Burne reported today (Tuesday, 5/24/11, page C24) that yields on five year callable CDs, at 2.4%, are now trading 76 basis points under the CPI at 3.16%.

There are, of course, many conventional explanations for the negative real yield on what are among the highest paying CDs, to wit: flight to quality, lack of loan demand, people’s not believing the inflation numbers, preferring instead to believe that the real danger remains not inflation but deflation, a lack of alternatives, etc. There is doubtless much to these explanations. But step back for a moment and think about it. The financial crisis from which we are supposedly currently emerging had its origins in, simply, too much debt. It was called a “housing crisis” but, as loyal and long time readers know, for years I have been saying, correctly, that this was a housing crisis only in the sense that, in many cases, houses were used as the ultimate collateral for the debt that was accumulated by the financially clueless at the urging of the financially clueless. The problem we encountered was not a housing problem but a debt problem. (I digress, but I do so for a reason beyond pure entertainment.) Further, even if one believes that the problems that spawned the near financial meltdown (too much drama in that oft-used description, but, again, I digress) are behind us, one has to admit that the world still suffers from too much debt, government, household, and, maybe, commercial.

So in a world characterized by too much debt, people are still willing to lend their money for five years, and to give the borrower a call option on that debt, at a rate 76 basis points under inflation! This is amazing, even when one considers that CDs are de facto (de jure for that matter) U.S. treasury debt. (Note, though, that the issuer of treasury debt has been far from immune to the popular impulse to spend one’s self into oblivion that is (was?) the origin of the aforementioned debt crisis.) If there is too much borrowing, why can people still borrow still cheaply? The least one can say about this is that there is a bubble in the debt markets. But what would someone with no special expertise in finance or economics say if s/he were confronted with a situation in which there is too much debt yet that debt is priced so richly? S/he would say that something has gone haywire, that there is something wrong with the financial system, and maybe with the world. Yours truly, who at least purports to have more than a passing familiarity with the way the financial world works, would go so far as to say that the world has gone, in the immortal words of Group Commander Lionel Mandrake, "as mad as a bloody March hare," but such an assertion on my part would be not at all new.