Rising interest rates will deflate asset prices. From MN Gordon at economicprism.com:
Daylight extends a little further into the evening with each passing day. Moods ease. Contentment rises. These are some of the many delights the northern hemisphere has to offer this time of year.
As summer approaches, and dispositions loosen, something less amiable is happening. Credit markets are tightening. The yield on the 10-Year Treasury note has exceeded 3.12 percent.
If yields continue to rise, this one thing will change everything. To properly understand the significance of rising interest rates some context is in order. Where to begin?
In 1981, professional skateboarder Duane Peters was busy inventing tricks like the invert revert, the acid drop, and the fakie thruster, in empty Southern California swimming pools. As part of his creative pursuits, he refined and perfected the art of self-destruction with supreme enthusiasm. His many broken bones, concussions, and knocked out teeth earned him the moniker, “The Master of Disaster”.
But as The Master of Disaster was risking life and limb while pioneering the loop of death, the seeds of a mega-disaster were being planted. In particular, the rising part of the interest rate cycle peaked out in 1981. Then, over the next 35 years, interest rates fell and these seeds of mega-disaster were multiplied and scattered across the land.
Credit and Asset Prices
The relationship between interest rates and asset prices is generally straightforward. Tight credit generally results in lower asset prices. Loose credit generally results in higher asset prices.
When credit is cheap, and plentiful, individuals and businesses increase their borrowing to buy things they otherwise couldn’t afford. For example, individuals, with massive jumbo loans, bid up the price of houses. Businesses, flush with a seemingly endless supply of cheap credit, borrow money and use it to buy back shares of their stock…inflating its value and the value of executive stock options.
To continue reading: Tales from “The Master of Disaster”
