Why short-term rates matter.

A quick look at long rates. 

US corporations are going to cliff dive. To put it briefly, the average duration of a corporate bond is 21 years. The average life of an S&P company is 18 years. In other words, companies have borrowed past their life expectancies.

More to the point, why would they borrow past the life cycle of their processes? Simple. They have no intention of ever paying the loans back. 

Companies that took out loans for stock repurchases don’t even fantasize that those loans will be paid back.  

Short rates can be more of a cancer. 

The US has $750 billion in inventories. When ST interest was 1% it hardly mattered. At 5%, or $37.5 billion, it does. 

But a larger matter is the biggest part of US short term debt. Accounts receivable and accounts payable. This is money companies owe their vendors. 

AP and AR are typically 3 months sales, but this can vary depending on the payer. Major corporations are notoriously slow payers. 

US gross retail sales are about $7 trillion making AP and AR about $1.75 trillion. Despite the fact that these things balance (on a balance sheet) they have to be financed. This is because certain payments like wages, bonuses, rent, and utilities have to be paid immediately. Some, like oil imports, have to be prepaid. 

If we assume part of accounts payable is financed out of company profits, then part, say $1.5 trillion must be financed. At 5% this would be, hypothetically, about $85 billion.

The actual effect is a huge unknown.

The reason is that from an operational standpoint, a company is like drooping a rock into a pool. The ripple effects go in every direction. 

  A $100 billion interest cost may seem small from a macro-economic standpoint, but it’s not evenly distributed. It will hit retailers far harder than tech companies, since retail often operates at thin profit margins. 

Another aspect is American big-box retail. Stores like Walmart and Home Depot have enormous worldwide distribution chains. They cannot operate small. Their profit doesn’t come from what they sell, but their efficiency in distribution. Their biggest fear is Amazon selling building products, which explains their lame attempts at online distribution. US retailers have morphed into monopolistic shit merchants. 

It will hit manufacturers particularly hard because their inventory to sales ratios, including finished products as well as in process inventory are very high. 

Companies can mitigate this by using sub-contractors, but all this does is move it to a different (typically weaker) balance sheet. 

Globally, this is a nightmare scenario.

The US is dollar connected worldwide. This means more than simply using US treasuries as global bank reserves. 

If a Chinese company sells to the US in dollars and buys supplies from (say) Australia using US dollars, you have basically an American company. A Chinese bank that can make 5% in short term treasuries is not lending to a local company at 2%. 

In other words, raising US rates increases costs worldwide. 

The inflation rate is economics for idiots.

And you should ignore it. 

Products have price points. If a pint of iced cream has a $4.99 price point that’s what the customer will pay. Raise the price to $5.25 and the customer will by your competitors that hasn’t raised the price. (Don’t even imagine that people who buy scratch offs are making intelligent purchasing decisions) 

Product manufacturers will jump through hoops to hit their price point.

They may change the quantity. (Remember the 1.5-quart half gallon) But’s more likely they’ll change how the product is made. America really doesn’t even make iced cream anymore. American pasta tastes like shit, as does bread. 

In other words, a main impact on higher rates is low quality products. This is especially true in American building materials. US homes today are basically petroleum products.

My point isn’t that economists are idiots, but the that real inflation rate cannot be accurately calculated. Estimating what that rate is or what it will be is like trying to accurately predict the temperature at 5PM a year from now. 

The other issue is duration space. 

If the stock market falls 50% but you are 25 and have $8,000 in your 401K, it’s a nuisance. If it falls 50%, you’re 70 and have $1 million it’s a death sentence. 

Look at mortgage pools. In a falling rate environment, people continually refinance at lower rates. This means mortgage pools quickly disappear. In a rising rate environment, people typically don’t refinance often because they can’t. 

This leads to mortgage investment losses as in the global financial crisis. 

Another issue is frozen markets.

Certain things that sell well in low-rate environments, like summer homes and motor homes don’t sell at all when rates rise. 

In the high interest 80’s, hundreds of thousands of lakefront properties lay idle as they simply couldn’t be sold at any price. Property assessments fall at a much slower rate than prices, making vacation homes boondoggles. 

Which leads to the FED dilemma. 

Cutting rates and deficit spending can increase GDP far faster than raising rates can slow it. 

There’s little evidence that the FEDs governors understand either business or accounting. In fact, to listen to them you’d wonder if they understand anything. 

But their job is not to understand business. It’s to provide banks liquidity and protect the dollar. 

To see this, you have to ignore macro-economics and think in systems.