7/5/13 10:11 AM – Interest Rates Staying Low in Europe, Higher in U.S.

Yesterday, European Central Bank president Mario Draghi announced that interest rates would stay low in Europe for “an extended period.” That stands to reason – Europe is still mired in recession, Greek and Spanish unemployment are a whopping 25%, and 18% in Portugal, which is crumbling.

That announcement was unusual because of how famously concerned Europeans are about inflation, especially Germans – the biggest power in European finance. The ECB has always stayed away from giving forward guidance on rates, but Europe’s sickliness is prompting more cries for government help.

The problem in Europe remains what it has been for years. A socialist mentality has created enormous governments with endless restrictions on government, especially when it comes to labor. Because of that, Europe is failing to stay competitive in a number of industries. They seem to be unwilling to let capitalism reign and until they unwind their enormous bureaucracies their businesses, economy, and the lives of Europeans will suffer. So far, few have been willing to even talk about that, much less do anything.

Bottom line – it is not imposed austerity that is killing Europe but stifling bureaucracy.

Many troubled European nations claim their economic malaise is due to enforced austerity. The truth is that since 2009 every European government but Greece has increased its spending. Bureaucracies are notoriously difficult to unwind. Look at all the grief Margaret Thatcher went through and many in the U.K. still hate her for it. As Ronald Reagan famously quipped, “The nearest thing to eternal life we will ever see on this earth is a government program.”

In the U.S. Fed Chairman Ben Bernanke’s statement after the June Fed meeting that the Fed would be tapering back on bond purchases triggered an outbreak of selling in the stock and bond markets, especially bonds. That has reversed quite a bit in the case of stocks and somewhat in bonds. But, with the Fed buying fewer bonds, interest rates on government bonds are almost sure to go up more since the Fed has been an enormous buyer of U.S. Treasury bonds, dwarfing all other buyers over the last few years, including foreign countries. With a big drop in demand, come lower prices on bonds and higher rates needed to sell them.

The only headwinds to rates going higher in the U.S. are
1) U.S. strength compared to the rest of the industrialized world thus making it a haven for foreigners wanting safe bonds, and
2) The dampening effect of low exports on our economy. That comes from the weakness in Europe and increasingly in emerging markets like China and Brazil.

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