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M.I. Tugan-Baranovsky

J.A. Schumpeter

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IEE Forecast. The World Economics Will Run a Fever For Some More Time

About Long-Term Yield Growth

According to leading economist's opinion, continuous decrease of long-term rates in the world's most developed countries is one of the greatest puzzles in the financial world today. The problem is important for the USA, and other national economics. As Financial Times stated, both, US and international percentage rates are low. (Cbonds)

Long-term yield decrease started while the monetary policy went tougher. This phenomenon is rather difficult to explain. It refers to decreasing long-term rates, while the US Central bank increases the rates. As FT stated, "financial markets are perplexed by the rates of bonds. FRS in the US was increasing refinancing rates from one per cent a year ago to 2.5 per cent, moving to the level it considered right. However paradoxical it may seem, long-term yield continues to fall. It was equal 4.7 per cent in the USA in Summer 2004. Since that time, it decreased almost by a quarter and continues to fall. Since late June to December the rate was raised almost five-to-one. At the beginning of February it raised again, but it didn't influence long-term yield much. At the auction on February 9, the yield of treasury bonds for ten years decreased even lesser than 4% and made 3.98%.

Investors worry, that bonds cannot provide the alternative to the stock market in this situation, while stock market is more and more disappointing. According to FT, earlier such trends were the consequence of illusion, when investors ignored the necessity to stick to the inflation. High nominal income partially compensated inflationary expectations as dollar (pound) decreased. Real percentage rates, received by subtraction inflationary index out of nominal yield, also prove trends of decrease of long-term rates from about 6% at the middle of eighties to present 2%. This conclusion is proven by yield of indexed bonds in Great Britain, which are now sold at about 1.5 - 2 per cent. The yield of newer bonds US TIPs (indexed state bonds in the USA) also decreased by 1.5 per cent. Such low yield impresses, according to the common among depositors thought that dollar and pound rate is overpriced, and the bond yield should include bonus for connected risks.

Almost identically, the head of FRS, Alan Greenspan, expressed the same concern about market percentage rates decrease.

At first Greenspan reported to the Bank Committee in Senate, on Wednesday, February 16. He repeated it to the Board for Financial Services at the House of Representatives on Thursday, February 17. A. Greenspan discussed "unpredicted" trends of long-term bonds: "Long-term percentage rates tend to decrease even though FRS increased rate at Federal Funds for 150 basic points. This situation differs from the majority of those in the past, when at the equal conditions, increased short-term percentage rates called for increasing of long-term yield. Some experts consider, that the decrease of long-term real percentage rates which started in June, may signify, that the participants have worsened their evaluation for economical growth. It may be connected with the increased prices for oil." But this interpretation does not coincide with increased prices for shares and short-term deposits, which takes place at the same time. During the report Greenspan considered several more possible explanations for decrease of long-term percentage rates, but he could not find the answer. "At present, the world bond markets' conduct remains a puzzle. The movement of bond quotations may be a short-term aberration. Some time should pass before we could judge about the forces, that determined it", the Head of FRS stated.

Explanation of possible reason for percentage rate decreasing

Technical tools of the financial market might explain this phenomenon. But for the observed long period the market should have corrected such mistakes. It may be presumed, that this process was influenced by decreased rates, which continued for too long (by summer of the previous year). Now but for all the policy toughening, yield of both short-term and long-term debt is at very low level.

The answer to the question about reasons for decreased long-term yield may be partially found in works by classical economic scholar M.I. Tugan-Baranovsky. He wrote in "Production Crises" (1894), "Accumulation of loan capital makes something completely different from real production capital increase. Loan capital may accumulate not only in production expansion, but in shortening as well. Not only it can, but it does at these conditions", the author states.

...After every crisis finishes, bank funds accumulate. Savings deposit of a private person grows. So free capital accumulates, and search for investment markets. Low rate percentage follows a crisis and keeps for several years. It testifies to the extreme plenty of free funds...a prosperity period is characterized by considerable investments. Free capital turns into basic capital. A depression period is characterized by accumulation of loan, free, and active capital.

Loan capital accumulates in every cycle period. But turning of this unbound capital into production capital meets obstacles as well as passing loan capital into production. Nobody doubts these obstacles, as the market is flooded with capital at depression periods.

So free capital continuously accumulates. It searches for investment areas, but cannot find them. Non-invested capital does not bring profit. The bigger the sum, the stronger is its tendency for investment. On one hand, there is production, flooded with capital. On another hand there is new and unbound capital, which accumulates daily and tends to penetrate into production sphere.

Finally, there comes a moment when production resistance is over. Loan capital turns into production capital. So a new prosperity period starts.

New production capital sets up. It increases demand both for production devices and for products. Production finds a new market, which has been created by the very extension of production. The production is the result of large capital, kept at the banks before. The source of the enlarged demand makes no difference for production. It cares that demand increases, and absorbs all accumulated loan capitals. Prices rise, and production at every sphere extends. The rising period holds out because of continuous setting up of production funds.

According to Tugan-Baranovsky logics, decreasing of percentage rates signals excess in the world of free capital. It also means insufficient number of projects, which may absorb the capital. If the assumption is true, when industry filled with traditional capital, FRS in the USA made their best to improve the situation by decreasing rates. Decreasing of dollar rate followed it and it "pushed off" products excess (which also became traditional) abroad.

In this case, the US government or the US business should have had a prepared strategy, directed to create an innovational project of the world importance. It should have also been able to absorb the excess of free and unbound capital. It could work for FRS and join in the initiative to liven up the current state of affairs it has started. As long as it did not happen, the current account deficit was compensated by active capital account, a traditional capital that comes into the USA from abroad. As the result, the US economics was flooded and satiated with traditional capital. It became the reason for unstable share market and simultaneously, yields decrease for long-term treasury liabilities.

FRS credit and currency policy is important for short-term loans because of its influence at the inflationary level. But now the most important force at the market of long-term loans is not the US balance, but the world balance of savings and investments. If our assumption is true, we come to the simple conclusion, that the real percentage rates decrease reflects the grooving lack for innovational projects. It explains the decreasing of long-term yield not only in the USA, but also in the whole world. Here we mean lack of innovations not in the developing countries, but in the world.

The world accumulations continue to flow into the US economics even now.  There are no alike regions for investments in the world. Besides, the US current affairs are instable, and the investments make a meeting flow to the current operations. Its large deficit troubles G-7.

The Conclusion

1. The world economics becomes unified. It means that soon it will call for sovereign regulation.

2. The growing world consuming could compensate the decrease of long-term yield. It would look attractive to decrease the world unequal income. But simple sharing (which was proposed at one official G-7 meeting) would bring up lazy bones and unfair policies. To encourage scientific researches and to create innovational projects at economical fields looks more attractive. Besides, it can provide new institutional conditions.

3. The world economics differs from national. It is a close system, which is why balances and proportions are more important for it than for any national economics.  Only innovation as a system process makes new areas and new markets. That is why the problems, rose by Medows and Forrester at their report to the Roman Club become more and more obvious.

4. The world economics will run a fever for some period (5-10 years). It will suffer decreased production effectiveness, raised consumption of oil in China, price fluctuations for fuel. After that, we will experience an unprecedented and grand innovational project. The project will change the quality of all the world economics, absorb all the free capital, and increase long-term yield.

We would like to turn attention of the world depositors to Ukraine, as to a promising and forward-looking area for innovational projects.


I. Makarenko


Posted on the website: 2005-02-23

Comments on this article:

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IEE Forecast. The World Economics Will Run a Fever For Some More Time
According to leading economist's opinion, continuous decrease of long-term rates in the world's most developed countries is one of the greatest puzzles in the financial world today. The problem is important for the USA, and other national economics
IEE Forecast. The World Economics Will Run a Fever For Some More Time
The world economics will run a fever for some period (5-10 years). It will suffer decreased production effectiveness, raised consumption of oil in China, price fluctuations for fuel. After that, we will experience an unprecedented and grand innovational project. The project will change the quality of all the world economics, absorb all the free capital, and increase long-term yield.
IEE Forecast: Growth of a dollar exchange rate can cause growth of the external economic risks for Ukraine
As to the internal factors, which compensate specified risks, it is necessary to carry significant potential of economic growth to them due to activization of internal consumption. It is a question of activization of the factors removing restrictions on ways of incomes growth of people, of fine and average business.
IEE Forecast. In economic there can be a slow economic growth with the crisis periods
The deficiency growth of the account of current operations in the USA is connected first of all with smooth and deep downturn of a discount rate.
IEE Forecast: on a dollar exchange rate, OPEC conference, and session of FRS board, Bush's speech and meeting of G7.
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IEE Forecast
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