[OPE-L] profits

From: Rakesh Bhandari (bhandari@BERKELEY.EDU)
Date: Fri Feb 04 2005 - 18:12:46 EST

some discussion of profits

re: Schumpeter, profit rate



And this:

Financial Times - February 3, 2005

Why long-term bond yields are low
By Samuel Brittan

The behaviour of bond prices is puzzling the financial markets. The
US Federal Reserve has for some time been gradually raising the
Federal Funds rate from the 1 per cent of a year ago towards what it
regards as a more normal level, reaching 2.5 per cent this week. Yet,
paradoxically, long term bond yields have continued to fall. In the
US, they reached a high of 4.7 per cent last summer and have since
dropped by about half a percentage point. There is little doubt that
interest rates - international as well as US ones - are low for what
is regarded as a recovery phase of the business cycle. Having at last
abandoned their more unrealistic expectations about equities, some
investors are unhappy that bonds do not offer a promising alternative.

Part of this grumbling merely reflects "money illusion" - the failure
to take inflation into account. The high returns previously
experienced in nominal terms from holding bonds were partly
compensation for the fear that dollars and pounds would shrink in
real value. But OECD real interest rates, obtained by subtracting an
inflation index from the nominal yield, also show a pronounced long
term downward trend - from about 6 per cent in the mid-1980s to 2 per
cent recently. The message is confirmed by the yield on UK
index-linked gilt-edged, which is now in the 1?-2 per cent range. The
yield on the more recently introduced US TIPs (Treasury
inflation-protected securities) is now also down t owards the 1? per
cent level. These low returns are all the more impressive in the
light of the common belief that the dollar and sterling are both
overvalued and that bond yields must contain a risk premium to allow
for this.

One can try to explain what has happened in terms of financial
markets technicalities or the vagaries of monetary policy. For,
despite recent central bank tightening, short-term as well as
long-term real interest rates are still historically very low. On a
Goldman Sachs computation they are well over one standard deviation
below average. This gives an incentive to the "carry trade" in which
participants borrow short to invest in bonds.

Yet there may be a more elementary explanation for low long-term real
interest rates. Just as the price of bananas balances the supply and
demand for this fruit, so the rate of interest balances the supply of
savings against the demand for funds to invest. Monetary policy is
important mainly at the short end and for its effect on inflation.
But the important influence at the longer end is the balance of world
savings and investment.

Thus, I come to the simple hypothesis that falling real interest
rates reflect a growing shortage of attractive investment projects to
absorb savings. The world is indeed supposed to be short of capital
and we are told that we do not save enough. But what matters in this
context is not the developing world projects that might be desirable
but the number of projects world-wide that promise a commercial
risk-adjusted return.

The reason why so much of the world's savings has gone to the US is
surely just because of the dearth of such investment outlets
elsewhere. In the 1930s, Lord Keynes feared that the rate of interest
could not fall low enough to balance savings and investment at a
reasonable level of employment. But up to now, world capital markets
have worked well and interest rates have fallen enough to balance
savings and investment without generating a depression.

We should, however, be grateful that governments and citizens are
going slow on the exhortations of the great and the good to save
more. If they did, the strain on financial markets might be too great
and we really could have the much-feared Keynesian slump.

The authors of global co-ordination plans would like to avert this
threat by balancing an increase in savings in the Anglo-Saxon world
by a reduction in saving in east Asia and possibly the eurozone -
although, of course, they do not put it in this way but talk instead
of Asian currency appreciation and European economic stimulus. I
noted in a previous column the lack of both knowledge and the
authority to carry out this balancing act.

There may still be a problem. An article in the current NIESR Review
argues that the UK savings rate is too low to fulfil the needs of
British citizens. Tim Congdon puts forward a dissident view in the
current Lombard St Review that if total savings - and not just the
household variety - are taken into account, the savings rate has been
quite adequate. In any case, there is no God-given rule that money
invested in secure fixed interest securities should bring any
particular rate of return. Keynes's "euthanasia of the rentier" could
yet happen. Meanwhile, the obstinate resistance to the exhortation to
save more is putting off the problem that the zero floor for interest
rates might pose for monetary policy, and for which the Fed has
wisely made contingency plans.

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