Banker's Spread (2)

Note: This is the second attempt to publish this blog (something happened to the first published version).

Real GDP Per Capita is the per-person average value of all goods and services produced. It tells you how "rich" you are (how much, in goods and services, you can consume).

The "Bankers' Spread" is a new concept related to the guaranteed spread that banks acquire when subtracting the interest rate on loans they get from other banks--called the "federal funds rate" [1]--from the interest rate (or yield) on a 10-year Treasury Bond [2].

A Treasury Bond is something thought to be a "guaranteed investment" because the government has a mandate to pay off such debts. The Bankers' Spread is the rate of the bond, minus the federal funds rate--and it is essentially a "no-risk" (or "guaranteed") profit for banks.

Inflation doesn't matter here, because whatever inflation we have, it affects both the yield that banks get from the bonds AND it simultaneously affects the debt obligation they took on from the loan.

When inflation gets applied to both, any decrease in the value of the bond is offset by a decrease in the debt obligation. The spread is a true spread, a true gain in value (under all levels of inflation).

Historical rates and outcomes

When the US had more economic freedom, the Real GDP Per Capita used to grow at about 4% a year. But, because of lost economic freedom, it has not grown by even 3% a year since 1999 [3].

In contrast to the past when we were more free, the people of today (on average) cannot expect to be even 3% richer each year--because, with less freedom, the entire economy does not support that much growth or wealth creation.

The Bankers' Spread is important because when it gets too high, banks will be "guaranteed" too much income--so much income that it is well above the growth in Real GDP Per Capita (well above the growth in national wealth creation).

It's fine for banks to make a lot of money, profit is very important for economic health. But it is not "fine" for them to make so much money that the entire economy cannot keep up. If they are guaranteed income much higher than overall economic growth, it misallocates the resources of society.

What's "too high" for the Banker's Spread?

From 1954 to 1974--when Real GDP Per Capita grew by an annual average of around 4% per year--the Banker's Spread never even reached as high as 3%. There was always enough extra money being made in the economy at large for them to be able to have that level of "guaranteed" income.

Three spikes are notable in the Bankers' Spread, all occurring when Real GDP Per Capita was growing by less than 3% a year. One time was in 1992 (3.78%), one was in 2004 (3.72%), and one was in 2010 (3.65%).

In all 3 cases, the growth in Real GDP Per Capita was not high enough to support that much "guaranteed" income to the banks--and we ended up with economic recession following an ulimately-inverted yield curve.

Using the 2010 rates for growth and spread, the "guaranteed income" (Bankers' Spread) for banks was almost 2 full percentage points higher (1.93%) than the growth in Real GDP Per Capita--representing an enormous redistribution of produced wealth toward the banks!

Early Indicator of Inverted Yield Curve

When the peaks of Banker's Spread in 1992, 2004, and 2010 are kept in mind as you look at the yield spread between 10-year and 2-year US Bond yields [4], it appears they initiate the yield inversion process which culminates in our recessions:

When the Federal Reserve sets targets for the Federal Funds Rate, they should be held to account any time they set it so low that it results in a Banker's Spread that approaches 2 full percentage points higher than expected growth in Real GDP Per Capita.

If they are not held to account, they may set it very low and then the banks would be guaranteed an income that is 'percentage points' higher than the total level of wealth creation--which then (eventually) causes economic recessions for the rest of us, because it misallocates the resources of society.

Reference

[1] Board of Governors of the Federal Reserve System (US), Effective Federal Funds Rate [FEDFUNDS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/FEDFUNDS, [original retrieval: April 15, 2019].

[2] Board of Governors of the Federal Reserve System (US), 10-Year Treasury Constant Maturity Rate [GS10], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GS10, [original retrieval: April 15, 2019].

[3] U.S. Bureau of Economic Analysis, Real gross domestic product per capita [A939RX0Q048SBEA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/A939RX0Q048SBEA, [original retrieval: April 15, 2019].

[4] Federal Reserve Bank of St. Louis, 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity [T10Y2Y], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/T10Y2Y, November 17, 2019.

Image Attribution

Page URL: https://commons.wikimedia.org/wiki/File:Gold_bullion_1.jpg

Attribution: Szaaman [Public domain]