Low Rates: Dead or Alive?

It's the duel of the newsweekly pundits! Is God dead, or is God alive? (And by God, of course, I mean the era of low interest rates.) Put Justin Fox clearly in the atheist camp:

Something with far more impact on most Americans' lives than a stock-market correction has already happened.
That something is the close of a remarkable era of easy money. Cheap credit helped fuel the stock bubble at the end of the past millennium and almost entirely fueled the real estate boom of the first years of this millennium. It kept us spending through the tough years that followed the stock market's collapse, and it allowed the Bush Administration to finance big budget deficits without strain. Easy money also helped enable the rise of private equity as a major economic force.
Now, though, it's history.

Meanwhile, BusinessWeek's Michael Mandel is still preaching the gospel, armed with the power of the Market Bunny of Doom. (You're just going to have to click through to understand what I'm talking about there.) "It's still a low-rate world," says Mandel, with the 10-year Treasury at 5.02%, just 29 basis points above its level when he wrote a cover story headlined "It's a Low, Low, Low-Rate World: Why money may stay cheap longer than you think".

Can it be that both esteemed columnists are right? That God, a bit like Schrödinger's cat, can be both alive and dead at the same time? I think so.

The thing to realize is that even though rates are low, credit is getting tighter. It's a replay, in much milder form, of the flight to quality we saw in 1998. Private equity shops are finding it harder to raise cheap debt, because that debt was not priced in accordance with its underlying credit risk for the past couple of years. But if you look at risk-free interest rates, they show no signs of going up very much. In fact, they might even go down if risk-averse investors start rotating out of structured credit and into more traditional safe havens. Asset-backed triple-As might not be junk, as Floyd Norris's headline today would have you believe, but they're certainly not as safe as Treasuries.