Our Financial Future

Interest rates should be the rental cost of money. The greater the opportunities to make profits, the more people will be willing to pay for the available money to invest in further profitable ventures and the interest rates go up. That is reinforced in that if more people are trying to borrow the same limited supply of money the rental price of it must increase, to shake out the less determined borrowers. However, it does not quite work like that. If an economic boom comes along, who wants to kill good times when you can print more money? However, eventually interest rates begin to rise, and then spike to restrict credit and suppress speculation. Recessions tend to follow this spike, and interest rates fall. Ideally, the interest rate reflects what the investor expects future value to be relative to present value. All of this assumes no external economic forces.

An obvious current problem is that we have too many objectives as central banks start to enter the domain of policy. Quantitative easing involved greatly increasing the supply of money so that there was plenty for profitable investment. Unfortunately, what has mainly happened, at least where I live, is that most of it has gone into pre-existing assets, especially housing. Had it gone into building new ones, that would be fine, but it hasn’t; it has simply led to an exasperating increase in prices.

In the last half of the twentieth century, interest rates positively correlated strongly with inflation. Investors add in their expectation of inflation into their demand for bonds, for example. Interest rates and equity values tend to increase during a boom and fall during a recession. Now we find the value of equities and the interest rates on US Treasuries are both increasing, but arguably there is no boom going on. One explanation is that inflation is increasing. However, the Head of the US Federal Reserve has apparently stated that the US economy is a long way from employment and inflation goals, and there will be no increase in interest rates in the immediate future. Perhaps this assumes inflation will not take off until unemployment falls, but the evidence of stagflation, particularly in Japan, says you can have bad unemployment and high inflation, and consequently a poorly performing economy. One of the problems with inflation is that expectations of it tend to be self-fulfilling. 

As a consequence of low inflation, and of central banks printing money, governments tend to be spending vigorously. They could invest in new technology or infrastructure to stimulate the economy, and well-chosen investment will generate a lot of employment, with the consequent benefits in economic growth and that growth and profitability will eventually pay for the cost of the money. However, that does not seem to be happening. There are two other destinations: banks, which lend at low interest, and “helicopter money” to relieve those under strain because of the virus. The former, here at least, has ended up mainly in fixed and existing assets, which inflates their price. The latter has saved many small companies, at least for a while, but there is a price.

The US has spent $5.3 trillion dollars. The National Review looked at what would be needed to pay this back. If you assume the current pattern of taxation depending on income holds, Americans with incomes (in thousand dollars) between $30 – 40 k would pay ~$5,000; between $40 – 50 k would pay ~$9,000; between $50 – 75 k would pay ~$16,000; between $75 – 100 k would pay ~$27,000; between $100 – 200 k would pay ~$51,000. For those on higher incomes the numbers get out of hand. If you roll it over and pay interest, the average American family will get $350 less in government services, which is multiplied by however much interest rates rise. If we assume that the cost of a dollar raised in tax is $1.50 to allow for the depressed effects on the economy, the average American owes $40,000 thanks to the stimulus. Other countries will have their own numbers.I know I seem to be on this issue perhaps too frequently, but those numbers scare me. The question I ask is, do those responsible for printing all this money have any idea what the downstream consequences will be? If they do, they seem to be very reluctant to tell us.