Interest is a core price in capitalism, transmitting resources across time rather than space and allowing entrepreneurs to transform resources into more productive forms that produce outputs of greater consumer value. Modern capitalism finally took off from the primitive market economy when markets developed with financier capitalists funding the capital goods necessary to increase labor productivity and wages and unleashing the Industrial Revolution.
If people increase savings, all else equal, the basic monetary interest rate is lower, the rates on all types of loans decrease, investment expands, wages increase, and everything in the economy seems to be easier, better, and optimism about the future grows. Likewise, if savings by individuals and businesses fall, interest rates increase and all future-oriented activities are just that more difficult.
Government inflation encourages consumption, discourages savings, and greatly hinders productive business investment. It also warps our minds to have high time preferences that reduce personal growth and increase individual debauchery.
With the Fed contemplating its next move on interest rates, I am seriously concerned about two aspects of the general situation with interest rates. The first is that interest rates have become a government-administered price, like the price of a postage stamp or the cell phone tax. Now the Fed is managing every aspect of the process concerning every last nook and cranny of rates, liquidity, reserves, repos, balance sheets, confidence, etc. When the Fed only intervened in short-term rates with the Federal Funds Rate, they could at least gauge the response by studying all the other aspects of banks, lending, reserves, finance, interest rates, etc. If a single entity is regulating every aspect of an industry, how much good feedback information are they receiving about the impact of their own actions?
The second aspect is that the long-term trend in rates appears to be changing. In the post-WWII era, the interest rate on long-term government bonds was low, the economy was growing fast, and we were indirectly tied to the monetary discipline of the old gold standard. With the onslaught of the Keynesian Revolution, fiscal and monetary expansion pushed rates up in the latter 1960s. Unleashed from gold in 1971, rates continued to trend upward until 1981 when they peaked above 15 percent. The dramatic rise in trend interest rates is well illustrated by the history of the interest rate on 10-year US government bonds.
The public outcry against government inflation, spending, and debt finally created a backlash. President Carter did the right thing, appointing Paul Volcker to chair the Fed and Carter rigorously deregulated a host of commanding height industries. Legislation was passed called the Monetary Decontrol Acts of the early 1980s.
Inflation was stopped by proverbially smashing the printing presses with ultra-high interest rates. Quickly, the economy expanded and productivity increased with deregulation. Prime Minister Margaret Thatcher made free market reforms in the UK and encouraged them throughout the English Commonwealth nations. Communist central planning failed in China and later in the Soviet Union and Eastern Bloc countries. In other words, with peace, freedom, and sounder money, the world experienced increasing standards of living and greatly reduced poverty.
Economic expansion meant that controlling CPI inflation was easier for central banks. It also meant that nominal rates on bonds would go lower and lower. Freedom and higher incomes around the world meant more savings to be invested in bonds. In a response to the public outcry against price inflation in New Zealand, central bankers promised to not allow consumer prices to rise above a certain pre-determined level; a promise that swept around the world’s central banks, including the Fed; a policy now known as “inflation targeting.”
There was also a considerable tailwind from the late baby boomers and early Gen-X generations entering the workforce and saving for the future. This was multiplied many times over by the recently freed peoples of Europe and Asia. The combination of post-gold standard anti-inflation ideology combined with a very large dose of a kind of global Protestant ethic saw cutbacks in money printing, increased savings, and a very long period of falling interest rates. Referring to the graph of 10-year US government bonds, there was a 40-year trend of lower interest from 1981, ending in 2021.
Predicting interest rates is highly problematic because they are determined by all global factors. A few years of higher rates do not make a long-run trend change. Nevertheless, the weaker ideological, more statist orientation of people, combined with already-bloated government budgets and dangerous levels of national debt, and strong underlying demographic erosions in the form of declining birthrates would suggest a shift in trends toward higher interest rates into the future.
Implications
Even if the change in the long-term trend comes to pass, it doesn’t mean 10-year government bonds will be over 10 percent in 2026 or even that bonds won’t move lower in January. It means that longer-term bonds will move higher over the longer term: longer, higher for longer.
With all those caveats, it does mean that if you got a 2 percent 30-year mortgage during the covid crisis, you should probably try to keep it, particularly if higher future rates include a large monetary devaluation factor.
My reading of expert opinion on this topic also suggests that long-term bonds will fare poorly and that the real return on stocks will be lower than it has been under declining rates.
My reading of the experts also suggests that commodities will perform relatively better than they have been and relatively better than stocks. My guess is that companies with large amounts of readily-accessible commodities—not needing large amounts of capital and other commodities (especially energy) to “exploit”—will have a comparative advantage.
I hadn’t thought of it this way before, but the big run up in price since 2020 in gold—the only true permanent commodity—would suggest that some market participants figured all this out before I did.
