“There are more things in heaven and Earth, Horatio, than are dreamt of in your philosophy.” – William Shakespeare, Hamlet
Ticking Time Bomb
The American public is eagerly anticipating Election Day. Will their preferred candidate take residence in the White House come January 21, 2017? Or might we see a party member facing legal consequences instead?
These questions linger, but only time can provide answers. Here at the Economic Prism, we observe the situation with detachment. We question the merit of either candidate for high office, yet our curiosity about the election outcome remains heightened.
However, the critical issue at hand is not the identity of the next President. That’s merely a distraction. The real concern lies within the looming financial crisis beneath both the U.S. and global economies.
In particular, we should be paying close attention to interest rates. Recent trends show them rising significantly. Have you noticed?
Just this past Tuesday, the yield on the 10-Year Treasury note reached 1.88 percent. While this figure may seem extraordinarily low from a historical viewpoint, it’s worth noting that back in early July, it dipped as low as 1.34 percent. This represents a staggering 40 percent increase in just four months. What does this mean?
The End of the Great Treasury Bond Bubble?
The last time interest rates hit rock bottom was in the early 1940s, when the 10-Year Treasury note yield hovered around 2 percent. Following that, interest rates generally trended upward for the next four decades.
The peak of this rising cycle occurred in 1981, when yields exceeded 15 percent. During that time, bond prices, which decline as yields rise, fell so consistently that Dr. Franz Pick referred to them as “guaranteed certificates of confiscation.”
Looking back, Pick may have been shortsighted. Had he projected forward, he might have anticipated a 35-year period marked by gradually declining interest rates. Unfortunately, such trend reversals are typically only recognizable in hindsight.
What about the present climate? Is it possible we are now witnessing a reconsideration in the credit markets, transitioning back to a long-term upward trend in interest rates?
The truth is, we’re uncertain. We’ve been predicting the end of the Treasury bond bubble for roughly eight years. Yet, during this period, we’ve been led astray by various false signals. Instead of the anticipated rise in yields, they have continued to decline.
The most plausible explanation is that the fiat currency system, along with extensive central bank interventions, has forced rates down to levels that defy rational expectations. Nonetheless, we remain confident that market forces will eventually push beyond the constraints of monetary policy.
The One Thing that Will Change Everything
It appears that the long-term trend in the credit market, which has been in place for over 35 years, may indeed be reversing. If this is not just another false signal, it could imply that the cost of credit will escalate significantly over the coming decades. Specifically, we may see rising interest rates for a generation and beyond. This shift will have profound implications.
One obvious result could be a decline in the affordability of items typically purchased on credit, such as houses and vehicles, as people adjust to higher interest rates. We could also see stock prices drop as corporate earnings and, subsequently, share prices are impacted by tightening monetary conditions.
While these scenarios may seem straightforward, the specifics are far from certain. It’s likely we’ll encounter unexpected developments as we navigate this transition.
Less visible consequences will relate to the necessary adjustments in an economy that has depended on increasingly cheaper credit to remain stable. The ability to refinance costly assets at continuously lower rates will diminish, leading to heavier debt burdens that won’t ease over time.
Consider businesses that operate on tight margins with high sales volume, such as those producing inexpensive consumer goods. How will their profitability be affected when borrowing costs rise? Will these changes lead to consumer price inflation?
And then there’s the staggering $19.8 trillion national debt. What happens if the tax revenues required to service this debt double and then double again? Such a scenario is likely to provoke significant public outrage.
The crux of the matter is that every dynamic in the economy is interconnected, creating a balance that prevents chaos. Just as every village has its share of challenges, we, too, must confront the realities of a shifting economic landscape.
As interest rates ascend, we can expect a general reversal of the trends that have characterized our declining rate environment. Things will rapidly change, reshaping our world and the fundamental principles of financial stability that we’ve relied on for the last 35 years.
Now is the time to recalibrate our understanding and expectations.
Sincerely,
MN Gordon
for Economic Prism
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