(As an aside, in my last message I said I would talk about how the new Presidential administration plans to spend your tax dollars. I still intend to address that in the coming weeks.)
If we go back to a year ago, the Fed’s stated intentions were to regularly increase interest rates until they reach a “normal” level. Specifically, they said they intended to increase interest rates by about 1% per year (assumed to be generally ¼% per calendar quarter) until interest rates were “normalized”. As we can see from the graph above, until the turn of this century and the era of below-market interest rates began, “normal” interest rates generally averaged at least 5%.
A year ago I expressed my doubts about whether the Federal Reserve would carry through on its stated goals. (If you feel so inclined, you might want to go back and read that article I wrote a year ago. Since there has been almost no change in Fed actions, the words I wrote then seem as appropriate today.)
I wrote this in that message the last week of 2015,”The recent increase in the Fed Funds Rate changes almost nothing. It’s too little and too late. In fact, it guarantees more of the same. The Federal Reserve will never raise interest rates to a normalized level again. It can’t. There’s too much debt, too much of the economy and financial assets leveraged to a world of ultra-low interest rates, too little in the way of economic fundamentals and too many individuals, businesses and governments addicted to and dependent upon cheap money.”
I then compared the path that the U.S. was taking with Japan, who has a longer history of negligible and negative interest rates and the many “benefits” resulting from them. Like Japan, the U.S. is now trapped in a world of low interest rates. If we again look at the graph above we notice that in nearly every economic expansion over the last 60 years, the Fed’s interest rate (and by extension most others), was allowed to increase. In nearly all of that U.S. history, interest rates generally fell during recessionary periods (white horizontal shaded areas), as would generally be expect by market forces, and resumed their upward climb in the years in the years of economic expansion, which would also be expected with market interest rates, when they are not distorted. (The only exception before the year 2000 was during the latter period of the 1980s, simply because interest rates had been driven to extraordinarily high levels in the late 1970s to break the back of inflation. Even so, interest rates were still higher by the end of the 1980s than in the mid-1970s.)
But notice how the interest rate increases since this last recession has been different. In every other post-recessionary period, the Fed Funds rate was again increasing within three years after the end of each recession. This time however, it would be more than seven years before the Fed Funds rate was increased. And that increase was trivial at best, just 0.25% increase, followed by an equally small increase a full year later. (There have been at least ten times in modern history when the Fed has increased rates by more than 3.0% within a year, dozens of examples of 1.0% or more.) At today’s sluggish rate of rate increases it will be more than a decade before rates are approaching normal levels. But as I pointed out a year ago here and other times, interest rates will never reach normal levels. They simply can’t be allowed to do so.
Outsized debt plus normal interest rates equals a broken budget
The difference between earlier economic periods and today is the level of outstanding debt in the U.S. It is immense at every level, but if we just look at Federal debt, we see the eight-fold increase from about $2.5 trillion in 1988 to about $20 trillion today. (Outstanding federal debt includes both “publicly” held debt – T-bills, Treasury Bonds, etc. – and “intragovernmental” holdings – mostly past Social Security that have been borrowed – and spent – by the federal government. Technically, the government pays interest on that intragovernmental debt, but that is essentially paying interest to itself.)
This graph also shows interest costs on federal debt (including that on “intragovernmental” debt). We see that while debt levels have increased about eight times in less than 30 years, the increase in yearly interest due on that debt has been much less, roughly doubling over the same period. This is solely a function of decreasing interest rates over that same period. Looking back to that earlier graph, in 1988, the government was paying nearly 10% a year on its debt; today it’s an average of about 2%. Without that steady decline in interest rates, the government’s interest costs would be astronomical today. These declining interest rates may be the primary reason the government has been allowed to accumulate such ridiculous levels of debt. In 1988 the government paid about $220 billion in interest costs on about $2.5 trillion of debt. Paying the same interest rate today, would amount to nearly $2.0 trillion in yearly interest costs on its massive debt. Instead, with its artificially lowered interest rates, interest costs on debt are barely one-fifth that level. Although there are other reasons, this is a primary reason the Federal will never normalize interest rates.
And the Fed will continually cite other excuses, as it has now done for years, as to why it cannot raise rates more rapidly. A year ago I wrote this, “Even though the last recession was said to have ended in 2009, over the last six years, the Federal Reserve has repeatedly come up with excuses as to why they cannot raise interest rates, even from extremely low levels.“ That was indeed the case this past year as well, as even a rising stock market, reported strong and steady economic growth, including the lowest unemployment rate in nearly a decade, was met with excuses for not raising rates as it said it would have. What will not be discussed when it comes to the reasons why interest rates will not be increased to normal levels are the costs of the government to finance its massive debt load (It will also not discuss its need for bankers, hedge funds, and speculators to have access to nearly free money to maintain high levels of speculation, and profits for the financial industry, but that it a matter for another time.)
What happened to our Congressional watchdogs?
In 2011, the U.S. Congress and President had an impasse over raising the Federal Debt Ceiling. At the time that debt ceiling was $14.3 trillion and the consequences to increasing debt levels further were well understand by a least a substantial part of those elected to protect the interests of Americans. Many in Congress, as well as the President, wanted a balanced budget provision, and a part of the compromise was that a Congressional vote was mandated to vote on such a bill. In fact, achieving a federal balanced budget, and stabilizing federal debt, was considered so crucial that to many, an overriding goal to avoid political and financial destruction was for an amendment to the constitution to mandate that the federal government balance its budget. That law was not passed, but another law passed that would mandate budget cuts of $1.2 trillion over ten years or face sequestration cuts in 2013. This was indeed the case as debts continued their upward climb. In early 2013, government had already reached the level of the debt ceiling increase from just 18 months earlier.
There are a couple things to learn from this. One is the enormous effort that went into (unsuccessfully) finding a trillion dollars in spending cuts over ten years. That was only $100 billion a year in limits to spending and debt accumulation. What would happen if and when the government is spending $1 trillion more each year than what is already being spent? If the average interest rates the government pays on its debt increases 5%, then that will be the result. Five percent on $20 trillion of debt is $1 trillion in additional yearly interest costs. Each year, the ballooning debt would result in ever-increasing interest costs. Obviously, the consequences to such deficits would be devastating. In a recent article I looked at how higher, normalized interest rates could quickly set the debt on an upwardly increasing course where outstanding federal debt reaches $100 trillion in 20 years. The simple arithmetic of interest payments and debt increases on even moderate interest rates is why the Fed will never allow normal interest rates and normal interest rate increases.
Another lesson of those past Congressional battles is that at least five years ago there was still some governmental concern about spending, deficits and debts. In 2011 and 2013, the financial collapse of 2008 was still fresh in the minds of government and the population. We heard over and over again during the crisis how it was in large part a consequence of the excessive levels of debt, at every level - corporate, financial and governmental. When the federal debt was $14 trillion just five years ago and $16 trillion two years later, there was a substantial part of the government and the population who wanted to ensure that U.S. government debt would not be part of the problem for the next financial crisis down the road, as well as one that reneged on its many promised benefits for its population. Ironically, while one might think that with several trillion dollars in additional debt over the last five years (and trillions more in other government’s debt over the same period), the concerns about debt would be higher, not forgotten and ignored. For decades now the U.S. Congress and President(s) have been unable to halt the runaway train of debt accumulation. It appears that as its debt crosses the $20 trillion mark, it is not a concern anymore.
Ironically too, people who talked about the increasing debt levels during the 2000s were also generally ignored until the world learned the lesson they were trying to teach. I have heard that there are two ways to learn. One is through analysis, logic and evidence. The other is through experience. It seems that the majority of the population, and certainly the government, do not want to learn from evidence and logic, but need the hard hand of experience to learn the lesson. That was the case in 2008 where experience had to teach most the lesson. Unfortunately, and amazingly, that experience, and its lesson, has now been forgotten or ignored by most. When logic has been abandoned and history forgotten, history will repeat itself until people can no longer ignore the lesson.