James Grant: Rates Are Going Much Higher. Is He Right?
James Grant, the revered editor of the Interest Rate Observer, recently proposed a thought-provoking perspective on interest rates, forecasting their rise in a cyclical pattern that could span multiple decades. Drawing from historical trends rather than abstract theories, Grant suggests that factors such as persistent inflation, increased military spending, and significant fiscal deficits are potent forces that could push rates higher. Additionally, the Federal Reserve’s 2% inflation target and popular policies favoring inflation further bolster his argument.
While I hold James Grant and his insights in high esteem, I find myself diverging from his viewpoint on the future trajectory of interest rates. Today, I’ll delve into why I believe the reality may unfold differently from Grant’s prediction, particularly focusing on his stance regarding the cyclical nature of interest rates and their relationship with debt levels and fiscal deficits.
Looking back at history, we can indeed observe a cyclical behavior in interest rates, with periods of rise and fall aligning with various economic phases. For instance, despite the economic downturn during the Depression, interest rates experienced a decline amidst robust economic growth and inflationary pressures, largely due to the era’s unique economic dynamics. This period saw a divergence in the fortunes of the wealthy and the middle class, which in turn affected the flow of money through the economy and monetary velocity.
The post-World War II era, particularly the 1950s and ’60s, is crucial in understanding the forces behind interest rate fluctuations. The United States emerged as a dominant economic power, leading to significant growth through industrialization, innovation, and technological advances spurred by the space race. These developments, coupled with a strong manufacturing sector, high levels of economic growth, increased savings rates, and capital investment, supported the rise in interest rates during this time.
However, the landscape of economic growth, inflation, and consequently, interest rates has significantly transformed since those years. The argument that interest rates will rise merely because they have been low for an extended period overlooks the complex interplay of economic growth, inflation, and debt dynamics that fundamentally influence interest rates. Contrary to the assertion that higher debt levels and deficits will lead to higher rates, evidence suggests otherwise.
The correlation between economic growth, inflation, and interest rates is undeniable. Historical data demonstrates that interest rates tend to increase in tandem with economic growth and inflation, as these factors create greater demand for credit and prompt lenders to charge higher borrowing costs. However, the structural shifts in the economy, mounting national debt, and changing demographics present a vastly different scenario today compared to the growth-driven periods of the past.
Increased national debt and deficits, largely attributed to non-productive investments, exert a depletive effect on the economy by diverting funds from productive assets towards servicing debts. This trend has led to a noticeable decline in economic growth since the 1980s. With debt levels now consuming virtually all economic growth, the suggestion that increasing debt and deficits would result in higher interest rates appears counterintuitive.
Moreover, shifts in employment structures, demographic trends, and the transition to a service-oriented economy have introduced deflationary pressures that dampen economic growth and wage growth. These factors, along with the advance of productivity-enhancing technologies and globalization, present significant challenges to the hypothesis that interest rates are poised for a sustained increase.
Despite James Grant’s compelling case for rising interest rates, the underlying economic conditions suggest a different outcome. Central Banks, facing increased debt and deficits, are likely to continue adopting measures to artificially suppress interest rates to maintain manageable borrowing costs and support the economy.
In conclusion, the notion that higher rates are an inevitability fails to account for the myriad of economic variables that influence interest rates. Unless there’s a major shift in government policy towards massive infrastructure development or a radical change in economic management, the trajectory of interest rates seems more likely to remain on a downward path. The current economic landscape, characterized by high leverage, suppressed wages, and structural shifts, suggests that lower, not higher, interest rates are on the horizon, mirroring the experience of economies like Japan.
Understanding the intricate dynamics that drive interest rates requires a nuanced analysis of economic growth, inflation, debt, and other macroeconomic factors. While predictions are valuable for sparking debate and analysis, they must be grounded in the realities of today’s economy.
