Countless financial fortune tellers and Wall Street wizards were once members of strange cults. What is their doctrine? The unwavering belief that interest rates had found something akin to the fabled “fountain of youth” and that the number would remain forever low, never rising. The “forever low” brigade scoffed at those of us who argued that high levels of government debt are unsustainable, that low repayment rates cannot last forever, and that we should rein in spending.
Now, let’s be clear. Predicting the future of the economy is not like reading the weather forecast in the morning. Nevertheless, the Forever Law Cult’s conviction felt like a confident assertion that winter would never come to Alaska, as June was particularly warm. Interest rates have historically fluctuated due to various economic factors. For some reason, many believed that the era of unprecedented interest rate declines and low interest rates of the past few decades had become the new normal and that nothing much would change.
Every time someone suggests that interest rates could rise in the future, and therefore recommends a shift toward greater fiscal discipline today, the Forever Law Club frowns, grins, and denies such heresy. be rejected immediately. “That’s weird,” they might say, hinting, before going on to tell you how wrong they were in predicting inflation and rising interest rates after the 2008 financial crisis.
Admittedly, I was one of those who didn’t understand that the Federal Reserve’s new policies at the time actually meant that there would be no inflation. Nor did they believe that ultra-low interest rates, coupled with rising government debt and a steady expansion of the money supply that looks like permanent quantitative easing, would continue for the next 15 years.
But I never thought it was wise to bet on interest rates remaining low to justify further debt. After all, even low interest rates on growing debt mean interest payments are going to get bigger and bigger. That would mean more of their income would have to be spent on interest, rather than spending on government programs that people value.
In some ways, the certainty of this curious cult was impressive. It’s not every day you see such unwavering confidence in the face of rising deficits. It was even more surprising when, during the pandemic, he saw the national debt increase by just $5 trillion in two years. This includes $2 trillion in March 2021, when no future austerity was called for, at a time when the economy was already recovering and inflation was high.
When the inflation warnings became impossible to ignore, the Forever Law gang countered that it was foolish to worry because, in the worst-case scenario, “the Fed has the means to lower inflation.” That measure amounts to raising interest rates to slow down the economy. This seems to directly contradict the idea that accumulating debt is okay because interest rates will remain forever low.
But then, as fate (and economics) arranged things, the winds changed. Whispers began to spread about concrete changes on the horizon. The first signs were subtle, but the buzz soon grew louder. The possibility of interest rate increases, once denied, is now a reality. With the yield on the 10-year U.S. Treasury above 4.5%, there is a renewed belief that while deficits could be ignored in the past, they can no longer do so.
Of course, this is also wrong. We should never have ignored the budget deficit. The budget deficit, along with spending and debt projections, is on an uphill trajectory, making it vulnerable to a crisis if interest rates suddenly rise, especially since half of the debt has three years or less to mature.
In the face of rising interest rates, the eternally low caucus has weakened. However, it appears that these high interest rates are being replaced by a sense that they are temporary and will inevitably fall again. I predict that inflation will be as temporary as it was supposed to be, meaning it will last longer than people think.
Inflation is a persistent problem, and paying for rising interest payments through more borrowing rather than fiscal restraint will make inflation even worse, leading to further rate hikes and higher interest payments. This is a vicious cycle that, barring the miracle of economic growth through great innovation, can only be stopped by fiscal contraction.
As it turns out, the Forever Law believers were right in a temporary way. After all, interest rates have remained low for a long time, surprising many. However, their main mistake was tragic. They have concluded that trillions of dollars in additional debt is not worth the cost.
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