Are Interest Rates Dangerously Low?

Popular Economics Weekly

Graph: FRED

Why should historically low interest rates be a problem, you say?  Doesn’t that help consumer demand by enabling consumers to buy more by borrowing more cheaply, and economic growth by encouraging companies to create more jobs?  Not when rates have remained low for such an extended period.

Interest rates are far too low this late in the recovery from the Great Recession. It isn’t only because the Treasury Yield Curve slope has been steadily declining since 2014 that measures the difference between the 10-year and 2-year Treasury bond yields, as we said last week.

The Benchmark 10-year Treasury yield itself hasn’t risen above 3 percent in at least one year. It was this low for sustained periods during the Great Recession, when it dipped below 2 percent. But it shouldn’t be as low today (2.85 percent at this writing). In fact, interest rates haven’t recovered from the Great Recession. It normally ranges from 4 to 5 percent during prosperous times when there is a greater demand for money—e.g., from 2000 to 2008—as the FRED graph shows.

It signals a significant weakness in aggregate demand for goods and services; which is the sum of demand by consumers, investors, government spending and net exports, (and somewhat mirrors the weak 2 percent GDP growth since then). This could means we are dangerously close to another recession, if economic shocks such as the Turkish Lira plunge, or a full-fledged trade war occurs.

Consumer spending is perking along above 3 percent only because of excessive borrowing due to the low interest rates, rather than rising incomes, so it won’t be sustainable. And capital spending is half of what it should be with the stimulus from the Republican tax cuts and $1.3 trillion in additional federal spending.

Exports—another component of aggregate demand—is momentarily rising, but it could be a one-time surge in orders to escape rising costs from the trade war. And there is always the threat of cuts to government entitlement programs like food stamps, Medicare and Medicaid, which increases costs of many low and middle-income consumers.

So we could be teetering on the edge of an economic slowdown, no matter what the pundits are saying about full employment and the latest 4.1 percent GDP 2^nd quarter growth, with excessive government and private debt providing little cushion for support should geopolitical and financial problems worsen.

However, there is a caveat to this dismal scenario. It may not be a recession for all Americans. Household debt — including mortgages, credit cards, auto loans, student loans and other credit — grew for the 16th consecutive quarter in the April-to-June period, rising by 0.6%, or $82 billion, to $13.29 trillion, the New York Fed reported Tuesday.

That’s because the recovery has really benefited just the top 10 percent income-earners, who have been able to pay down their debts. With personal disposable incomes at a $15.46 trillion annual rate in the quarter, the debt-to-income ratio dipped to 86 percent. That’s the lowest, by a tiny amount, since the fourth quarter of 2002. At the height of the credit bubble in 2008, debts topped at 116 percent of disposable income.

And we have government debt approaching 100 percent of GDP by 2020, according to the watchdog Congressional Budget Office. The sad denouement of this scenario could be that another downturn will hurt those most dependent on the federal government for protection, as has happened in the past.

Harlan Green © 2018

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