Credit cycle: RIP

Not much action in the markets yesterday, so let us return to the economy.

That’s where the excitement is. According to leading economists – notably those paid by the US government to forecast the future – interest rates are going to stay low for a long time.

Perhaps we should pause here and say a little Ave Maria, or whatever you say when you put a market cycle into the grave.

Maybe we should proclaim a day of mourning. Or at least raise a glass or two. Yes, the feds have pronounced our old friend dead, dead, dead, stiff dead, cold dead. Immobile.

They denied responsibility for the death of the interest rate cycle, but admit that it was in their custody when it expired.

The credit cycle has been with us for a long time. Ever since there were markets there was credit too. And like all things available in a market, it was subject to rhythms – usually related to harvests – and its price varied according to the rules of supply and demand.

The credit cycle seemed permanent. But like so many things in this transitory life, now it has been taken from us by the feds’ central planners. Exeunt omnes. halleluiah!

Specifically, the Congressional Budget Office tells us that the feds’ interest rate expense for the next 25 years will bear a striking resemblance to the yields we have seen over the last few years.

That is, it projects a financing cost of 4.1% – very near the average of the last ten years, and substantially lower than the long term average of 6.59% since 1962.

The CBO’s estimate – if we believe it – tells us that interest rates are locked in a permanently low range, like the brain waves of a patient in coma.

Gone, they say, is the excitement of the 1960s and 70s upcycle, when rates on the feds’ ten-year bond went up to 15%.

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This is not an inconsequential outlook. If interest rates were to rise appreciably, the ‘borrow, borrow, borrow, spend, spend, spend’ economy would disappear.

No kidding. The post-70s world was enabled by several interlocking trends. But most important was the decline in interest rates, which allowed debt to expand in a remarkable way.

Total credit market debt went from 170% of GDP in the early 1980s to over 350% in 2007. In nominal terms, total debt went from about $5trn to over $50trn in 2007.

This had the following effects:

Borrowing masked the effects of a slowing real economy. Wages were mostly stagnant. But consumers still spent more money.

Spending in excess of real output shifted the economy from one focused on production to one focused on finance and consumption. The financial industry, in particular, saw soaring profits, and used its wealth to control government policy.

Governments, too, increased spending. Tax receipts grew along with debt-financed consumption and financial engineering. Tax receipts in 1990 were only about $1trn. Now, they are $2.5trn. In addition, governments took advantage of low interest rates to borrow more.

This tilted and distorted the economy even further; whether the funds come from borrowing or taxing, government transfers wealth from the productive parts of the economy to those that are unproductive or even anti-productive.

As time went by, it became more and more important to continue expanding debt. Consumers, business, and the government had come to depend on expanded credit just to stay in the same place.

Debt expansion became not only an indispensable component of the new economy; it also created its own political support. With so many people now relying on easy access to credit, including the government itself, neither the Fed nor Congress could refuse efforts to hold down interest rates.

So, Congress, the CBO, the Fed, Wall Street, millions of households and zombies everywhere all now agree that interest rates cannot be allowed to rise. They must be held down at all cost. And if the interest rate cycle is not dead yet; it should be.

Look at a chart of the fed funds rate. You will see, it looks like the EDG of a man who has been brain dead. Flat-lined for 69 months. And there they are, huddled around.

Economists. Policy-makers. Politicians. They are all watching it carefully. Checking its pulse. Listening to its breathing…

… and holding a plastic bag in their hands, just in case it tries to get up.

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